SMALL AND MEDIUM SIZED ENTITIES (SMES)
REPORTING REQUIREMENTS OF SMES
International accounting standards are written to meet the needs of investors in international capital markets. Most companies adopting IFRS are large listed entities. The IASB has not stated that IFRSs only aimed at quoted companies, but certainly the majority of adopters are large entities. In many countries IFRSs are used as national GAAP which means that unquoted small and medium-sized entities (SMEs) have to apply them.
A SME is often owned and managed by a small number of entrepreneurs, and may be a family-owned and family-run business. Large companies, in contrast, are run by professional boards of directors, who must be held accountable to their shareholders.
Some commentators suggest that SMEs and public entities should be allowed to use simplified or differing standards as the nature of their business is different from large quoted entities.
The principal aim when developing accounting standards for small to medium-sized enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful information which should provide a high quality and understandable set of accounting standards suitable for SMEs.
Approaches/Options for IASB in Developing IFRS for SMEs
There were several approaches, which could have been taken in developing standards for SMEs.
- One course of action would have been for GAAP for SMEs to be developed on a national basis, with IFRS focusing on accounting for listed company activities. The main issue would have been that the practices developed for SMEs may not have been consistent and may have lacked comparability across national boundaries. Additionally, if a SME had wished to list its shares on a capital market, the transition to IFRS would have been more difficult.
- Another approach would have been to detail the exemptions given to smaller entities in the mainstream IFRS. In this case, an appendix would have been included within the standard detailing the exemptions given to smaller enterprises.
- A third approach would have been to introduce a separate set of standards comprising all the issues addressed in IFRS, which are relevant to SMEs.
Issuance of IFRS for SMEs
In July 2009, the International Accounting Standards Board (IASB) issued the IFRS for Small and Medium-sized Entities (IFRS for SMEs). This standard provides an alternative framework that can be applied by eligible entities in place of the full set of International Financial Reporting Standards (IFRSs).
The IFRS for SMEs is a self-contained standard, incorporating accounting principles based on existing IFRSs which have been simplified to suit the entities that fall within its scope.
The Standard is organised by topic with the intention that the standard would be helpful to preparers and users of SME financial statements. The IFRS for SMEs and full IFRSs are separate and distinct frameworks. Entities that are eligible to apply the IFRS for SMEs, and that choose to do so, must apply that Standard in full and cannot choose the most suitable accounting policy from full IFRS or IFRS for SMEs.
Due to big differences between SMEs and large quoted companies, it is not clear whether there is any reason why SMEs should comply with IFRSs. There are arguments in favour of using SMEs, and arguments against.
Arguments against the use of IFRSs by SMEs
There are several reasons why SMEs should not adopt IFRSs for the preparation of their financial statements.
- Some IFRSs deal with subjects that are of little or no relevance to SMEs, such as accounting standards on consolidation, associates, joint ventures, deferred tax, construction contracts and standards that deal with complex issues of fair value measurement.
- The costs of complying with IFRSs can be high. For SMEs, the cost is proportionately much higher, and it is doubtful whether the benefits of complying with IFRSs would justify the costs.
- There are not many users of financial statements of SMEs, and they use the financial statements for a smaller range of decisions, compared to investors in international capital markets. So would it be a waste of time (as well as cost) to comply with IFRSs?
Arguments in Favour of the use of IFRSs by SMEs
There are also reasons why SMEs should adopt IFRSs for the preparation of their financial statements.
- If SMEs use different accounting rules and requirements to prepare their financial statements, there will be a ‗two-tier‘ system of accounting. This could make it difficult to compare results of larger and smaller companies, should the need arise. Confidence in the quality of financial reporting might be affected adversely.
- If SMEs prepared financial statements in accordance with their national GAAP, it will be impossible to compare financial statements of companies in different countries. If SMEs grow in size and eventually obtain a stock market quotation, they will have some difficulty in the transition from national GAAP to IFRSs.
- It has also been argued that full statutory accounts for SMEs would be in the public interest, and might help to protect other stakeholders in the company (such as suppliers, customers, lenders and employees).
IFRS for SMEs
The IFRS for SMEs is designed to facilitate financial reporting by small and medium-sized entities in a number of ways:
- It provides significantly less guidance than full IFRS.
- Many of the principles for recognising and measuring assets, liabilities, income and expenses in full IFRSs are simplified.
- Where full IFRSs allow accounting policy choices, the IFRS for SMEs allows only the easier option.
- Topics not relevant to SMEs are omitted.
- Significantly fewer disclosures are required.
- The standard has been written in clear language that can easily be translated
The IFRS is suitable for all entities except those whose securities are publicly traded and financial institutions such as banks and insurance companies. Although it has been prepared on a similar basis to IFRS, it is a stand-alone product and will be updated on its own timescale.
There are no quantitative thresholds for qualification as a SME; instead, the scope of the IFRS is determined by a test of public accountability.
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 IFRS will be revised only once every three years. It is hoped that this will further reduce the reporting burden for SMEs.
Small and medium-sized entities are entities that:
- Do not have public accountability, and
- Publish general purpose financial statements for external users. Examples of internal users include owners who are not involved in managing the business, existing and potential creditors, and credit rating agencies. General purpose financial statements are those that present fairly financial position, operating results, and cash flows for external capital providers and others.
An entity has public accountability if:
- Its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments; or
- It holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses (e.g. banks, mutual fund, securities brokers/dealers and insurance companies).
The standard does not contain a limit on the size of an entity that may use the IFRS for SMEs provided that it does not have public accountability. Nor is there a restriction on its use by a public utility, not-forprofit entity, or public sector entity. A subsidiary whose parent or group uses full IFRSs may use the IFRS for SMEs if the subsidiary itself does not have public accountability. The standard does not require any special approval by the owners of an SME for it to be eligible to use the IFRS for SME. Listed companies, no matter how small, may not use the IFRS for SMEs.
Key Features of the IFRS for SMEs
A complete set of financial statements of an entity reporting under the IFRS for SMEs is similar to that required by full IFRS and comprises:
- A statement of financial position
- Either a single statement of comprehensive income, or a separate income statement and a separate statement of comprehensive income
- A statement of changes in equity
- A statement of cash flows
- Notes including a summary of significant accounting policies Comparative information
The IFRS for SMEs imposes a lesser burden on SMEs due to:
- Some topics in IFRSs being omitted because they are not relevant to typical SMEs
- The simplification of many of the recognition and measurement requirements available in full IFRSs
- Substantially fewer disclosures
For situations where the IFRS for SMEs does not provide specific guidance, it provides a hierarchy for determining a suitable accounting policy. An SME must consider, in descending order:
- The guidance in the IFRS for SMEs on similar and related issues.
- The definitions, recognition criteria and measurement concepts in Section 2 Concepts and Pervasive Principles of the standard.
There are a number of accounting standards and disclosures that may not be relevant for the users of SME financial statements. As a result the standard does not address the following topics:
- Earnings per share
- Interim accounting
- Segment reporting
- Insurance (because entities that issue insurance contracts are not eligible to use the standard) and Assets held for sale
Examples of options in full IFRS not included in the IFRS for SMEs
- Revaluation model for intangible assets
- Choice between cost and fair value models for investment property (measurement depends on the circumstances)
- Proportionate consolidation for investments in jointly controlled entities
- Options for government grants
Following are the differences in IFRSs for SMEs from regular Standards. Remaining treatments are significantly same in both.
Investments in associates and joint ventures
- Can be measured at cost unless there is a published price quotation (Then fair value must be used).
- Jointly controlled entities can be accounted for using the cost model, the equity method or the fair value model (proportionate consolidation is not allowed)
- Must be measured at fair value (cost model not allowed, unless fair value cannot be measured reliably without undue cost or effort)
- If fair value cannot be calculated then must be treated as property, plant and equipment
Property, plant and equipment
- Historical cost-depreciation-impairment model or revaluation model
- Residual value, useful life and depreciation need to be reviewed only if there is an indication they may have changed since the most recent annual reporting date (full IFRSs require an annual review). Impairment testing and reversal
- All borrowing costs must be recognised as expense when incurred (cannot be capitalised)
- Revaluation not allowed
- Research and development costs must be recognised as expenses (cannot be capitalised)
- Indefinite-life intangibles are amortised over their useful lives, but if useful life cannot be reliably estimated then use the management‘s best estimate but not more than 10 years
Business combinations and Goodwill Acquisition (purchase) method used.
- Acquisition costs are capitalized in the cost of investment
- Goodwill is amortised over its useful life (10 years if this can‘t be estimated reliably )
- Contingent considerations are included as part of the cost of investment if it is probable that the amount will be paid and its fair value can be measured reliably.
- Lease classified either as finance lease or operating lease and treated accordingly
- If a sale and leaseback results in a finance lease, the seller should not recognise any excess as a profit, but recognise the excess over the lease term. If a sale and leaseback results in an operating lease, and the transaction was at fair value, the seller shall recognise any profits immediately.
- All grants are measured at the fair value of the asset received or receivable
The standard eliminates the ‘available-for-sale’ and ‘held-to maturity’ classifications of IAS 39, Financial instruments: recognition and measurement. All financial instruments are measured at amortised cost using the effective interest method except that investments in non-convertible and non-puttable ordinary and preference shares that are publicly traded or whose fair value can otherwise be measured reliably without undue cost or effort are measured at fair value through profit or loss. All amortised cost instruments must be tested for impairment. At the same time the standard simplifies the hedge accounting and derecognition requirements. However, SMEs can choose to apply IAS 39 in full if they so wish.
Defined benefits plans
- The projected unit credit method is only used when it could be applied without undue cost or effort.
- Otherwise, en entity can simplify its calculation:
- Ignore estimated future salary increases
- Ignore future service of current employees (assume closure of plan)
- Ignore possible future in-service mortality
- Plan introductions, changes, curtailments, settlements: Immediate recognition (no deferrals)
- For group plans, consolidated amount may be allocated to parent and subsidiaries on a reasonable basis
- Actuarial gains and losses may be recognised in profit or loss or as an item of other comprehensive income – but No deferral of actuarial gains or losses, including no corridor approach and all past service cost is recognised immediately in profit or loss
Financial statements Presentation
In full IFRSs, a statement of changes in equity is required, presenting a reconciliation of equity items between the beginning and end of the period. Same is the requirement for SMEs. However, if the only changes to the equity during the period are a result of profit or loss, payment of dividends, correction of prior-period errors or changes in accounting policy, a combined statement of income and retained earnings can be presented instead of both a statement of comprehensive income and a statement of changes in equity.
Assets held for sale
Assets held for sale are not covered in IFRSs for SMEs, the decision to sell an asset is considered an impairment indicator.
The standard also contains a section on transition, which allows all of the exemptions in IFRS 1, First-time Adoption of International Financial Reporting Standards. It also contains ‘impracticability’ exemptions for comparative information and the restatement of the opening statement of financial position.
As a result of the above, the IFRS requires SMEs to comply with less than 10% of the volume of accounting requirements applicable to listed companies complying with the full set of IFRSs.
There is no universally agreed definition of an SME. No single definition can capture all the dimensions of a small or medium-sized business, or cannot be expected to reflect the differences between firms, sectors, or countries at different levels of development.
Most definitions based on size use measures such as number of employees, net assets total, or annual turnover. However, none of these measures apply well across national borders. The IFRS for SMEs is intended for use by entities that have no public accountability (ie its debt or equity instruments are not publicly traded).
Ultimately, the decision regarding which entities should use the IFRS for SMEs stays with national regulatory authorities and standard setters. These bodies will often specify more detailed eligibility criteria. If an entity opts to use the IFRS for SMEs, it must follow the standard in its entirety – it cannot cherry pick between the requirements of the IFRS for SMEs and those of full IFRSs.
The International Accounting Standards Board (IASB) makes it clear that the prime users of IFRSs are the capital markets. This means that IFRSs are primarily designed for quoted companies and not SMEs. The vast majority of the world’s companies are small and privately owned, and it could be argued that IFRSs are not relevant to their needs or to their users. It is often thought that small business managers perceive the cost of compliance with accounting standards to be greater than their benefit.
Advantages of the IFRS for SMEs
- It is virtually a ‘one stop shop‘.
- It is structured according to topics, which should make it practical to use.
- It is written in an accessible style.
- There is considerable reduction in disclosure requirements. (e) Guidance not relevant to private entities is excluded.
Disadvantages of the IFRS for SMEs
- It does not focus on the smallest companies.
- The scope extends to ‘non-publicly accountable’ entities. Potentially, the scope is too wide.
- The standard will be onerous for small companies.
The main argument for separate SME accounting standards is the undue cost burden of reporting, which is proportionately heavier for smaller firms. The cost burden of applying the full set of IFRSs may not be justified on the basis of user needs. Further, much of the current reporting framework is based on the needs of large business, so SMEs perceive that the full statutory financial statements are less relevant to the users of SME accounts. SMEs also use financial statements for a narrower range of decisions, as they have less complex transactions and therefore less need for a sophisticated analysis of financial statements. Thus, the disclosure requirements in the IFRS for SMEs are also substantially reduced when compared with those in full IFRSs partly because they are not considered appropriate for users’ needs and for costbenefit considerations. Many disclosures in full IFRSs are more relevant to investment decisions in capital markets than to the transactions undertaken by SMEs.
There are arguments against different reporting requirements for SMEs in that it may lead to a two-tier system of reporting. Entities should not be subject to different rules, which could give rise to different ‘true and fair views’.
The IFRS for SMEs is a self-contained set of accounting principles that are based on full IFRSs, but that have been simplified so that they are suitable for SMEs. The standard has been organised by topic with the intention that the standard would be user-friendly for preparers and users of SME financial statements.
The IFRS for SMEs and full IFRSs are separate and distinct frameworks. Entities that are eligible to apply the IFRS for SMEs, and that choose to do so, must apply that standard in full and cannot chose the most suitable accounting policy from full IFRS or IFRS for SMEs.
However, the standard for SMEs is naturally a modified version of the full standard, and not an independently developed set of standards. They are based on recognised concepts and pervasive principles and they will allow easier transition to full IFRS if the SME decides to become a public listed entity. In deciding on the modifications to make to IFRS, the needs of the users have been taken into account, as well as the costs and other burdens imposed upon SMEs by the IFRS. Relaxation of some of the measurement and recognition criteria in IFRS had to be made in order to achieve the reduction in these costs and burdens. Some disclosure requirements are intended to meet the needs of listed entities, or to assist users in making forecasts of the future. Users of financial statements of SMEs often do not make such kinds of forecasts. Small companies pursue different strategies, and their goals are more likely to be survival and stability rather than growth and profit maximisation.
The stewardship function is often absent in small companies, with the accounts playing an agency role between the owner-manager and the bank.
Where financial statements are prepared using the standard, the basis of presentation note and the auditor’s report will refer to compliance with the IFRS for SMEs. This reference may improve access to capital. The standard also contains simplified language and explanations of the standards.
In the absence of specific guidance on a particular subject. An SME may, but is not required to, consider the requirements and guidance in full IFRSs dealing with similar issues. The IASB has produced full implementation guidance for SMEs.
The IFRS for SMEs is a response to international demand from developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized businesses that is much simpler than full IFRSs. The IFRS for SMEs should provide improved comparability for users of accounts while enhancing the overall confidence in the accounts of SMEs, and reducing the significant costs involved of maintaining standards on a national basis.