A closer look at the proposed accounting for small and medium-sized entities (SMEs)

The full adoption of the International Financial Reporting Standards or IFRS that started in 2005 has posed a big challenge for many entities. The complexity, real or perceived, of either the full IFRS or, for that matter, any full set of accounting standards may impose a high cost of implementation especially for SMEs. In addition, some provisions of the complex standards are not applicable to SMEs. Consequently, the need to develop a separate accounting standard for SMEs has become increasingly important. Cognizant of the many IFRS-related implementation issues and concerns, our regulators/standard setters have put in place stop-gap measures as they deemed appropriate. Just about someone from the “smaller” entity group was to press the “panic button” in 2005 when full IFRS implementation was required, the Philippine Accounting Standard (PAS) 101, Accounting for Non-publicly Accountable Entities or NPAEs was issued. Under PAS 101, NPAEs – the Philippine version of SMEs, are given a relief via an option not to apply the full IFRS. PAS 101 was originally effective only until 2007 but its effectivity has been extended until reporting standards for SMEs are approved and made effective by the standard-setters. On February 15, 2007, the International Accounting Standards Board (IASB) issued for public comment the exposure draft of its IFRS for SMEs. Discussions are still ongoing. Some changes to the proposal are also expected to address the findings from the field testing that has been carried out. Now that an IFRS for SMEs is in the works – the final standard can be expected to be released before the year ends. When that happens, the Philippines will most likely follow suit. PAS 101 will then be withdrawn and a Philippine equivalent of the IFRS for SMEs will be adopted.

Now let us take a closer look at the proposed standard.

Rationale, objective and definition of a SME

In developing the proposed IFRS for SMEs, the IASB’s intention is to facilitate financial reporting by and to provide accounting standards suitable for SMEs that want to use international standards. The IFRS for SMEs is intended to be a stand-alone document organized by topic. It is published containing three documents: a) the draft IFRS for SMEs, b) implementation guidance with illustrative financial statements and disclosure checklist, and c) basis for conclusions. The IFRS for SMEs will be updated every two years through the release of an omnibus exposure draft of proposed amendments. Since there is no proposed effective date, the IFRS for SMEs would take effect from a date determined by the national regulator in each jurisdiction. The proposed standard purports to provide a simplified, self-contained set of accounting principles based on full IFRS to be used by entities that do not have public accountability, i.e., smaller, non-listed companies. An entity has public accountability and therefore should use the full IFRS if: a) It has issued debt or equity securities in a public market; or b) It holds assets in a fiduciary capacity for a broad group of outsiders, such as banks, insurance companies, securities broker/dealers, pension funds, mutual funds and investment banks. There is no imposition of a size test in defining a SME, though each jurisdiction may consider one. IASB’s intent is for the IFRS for SMEs to be suitable for a typical SME with about fifty (50) employees.

Modifications of IFRS

There are three types of modifications to the content of the full IFRS based on the needs of users of SMEs’ financial statements and cost-benefit concerns, namely: (a) certain topics not applicable to SMEs were omitted (b) only the simpler options were included and (c) recognition and measurement principles were simplified. As a result of these modifications, the length or volume of the proposed standard has been reduced considerably when compared to the full IFRS.

Topics omitted

IFRS topics that were deemed not relevant to a typical SME were omitted from the draft IFRS for SMEs, with cross-references to the full IFRS if necessary. Examples of these topics omitted include determining fair value of agricultural assets, interim financial reporting, earnings per share and segment reporting, among others. Since SMEs are not prevented from applying any of the existing IFRS, the use of such IFRS for SMEs would in effect be optional.

Only the simpler option included

The IASB recognized that most SMEs are likely to prefer the simpler option in full IFRS. Therefore, the IASB concluded that where the full IFRS allows accounting policy options, the IFRS for SMEs should include only the simpler option, and the other more complex option(s) should be available to SMEs by cross-reference to the full IFRS. Actually, the IASB considered whether the IFRS for SMEs should eliminate all accounting policy options. However, it concluded that prohibiting SMEs from using an accounting policy option that is available to entities using full IFRS could hinder comparability between SMEs and entities applying full IFRS. Simpler options were selected for investment property, property, plant and equipment, intangible assets, borrowing cost, presenting operating cash flows and accounting for government grants.

Recognition and measurement simplifications

Significant simplifications to the recognition and measurement principles in IFRS have been proposed. Simplifications were made to financial instruments, research and development costs, investments in associates and joint ventures, goodwill impairment, income taxes, agriculture, employee benefits – defined benefit plans, share-based payment, leases and transition to the IFRS for SMEs.

Conclusion

When the proposed IFRS for SMEs is finally adopted, the full IFRS will now become some sort of an “exclusive” domain for public interest entities, although SMEs could still refer to IFRS for guidance as necessary. Many national and international accounting standards setters are supportive of this IASB initiative. The U.S Financial Accounting Standards Board (FASB), the International Federation of Accountants (IFAC), the Australian Accounting Standards Board (AASB) and the U.K’s Accounting Standards Board (ASB) have all, in one way or another, expressed support for the said project. IFAC regards this project as of utmost importance, indicating that this is possibly the most important on the IASB’s agenda. Our own Financial Reporting Standards Council or FRSC has expressed its support as well for the IASB issuance of a separate financial reporting standard for SMEs, which incidentally constitute the major portion of reporting entities in the Philippines. Others may argue that all entities must adopt the same accounting principles or standards in the preparation of their general-purpose financial statements – emphasizing that the complexity in accounting is attributed to the fact that transactions are getting more and more complex. Whether this IFRS for SMEs will ultimately provide the solution to the accounting and financial reporting needs of the SMEs remains to be seen. But for now, the IFRS for SMEs is considered as a welcome development that will minimize the difficulties encountered by SMEs in complying with IFRS-based standards.

(Enrico E. Baluyut is a Senior Manager for Technical Advisory of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email [email protected] or [email protected]).