International Financial Reporting Standard for Small and Medium Entities - Essay Example

International Financial Reporting Standard for Small and Medium Entities: Reasons and Considerations for Adoption Introduction The globalisation ofbusinesses and merging of economies led to the intermingling of business operations and practices. But in order for businesses from various locations or countries and industries conduct a relationship with one another, it is important that a certain financial understanding fully comprehended by both or all ends is established. This is usually achieved by the entities conducting business together for a while, and with various similarities such as leadership, countries of origin, and probably, even work culture. This may not be the case of new businesses as well as those who have yet to establish rapport with others, specifically in the business-to-business cases. In the fast-evolving business environment brought about by the recent advances in information and communication technologies, transportation, and others, conducting business have also changed. Requirements and understandings need to be ready, clear, and acceptable for all of those conducting business due to various factors such as internet connectivity that allows transfer of funds from one point of the globe to another in a matter of seconds, purchase and sales of high-end to low-end products at the click of the mouse, and the various automations that have increased organizational efficiencies in business operations. With this premise, this paper will explore the reasons for the introduction of the International Financial Reporting Standard for Small and Medium Entities by the International Accounting Standards Board and provide the adjustments and clarifications that SMEs need to consider in adopting the proposed IFRS. Discussion 1. Reasons why the standard was introduced & other options the IASB considered before a standalone standard was developed. Include a critic of each of the options and whether this standard fulfils the objective of providing useful information to users. Small and medium entities or enterprises have certain characteristics that are not exactly the same with bigger entities or corporations whether local or international. Due to their size and other factors, they require more flexible options in order to continue operations as well as other forms of flexibility and considerations to grow. The characteristic of small and medium entities or SMEs include lack of public accountability, issued or would issue debt or equity securities in public market, or hold assets in a fiduciary capacity for outsiders such as banks, insurance companies, securities dealer, or investment bank (Deloitte, 2007). However, other small listed companies are not qualified to use IFRS for SMEs for they seek capital from outside investors separate from managing the business, thus, cannot demand information they might want (Deloitte, 2007). These qualities were found to be in conflict with full IFRS requirements and standards prompting the IFRS for SMEs. The International Financial Reporting Standard for Small and Medium Entities or IFRS for SMEs was formulated by the International Accounting Standards Board which intention was to facilitate financial reporting for SMEs (KPMG, 2010). This can be achieved through simple and reduced detailed requirements and guidance from full IFRS and removal of the complex option in areas where full IFRS require more than one accounting option (Tomlinson, 2010). It was published in July 2009 after five years of development process in response to the call of many small and medium enterprises which find the full IFRS as burdensome in cost and user-friendliness (Tomlinson, 2010). The full IFRS required extensive adoption and guideline that mandated reporting entities to: “expense all borrowing costs, removing the requirement for full IFRSs for entities to assess whether such costs should be capitalised; amortise goodwill and intangible assets over a maximum 10-year period removing the requirement from full IFRSs for entities to perform an annual mandatory impairment test; and similar to the requirements in IFRS 9 Financial Instruments for financial assets, categorise all financial instruments in two categories: amortised cost and fair value; simplifying the accounting requirements in IAS 39 Financial Instruments: Recognition and Measurement for financial instruments,” (Tomlinson, 2010, 2). It was noted by the IFRS Foundation (2011) that about 95 per cent of all companies compose of small and medium sized entities. Specifically, the IASB have undertaken to deliberate on the IFRS for SMEs because the full IFRSs were originally intended to meet the requirements of equity investors of companies in public capital markets. These encompass a wide range of issues, required a sizeable implementation guidance, and disclosure policies fit for public companies that are considered impractical and a burden for SMEs. It has been identified that SMEs require less financial statement contents and characteristics but instead centre on assessment of shorter term cash flows, liquidity, and solvency (IFRS Foundation, 2011). For Deloitte (2007) the IFRS for SMEs have simpler options for cost-depreciation-impairment model for investment property where fair value from profit or loss is permitted in relation to IAS 40 Investment Property, plant and equipment; borrowing costs become expenses with capitalisation allowed in relation to IAS 23 Borrowing Costs; use of indirect method for reporting operating cash flows and; single method for all kinds of grants although SMEs may use the alternatives pointed out in IAS 20 Government Grants and Disclosure of Government Assistance (Deloitte, 2007). Under IFRS for SMEs, measurement and recognitions simplified under financial instruments are presence of only two financial asset categories, adoption of clear and simple derecognition where transferor has significant continuing involvement and avoiding the pass-through testing and control retention testing of IAS 39, and most importantly, a more simple hedge accounting (Deloitte, 2007). Other simplified procedures include use of goodwill impairment; use of research and development costs as expenses; use of cost method for associates and joint ventures instead of equity method or proportionate consolidation; “less fair value for agriculture” (Deloitee, 2007, 2); use of specific benefit plans; use of intrinsic value method or share-base payment, simpler measure for lessee rights and obligations; and use of less prior period data (Deloitte, 2007). KPMG (2010) suggested that entities seeking cross-border trade or foreign investment would benefit from the IFRS for SMEs as this is widely accepted and considered a “high-quality financial information,” (6). The IASB’s main reason for introducing the IFRS for SMEs is to enable more entities to become listed as well as the percentage of small and medium entities at around 95 %. A simpler and more adoptable framework that is not as detailed as the full IFRS will entice firms to adopt the system and easier for finance institutions and providers to integrate the entities where investment opportunity may be presented (Melvin, 2008). The framework, as already repeatedly indicated, is simpler and much easier to implement than the full IFRS. This means that sufficient information has been disseminated to finance providers as well as the targeted entities. However, as already admitted elsewhere (KPMG, 2010), consultation with outside experts as well as other costs for the adoption of IFRS for SMEs is inevitable. Adopters must have sufficient long-term reasons such as growth and inducement of foreign investment as main goals prior to adopting the framework. The adjustments made by IASB are in line with the growing connectivity of businesses around the globe today. Putting up another version of the full IRFS for SMEs seeks to meet the needs and requirements of smaller entities other than the ones being served by regular IASB members. In this way, a clearer integration and smoother financial transactions could transpire between businesses. On the other hand, the IFRS for SMEs is also a tool for financial institutions interested at creating relationships between them and the SMEs. It is similar to a marketing tool to enhance as well as hasten transactions between these existing financial businesses and their targeted markets. This IFRS for SMEs is a protection and a systematized indication that one entity is qualified to avail of services or additional investments from existing bigger entities from out of their league. But as mentioned earlier, while meeting up the standards of the IFRS for SMEs is a good indication of the readiness and qualification of SMEs, it is always up to the auditor or the firm’s accountant on how to get around and fully integrate the IFRS for the SME. As already have proven by global instances of financial breakdown and embarrassment such as the ENRON and other accounting scandals (Bratton, 2002), accountancy is a fragile undertaking. The real score on the performance of SMEs or even giant entities for that matter remain in the hands of a few: decision-makers, managers, and their accountants or auditors (Robbins and Judge, 2009). This means that standards will only serve as guide to be implemented but not a guarantee that financial statements are correct and proper. 2. Discuss the factors that SME’s will have to consider in managing the change to IFRS for the first time When the International Accounting Standards Board formulated the IFRS for SMEs, local jurisdictions were left to decide whether or not adopt and require its use in their areas. The factors that SMEs would need to consider in adopting the IFRS for SMEs include local financial reporting requirements, implications on business and cost, long-term goals, group reporting requirements, and other issues that may arise (Tomlinson, 2010). In the process where SMEs will not be able to address provisions of the IFRS for SMEs, entities are advised to refer to the requirement and guidance in the IFRS for SMEs to analyse proper treatment; or refer to Concepts and Pervasive Principles under Section 2 of IFRS for SMEs to fully understand the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses (Deloitte, 2007). What may be a setback is the Exposure Draft (ED)’s suggestion to revert to the full IFRS as guidance and reference for other or related issues. It has also recommended reference to updated policies of other standard-setting bodies with similar concepts in accounting standards, or other widely accepted accounting literatures and industry practices although it must be again checked that these do not run in conflict with current IFRS standards (Deloitte, 2007). In turn, SMEs are expected to rely solely on the two sets of standards for their questions so that the IFRs remains a mandatory fall-back and invoked; the SMEs will be left on their own to determine what the IFRs requires, as well as induce conflict and confusion among auditors charged at preparing such financial statements (Deloitte, 2007). The KPMG (2010) provided a checklist for entities to consider prior to adopting the IFRS for SMEs. In an overview, it suggested that the IFRS for SMEs simplifies and reduces the costs of preparing financial statements and applicable only for certain entities already described above. The first to consider is the local financial reporting requirements. This is applicable under which jurisdiction the entity belongs. First, the standard must first meet local laws after which the jurisdiction has already accepted and permits the use of the standard as an acceptable financial reporting framework. Prior to application, the firm must first determine whether they can claim compliance with the standard in their specific condition. It should not have any publicly-traded debt instruments (KPMG, 2010). The business environment should also be characterized by wide acceptance of the financial reporting standard where the entity operates. It must be able to confirm if local finance providers accept the IFRS for SMEs or require other financial information, disclosures, or statements. Additional requirements indicate that a cost-benefit test was not met (KPMG, 2010). The second consideration that KPMG (2010) enumerated is the user and comparability to other entities of which users may find certain differences in accounting treatments. Then, it becomes less comparable to the IFRS for SMEs although this is described as short-term concern for users or finance providers although decreased differences may transition over time (KPMG, 2010). It is assumed however, that IFRS for SMEs maybe “easier to understand and … less complex,” (KPMG, 2010, 7). The third consideration for entities in the adoption of the framework is its business impacts specifically effects on financial metrics such as on reporting ratios and net profit, debt covenants, and terms and conditions of contractual arrangements such as: amount of taxes payable, ability to pay dividends, and management compensation (KPMG, 2010). KPMG (2010) suggested that entities should ensure sufficient advance planning to ensure that adverse impacts are minimized and that the entities should capitalize instead on beneficial impacts. In addition, the entity applying IFRS for SMEs for the first time should consult the guidance on the framework under similar or related issues; as well as be clear with definitions, recognition criteria, and measurement concepts specified in Section 2 (KPMG, 2010). Increased consultation with experts or external advisers is expected. The fourth consideration is the entity’s long-term goals and plans including growth and listing where early adoption is proposed as an advantage as well as a ready indication to adopt full IFRS. The fifth consideration suggested by KPMG (2010) is group reporting of which groups with subsidiaries, joint ventures, or associates in various countries use the framework as a compelling tool. IT also applies to transitional reporting from locally adopted framework to IFRS for SMEs, and until it reaches full IFRS (KPMG, 2010). The sixth and last consideration for KPMG (2010) is the cost of the adoption, that may cover among others upfront investment, on-going training, financial reporting, disclosure requirements, advisers, and the IFRS for SMEs update process. In details, these are upfront investment for system changes such as reformatting of financial statements and training costs for auditors but with substantial adjustment through the years for the framework’s stability and consistency over the years; acceptability by a wider, international finance institutions; minimal disclosure requirements as compared to full IFRS; less expert requirements due to simplified framework and system as compared to full IFRS; and stability of the system for a 3-year period (KPMG, 2010). On the part of SMEs, adopting the IFRS for SMEs is a positive move towards global integration and readiness. If one entity seeks growth through infusion from outside, bigger entities, then its adoption is an indication that the entity is poised for its target (Boreham and Lloyd, 2007). Meanwhile, those who are not ready to adopt the IFRS for SMEs but maintain a competitive performance may continue with their system (Davies and Shorrox, 2000) as long as they do not intend to attract investments, financial infusion, and other outside support. Conclusion The IFRS for SMEs is packaged as an enterprise tool towards growth and global competitiveness readiness. It is a financial tool towards attracting foreign investment, financial support or infusion from outer, bigger entities, and a framework that provides an identification of an entity for possible consideration by global financial institutions. On the other end, IFRS for SMEs is a mediator between full IFRS compliance and those who cannot afford it. It serves as a “come-on” for entities to adopt the framework towards full IFRS that is endorsed as promising bigger growth and investment from outside investors and finance institutions. At certain points, IFRS for SMEs is a positive tool for entities that are not capable of growth through their own capacity. It mediates them to finance institutions to realise or implement growth and ambition at international level. Entities which have not adopted the framework yet should aspire for its implementation through local business organisation efforts that would lobby its adoption in the jurisdiction if this is not yet accepted as well as through their own initiatives. Adoption is flexible in its terms and this would provide a guarantee of opened doors for international financial support and growth. Whilst there is a cost for everything including the IFRS for SMEs, auditors and accountants will find ways to cope and promises of possible international growth should not be far. Reference: Boreham, R. and Lloyd, J. 2007. “Asset Accumulation across the Life Course”, ILC-UK, London Bratton, W.W. 2002. Does Corporate Law Protect the Interests of Shareholders and Other Stakeholders?: Enron and the Dark Side of Shareholder Value. Tulane Law Review/Tulane University Law School (1275) 161. Davies, J. B., and Shorrocks, A.F. 2000. “The Distribution of Wealth”, Elsevier: Amsterdam, Pp. 605–675 Deloitte. 2007. IAS Plus: IASB offers IFRS relief for SMEs. March Special Edition. Accessed November 2011 from http://www.iasplus.com/iasplus/0703smeed.pdf IFRS Foundation. 2011. “IFRS for SMEs”, accessed November 2011 from http://www.ifrs.org/IFRS+for+SMEs/IFRS+for+SMEs.htm KPMG. 2010. The IFRS for SMEs: Considering the alternatives. January. Melvin, Neil. 2008. Engaging Central Asia: The European Union’s New Strategy in the Heart of Eurasia. Centre for European Policy Studies. Robbins, S. and Judge, T. 2009. Organisational Behaviour. Prentice Hall. RSM International. 2009. A Guide Through IFRS for Small and Medium-Sized Entities (SMEs). Accessed November 2011 from http://www.rsmfarrellgrantsparks.ie/wp-content/uploads/2011/04/FINAL-IFRS-for-SMEs.pdf Tomlinson, Sanel. 2010. The IFRS for SMEs: Considering the alternatives. KPMG International Standards Group. Accessed November 2011 from http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/IFRS-for-SMEs-O-201001.pdf Read More