Reporting: A survey of CPA Australia members across Australia, Hong Kong, Malaysia and Singapore adds to the debate about the proposed IFRS for SMEs, write Dr Yew-Kee Ho, Dr Yuen-Teen Mak and Dr Mark Shying.
'The field of financial accounting is not one in which guidance is to be found wholly in fixed principles it is a field of shadowy outlines in which the discovery of a correct course depends upon the possession also of an ability to recognise the essential facts and to appreciate their true significance (distinguishing where necessary between form and substance); upon informed and wise judgment; and upon objectiveness and honesty of purposes.'
George O. May, Journal of Accountancy (pre-1986), May 1937
The primary objective
The primary objective of financial reporting as defined by the IASB conceptual framework is: 'to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.'
The presentation of such financial statements is constrained by the fact that the 'benefits derived from information should exceed the cost of providing it'. This serves as the main context for the age-old debate: a single set of Generally Accepted Accounting Principles (GAAP), or the choice of a Big GAAP or a Small GAAP.
That debate centres on the premise of whether all firms engaged in business should be required to adopt a uniform system of accounts namely, the consistent application of the recognition, measurement and disclosure of transactions using a single set of GAAP, with no exceptions.
The debate has been relatively rigorous since the 1800s. For example, the US considered this issue in 1886 in the Senate Select Committee in Interstate Commerce where a similar question was raised: 'Should corporations engaged in interstate commerce be required to adopt a uniform system of accounts?' At that time some commentators supported uniformity for reasons of comparability. Other commentators rejected uniformity on the grounds that it did not necessarily result in the provision of useful information about an entity.
Fast forward 121 years and frame the above debate in the context of large and small firms, or firms with and without public accountability. Introduce the additional element of cost, and this is precisely what the IASB is currently trying to address in their latest exposure draft (hereafter called the ED) of a proposed IFRS for small and medium-sized enterprises (SMEs).
Two of the stated objectives of the IASB in the introduction of the ED are:
to develop, in the public interest, a single set of high-quality, under-standable and enforceable global accounting standards that require high-quality, transparent and comparable information in financial statements and other financial reporting to help participants in the worlds capital markets and other users make economic decisions
to take account of, as appropriate, the special needs of small and medium-sized entities and emerging economies.
With the complexities of modern transactions and the promulgation of numerous accounting standards to cater to these, the indiscriminate application of a consistent set of GAAP can result in excessive costs over benefits for entities. The costs result because these entities may have very limited uses for their financial statements.
The debate continues
To contribute to the debate in the context of the ED, CPA Australia commissioned the Corporate Governance and Financial Reporting Centre (CGFRC), National University of Singapore, to conduct a survey to capture the views of a sample of members who are in public practice, and/or are involved with SMEs across Australia, Hong Kong, Malaysia and Singapore. A total of 465 responses were received to a questionnaire survey, with 92 from Australia, 126 from Hong Kong, 117 from Malaysia and 130 from Singapore. This article seeks to provide an interpretation of the survey response in the context of the above debate.
The major framework for analysing the need to have a Small GAAP for certain entities is predicated on the identification of the users of financial statements for these entities.
On the basis of cost and benefit argument, if the users can obtain proprietary information from the entities, it is argued that financial reports should be prepared in a manner to meet those needs in a most cost-effective manner. In addition, the simplicity of the entities may not entail the production of financial information, which may fulfil the form requirements but does not provide added values to the users. For example, an entity that is closely held by family members may have little to benefit from the full application of the accounting standard for share-based payments since the information produced may not be relevant to the users.
We will highlight three main areas the survey may contribute to the debate.
Users of financial statements of SMEs
The respondents clearly indicated that banks making loans to entities will most likely be users of the financial statements of these entities. This is followed by shareholders and credit rating agencies. Interestingly, the general opinion of the respondents is that customers are less likely to use the financial statements of these entities. From a policy perspective, the results of the survey show clearly that these entities may not need the full suite of the IFRS in order to satisfy the information needs of bankers and shareholders who may already have customised or proprietary financial reports.
In fact, a significant percentage of the respondents (81 per cent) support the promulgation of an IFRS for such entities, which we interpret as giving due regard to the reduced information need of users. The major reasons cited for the support of a proposed IFRS include: ability to better meet the needs of users of SMEs financial statements (72 per cent); ability to reduce the financial reporting burden for SMEs that want to use global reporting standards (69 per cent); ability to reduce the audit burden of SMEs in general (59 per cent); and ability to reduce the financial reporting burden on all SMEs in general (58 per cent), among others.
In fact, more than half of the respondents clearly state that the proposed IFRS will result in cost and time saving in the preparation of financial reports.
To which type of entities should the proposed IFRS apply?
The ED provides a qualitative definition of entities that fall within the proposed IFRS. Unfortunately, such entities are called SMEs in the ED. In fact, the name of the ED is skewed towards the name of the SMEs. Namely, 'entities that do not have public accountability; and publish general-purpose financial statements for external users'. It is a very user-oriented definition.
The majority of the respondents do not disagree with this definition. On the other hand, many respondents do not agree that such entities should therefore be called SMEs because many believe the proposed IFRS should include large unlisted companies that do not have public accountability. Therefore the description of 'small and medium size' immediately becomes a misnomer.
A better name for the proposed IFRS should be IFRS for Private Entities. This suggests that the proposed IFRS should be applied to entities that are 'private' in nature regardless of size.
The qualitative definition of such entities is important because this is the basic reason for the need of the proposed IFRS. The challenge is whether the definition can be applied unambiguously to entities.
What should be the form and content of the proposed IFRS?
The major debate centres on the form and content of the Small GAAP, since there is an established case that such a proposed IFRS is desirable. It is clear that entities generally prefer simplified recognition, measurement and disclosure requirements. But they are also concerned about over-simplification, which might compromise the essential information.
For example, a large number of the respondents disagree that the cash flow statement should be omitted for the sake of simplification.
The respondents take a pragmatic approach by advocating the publication of a stand-alone IFRS for private entities, with the fall-back position that in the event the proposed IFRS is unable to address the issues faced by the entities, the full IFRS will be used. Therefore, the revealed desired position of respondents is to have a simplified GAAP along the line of the Big GAAP, with the option to rely on the Big GAAP where applicable.
This line of approach is reasonable, as it shows that entities as represented by the respondents in this survey give due regard to the importance of substance over form.
The entities are mindful of the importance of producing meaningful and useful financial standards for decision making. The cost constraint should be clearly in view.
Timely and useful
We believe the IASB project is timely and useful. The proposed IFRS will further strengthen the relevance and usefulness of financial reports, and have due regard for the cost constraint of those entities identified in the proposed IFRS.
The proposed IFRS gives support to the argument provided by George May in 1937.
That is, financial reporting must encompass 'an ability to recognise the essential facts and to appreciate their true significance' and may we add, 'without undue costs'.
Dr Yew-Kee Ho is vice-dean, NUS business school. Dr Yuen-Teen Mak is co-director, corporate governance and financial reporting centre (CGFRC), NUS Business School.
Dr Mark Shying CPA is senior policy adviser, financial reporting and governance, CPA Australia.
Reference: November 2007, volume 77:10, p. 59-61 (Asia edition)
