International Financial Reporting Standards for Small and Medium Enterprises - Assignment Example

IFRS for Small and Medium Enterprises Need of Seperate IFRS for SMEs and its benefits Whatever may be the organizational structure, Small and Medium Enterprises (SMEs) never like to refer plethora of documents containing full set of IFRS in order to keep themselves well informed for observing the requirements of compliances. As already they to comply with numerous other requirements prescribed under different statues of the states they are registered with. This leaves them not only helpless but even hapless sometimes. SMEs, with limited resources, are already constrained with meeting various deadlines. They find themselves at loss when their main objectivity of carrying business with dedication is ignored for the reasons that would make only holes in their kitties. Spending of time and funds for meting statutory and other compliances may be a nationalistic approach, but the fact is that such compliances add more to chaos and confusions than serving the real purposes for which those have been enacted or formulated. Thus there is a definite need for a separate IFRS for SMEs. Benefits of separate IFRS for SMEs It will be a stand alone document in the sense that it contains details of all the accounting standards to be followed by SMEs in one document. SMEs will have to make very few cross- references to full set of IFRS in order to meet compliances. Recognition and measurement of principles contained in full set of IFRS have been simplified. A number of compliances those are considered impractical and valueless for SMEs have been deleted. At different stages options are available to SMEs to follow standards contained in full set of IFRS. Certain topics and issues those are believed to be unconcerned with SMEs have not been taken up in the draft IFRS for SMEs. Cost/ benefit factor have been considered and taken up quite earnestly. 2. Entities to which IFRS for SMEs apply Section 1 of the exposure draft suggests that IFRS for SMEs shall be applicable to entities that fulfill the following criteria a) SMEs that do not have public accountability, and b) SMEs that publish financial statements for external users. This clearly implies that this set of simplified standards will not be applicable to public companies. Further filing of financial statements with any regulatory body like any security commission would be treated as compiling to public accountability. Also, holding of assets in fiduciary capacity for a group of outside people or for institutions like banks, insurance companies etc. would tantamount to public accountability. With regard to external use of published financial statement, such use by the owners or shareholders would be treated as external use. The important thing is that while emphasizing that the standard is a stand alone document, the draft states that, “In deciding the contents of the proposed IFRS for SMEs, the IASB focused on the types of transactions and other events and conditions typically encountered by SMEs with about 50 employees.”(Draft IFRS for SMEs, page 6)1. Accordingly this IFRS would not be applicable to SMEs with more than 50 employees. On a closer review of the draft, the scope of applicability and the suggested criteria for defining SMEs seem to be insufficient because of the following reasons: There might be organizations that have a clout on life of general public say because of their huge product turnover, but those are not publicly accountable. Categorizing these organizations as SMEs only on basis of non public accountability would provide such organization a chance to avoid the applicability of full IFRS. Thus the applicability criteria need to be enlarged and certain amount of ceiling of turnover and capital investments should also be made additional criteria for the applicability of this IFRS for SMEs. The Institute of Professional Accountants of Russia2, while responding to the draft, has rightly submitted that, “the IASB states that in developing the standard it focused on the types of transactions and other events and conditions typically encountered by SMEs with about 50 employees, while in the scope section of the standard the small and medium size of SMEs are described as entities that do not have public accountability.” (Comments on exposure draft dated 20th July 2007). Each jurisdiction has been empowered by IASB to enforce the applicability of draft IFRS to certain entities without public accountability. The Institute of Professional Accountants of Russia states that, “In number of countries IFRS is not part of national regulation and therefore entities use IFRS but are not required to produce such financial statements publicly. In that situation the jurisdiction will not be able to introduce additional criteria for applying IFRS for SMEs.” 3. Cost/ benefit criteria of application of IFRS for SMEs. It is believed that SMEs would need to make some preparation before the application of IFRS for SMEs. In fact its application would require a lot of training for the existing staff or fresh recruiters. That means entities would have to incur additional cost for implementation of IFRS for SMEs. SMEs also feel that such cost would be regular and not only just once. The Building Society Association of UK has issued its concern over the issue of cost of implementation in its response to proposed IFRS for SMEs. In its response, the said association has observed that, “smaller societies are concerned at the cost of implementing IFRS- in whatever form. They expect them to be very high, both financially through training, consultancy, and system changes, and also through time commitments. They would be ongoing and not just incurred at implementation. Therefore, smaller societies do not see any cost benefits of implementing IFRS for SMEs.”(Building Societies Association, 13 July, 2007)4 Now the pertinent question is whether such expenditure would match its benefits. Let us examine the benefit available on its application: IFRS for SMEs would be a stand alone document. As per exposure draft there would be minimal cross references to full IFRS. The result would be time and cost saving. IFRS for SMEs have been simplified on three fronts, namely, a) Certain topics of full IFRS have been omitted, b) Only the simpler of the options available in full IFRS have been made applicable to SMEs, and c) As far as possible principles of recognition and measurement of certain standards have been simplified like Goodwill impairment is based on indicator approach and not an annual routine, entire research and development cost would be recognized as total expense and many others like that. Accordingly the benefits far exceeds the cost of applying the IFRS for SMEs; and those arguing against its application are in fact against the simplification of applicability of standards. 4.1 Effect on Goodwill Impairment Sections 26.20 to sec. 26.24 of the drafts IFRS for SMEs deal with effects of impairment of loss on Goodwill. The approach here is that Goodwill is not to be amortized but only tested for impairment only when indications of impairment are there; and it need not be an annual affair. In a business combination Goodwill is to be recognized sans impairment losses. The process prescribed for recognition of impairment of goodwill is as under: i) Fair Market value of Goodwill is evaluated as a group of assets as there is no goodwill separate from the business. ii) Besides regular testing, goodwill shall be considered from the point of view whether the entity, that have acquired assets to which goodwill belong, has performed worse since such acquisition; or the entity is being restructured/ held for sale/ or abandoned, or the significant impairment losses have recognized for other assets iii) FMV of the goodwill shall be allocated amongst the components of entity that benefit from goodwill iv) FMV of each component will then be compared with its carrying amount. There will be impairment loss if FMV is less than the carrying amount of the component. v) Write down each component’s goodwill with the amount of loss and recognize this loss in profit and loss account. Where impairment loss is more than the value of component’s goodwill, the excess, besides being recognized in profit and loss account, shall be allocated to identifiable non cash assets and liabilities on the basis of their fair value. The goodwill impairment procedure provided in the draft IFRS for SMEs is extremely simple and practical, as it takes care of erosion in goodwill value alongside the value of components that benefit from such goodwill. 4.2 Cost method for associated companies Section 13 of drafts describes that any entity, having investments in an associate and thereby a significant influence into the affairs of associate, may account for its investments in such associate using cost method. The other methods that the investors may use are Equity method or the Fair Value method. In this respect the definitions of the terms ‘associate’ and ‘significant influence’ are important to take care of. As per draft the ‘associate’ need not necessarily be an incorporated entity. That means an associate may be sole proprietorship, HUF, trust, or even a partnership organization. Also, such association is neither an interest in a joint venture nor as a subsidiary of the investor. An investor is said to be exerting ‘significant influence’, only when the investor is holding 20% or more of voting powers in the associate. This holding of voting power may be direct or indirect, say when it is through subsidiaries of the investors. The main ingredients of prescribed cost method are as under: The investment shall be reflected in the financial statements at cost adjusted by the impairment losses. Dividend or other distributions received from the associate shall be treated as income of the investor only to the extent of profits earned on such investments. That means profits earned may be more but investor will treat only those profits as income that has been received as dividends and not the entire amount of profits on such investments Distributions received in excess of income or profits on such investments shall be treated as reduction of investments. 4.3 Effect on Finance Leases Sec. 19.3 of the draft aptly describes a lease “as finance lease if it transfers substantially all the risks and rewards incidental to ownership.”(IASB, Exposure Draft IFRS for SMEs, Sec. 19.3)5. However, section 19.4 of the draft states more clearly that, “Whether a lease is a finance lease or operating lease depends on the substance of the transaction rather than the form of the contract.”6 As per the draft of IFRS for SMEs, the accounting treatment of the financial leases would as under: Initially financial leases would be recognized as assets and liabilities at the fair value of leased property along with its other direct cost. The difference between draft IFRS for SMEs and IAS 17 is that under IAS 17 the recognition of assets and liabilities of leased property initially is at lower of fair value and the present value of the minimum lease payments. Lease payment shall be apportioned between finance charge and a portion reducing leased liability. Depreciation shall be charged on leased assets in normal way as prescribed under sec. 16 of the draft; but if there is no reasonable certainty that the lessee will take up the ownership of the leased property at the end of leased term, the asset will be depreciated during the leased period or asset’s useful life, whichever is earlier. 4.4 Treatment of Research and Development Expenses This issue has realized the basic concern of SMEs. SMEs are not resourceful to envisage whether project for which research and development expenses are being incurred would be successful on ongoing basis. Similarly stanza BC81 of ‘Basis for Conclusions on Exposure Drafts’ states that, “Banks lending officers told the Board that the information about capitalized development costs is of little benefit to them, and that they disregard those costs in making lending decisions.”(BC81, page 32)7. Keeping in view these two aspects, the proposed draft of IFRS for SMEs carry the following simpler approach of dealing with research and development expenses: All research and development expenses would be charged to revenue; and The entities have the option to adopt the provisions of IAS 38, where under research expenses may be expensed with, but development expenses need to capitalize. This approach is certainly simple as well as flexible when compared with provisions of IAS 38 that provides for expending only the research expenses and not the development expenditure. IAS 38 considers development expenditure as commercially viable to be capitalized. However, draft IFRS for SMEs provides enough flexibility to entities to opt for IAS 38 if in their opinion development cost need to be capitalized. 5. Conclusion Draft IFRS for SMEs is not only a simplified version of the full text of IFRS, but is concise as well as relevant to the needs of SMEs. Topics those are superficial from the point of view of SMEs have been deleted. SMEs shall always have an option to opt for full set of IFRS with regard to particular standard. And of course, wastage of funds, resources, and unnecessary timings of SMEs would be duly checked when this draft will come into operation. References: 1 IASB, Exposure draft IFRS for SMEs, February 2007, Invitation to comment, Question 1, page6, 2 The Institute of Professional Accounts of Russia, Comments on exposure draft of IFRS for Small and Medium sized Entities, 20th July, 2007, page 2, http://www.iasb.org/NR/rdonlyres/CCEBB7FD-1B7B-4422-BEF0-6B80FDB744FF/0/CL7.pdf 3 Ibid 4 Building Societies Association, Response, Accounting Standard Board’s consultation on proposed IFRS for SMEs, 13 July, 2007 5 IASB, Exposure draft IFRS for SMEs, February 2007, Classification of leases, Sec.19.3, page 126. 6 Ibid, Sec. 19.4, page 126 7 BC81, Basis for Conclusions on Exposure Drafts, IFRS for Small and Medium- Sized Entities, February 2007, page 32, http://www.iasb.org/NR/rdonlyres/B34721E3-9E09-47DF-AA84-B9C88E6057CC/0/SMEs.pdf Read More