A range of outcomes has emerged worldwide regarding the requirements of SME financial reporting. Graham Holt discusses
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This article was first published in the April 2016 international edition of Accounting and Business magazine.
Financial reporting requirements for SMEs vary according to the jurisdiction. Sometimes they have to comply with the same requirements as other limited companies; on other occasions they are subject to very few requirements. The variety of approaches to SME financial reporting seems to reflect the wide variety of economic contexts in which they conduct business.
Within the SME category there are arbitrary distinctions. Currently in the European Union (EU), the distinguishing characteristics for SMEs and micro entities are based on turnover, gross assets and number of employees. There is an argument that the publication of SME financial reports is the price of limited liability but this is not universally accepted. In some countries, limited liability SMEs make minimal public accounting disclosures with no audit requirement. The protection of creditors is dependent on the owners of the business and therefore there is an argument that there should be disclosure by these entities irrespective of whether they have limited liability.
In some quarters, it is felt that there should be limited financial reporting requirements for SMEs because of their size and the costs of meeting regulation. Generally, SMEs are owner-managed with a narrow ownership interest, and their shares are not traded by the public. However, SMEs interact with many different parties, some of whom benefit from the disclosure of financial information. It is therefore not surprising that a range of outcomes has emerged worldwide as regards the requirements of SME financial reporting.
IFRS for SMEs, International Financial Reporting Standard for Small and Medium-Sized Entities, was issued by the International Accounting Standards Board (IASB) in 2009. The concepts and principles of IFRS for SMEs are based on the framework document and therefore are very similar to full IFRS.
The most significant difference in the presentation of financial statements for SMEs, as opposed to full IFRS, is that there are fewer disclosure requirements. There are also a number of differences in the accounting treatment of items in the statement of financial position. Some topics in full IFRS are omitted because they are not relevant to typical SMEs, and there is simplification of many of the recognition and measurement principles in full IFRS.
Reduce the burdens
IFRS for SMEs also permits some of the statements required to be omitted or merged with other statements under certain circumstances. The standard is aimed at private companies, regardless of size, that are not public interest entities. It was developed to reduce the undue burdens placed on firms by full IFRS.
The decision as to which entities apply IFRS for SMEs is left up to individual governments and regulators. The standard has been adopted or adapted in many countries – sometimes with additional modifications such as in the UK, for example.
The IFRS Foundation is developing profiles of application of full IFRS and the IFRS for SMEs in individual jurisdictions. At present, 77 of the 140 jurisdictions being profiled require or permit IFRS for SMEs. There are many notable exceptions including France and Germany. However, of the 77, 52 allow SMEs to choose IFRS for SMEs or full IFRS and 19 allow them to additionally choose local GAAP. Sixty-nine out of the 77 jurisdictions do not allow any modifications to IFRS for SMEs.
In May 2015, the IASB completed its first comprehensive review of IFRS for SMEs and issued limited amendments; these are effective on 1 January 2017 with early application permitted. The most significant amendments are permitting SMEs to revalue property, plant and equipment and aligning the main recognition and measurement requirements for deferred tax with IAS 12, Income Taxes.
Additionally, the amendments allow exemptions from certain requirements when application would cause undue cost or effort. These include measurement of investments in equity instruments at fair value, recognising intangible assets separately in a business combination and offsetting income tax assets and liabilities.
There is guidance as regards the application of this amendment. The entity must determine the potential effect of applying this exemption on users of its financial statements and compare this with the cost or effort of complying with the requirement. The reasons behind the use of the exemption must also be disclosed. Other notable changes include the option to use the equity method for investments in subsidiaries, associates and jointly controlled entities in separate financial statements, and the use of management’s best estimate if the useful life of goodwill or another intangible asset cannot be established reliably. The maximum life must not exceed 10 years whereas previously there was a presumption of a 10-year life in the above circumstances.
In 2015, a radical change occurred to UK GAAP and therefore to SME accounting. All previous financial reporting standards (FRS), statements of standard accounting practice and Urgent Issues Task Force abstracts, apart from the Financial Reporting Standard for Small Entities (FRSSE), were replaced by five new standards. FRS 100 sets out the overall framework for financial reporting under UK GAAP and explains which standards apply to which types of entity.
Additionally, the standard sets out when an entity can apply the reduced disclosure framework and when it should follow a statement of recommended practice. FRS 101 sets out a reduced disclosure framework that is available in the individual financial statements of qualifying entities provided certain criteria are met. FRS 102 sets out the accounting requirements for those entities that are neither required nor elect to apply EU-adopted IFRSs, FRS 101’s reduced disclosure framework or the FRSSE. There are signiﬁcant differences between this version of the FRSSE (effective January 2015) and the FRSSE (effective April 2008) because of the revised reporting framework introduced into the UK.
FRS 103 applies to insurance contracts of entities that apply FRS 102 including reinsurance contracts that the entity holds, and to other financial instruments that the entity issues with a discretionary participation feature. FRS 104 sets out the financial reporting requirements for interim financial reports although it does not in itself require an entity to prepare such a report.
In 2015, significant changes to UK company law were introduced, including changes to the disclosures required within small company accounts. In addition, the accounting thresholds relating to SMEs were increased significantly, which allowed more entities to use the accounting requirements of the small companies regime.
In the UK, financial reporting for small and micro-entities is also going through a period of significant change. As a result, the FRSSE is being withdrawn and, from 2016, small entities will utilise FRS 102 or a new standard, FRS 105, The Financial Reporting Standard Applicable to the Micro-entities Regime. Additionally a new section 1A, Small Entities, has been added to FRS 102 outlining the disclosure and presentation requirements for such entities. Changes have been made to the new UK GAAP standards to ensure compliance with company law.
For some entities currently applying the FRSSE, the recognition and measurement of certain assets and liabilities may change dependent on whether the entity adopts FRS 102 or FRS 105. FRS 105 can be the best option for micro-entities that wish to avoid the more complex accounting treatments of FRS 102. It is unlikely that many micro-entities will see a significant effect when they move to the new standard but, because FRS 105 is drawn from FRS 102, albeit with some significant recognition and measurement simplifications, there may be a case for these entities to appraise themselves of the potential impact.
Questions can be raised over the type of financial reporting requirements that should apply to SMEs. Some of the major world powers have differing approaches to SME accounting. The Chinese Accounting Standard for Small Entities was issued by the Ministry of Finance (MoF) in 2011, having used the IFRS for SMEs as a reference point when developing the standard. However, the MoF in Russia has said that recent public discussions on the use of the IFRS for SMEs have suggested that the cost of transition outweighs the benefits to be gained by the entities and users.
In the US, there is no financial reporting framework that SMEs are either required or permitted to use for preparing their financial statements. There is no organisation that would make a centralised ‘adoption’ decision for the use of IFRS for SMEs in the US.
SMEs in the US are categorised as ‘private companies’ and, as such, can select the accounting framework that fits the purpose of its financial statements. These frameworks can include US GAAP, IFRS as issued by the IASB, or another basis of accounting such as the US income tax basis. However, the American Institute of Certified Public Accountants (AICPA) is in the process of considering comments on its proposed financial reporting framework for privately held small and medium-sized entities.
Thus there can be a wide variation in the national accounting requirements for SMEs. Questions such as whether SMEs should be required to produce financial statements, what information they should contain and whether they should be publicly available still need to be answered on a global scale.
Graham Holt is director of professional studies at the accounting, finance and economics department at Manchester Metropolitan Business School
CPD technical article
"SMEs interact with many different parties, some of whom benefit from the disclosure of financial information"