Financial reporting for SMEs by Maria Madeira R. Vestil (September 14, 2009)

Adopting international standards

SUITS THE C-SUITE by Maria Madeira R. Vestil
Business World (09/14/2009)

When small and medium-sized businesses aspire for the big time, sound financials are a must.

Many Philippine companies trace their roots to small and medium-sized enterprises (SMEs). Many C-Suite members would, in all likelihood, include experience in an SME as part of their work experience.
Over the last few years, there has been a strong push for entrepreneurship, encouraging SMEs to help drive the Philippine economy forward, and the response has been tremendous.

As SMEs grow, entrepreneurs are quick to realize the need to maintain sound financial reporting as this would prove extremely beneficial when they transition to big business.

In July 2009, the International Accounting Standards Board (IASB) published a five-year project, titled “International Financial Reporting Standards for Small and Medium-sized Entities” (IFRS for SMEs). With most Philippine businesses in the micro, small and medium-scale categories, this is a relevant, timely and useful standard.

Since 2005, Philippine companies with public accountability and private entities that breached the financial thresholds set by the Philippine Securities and Exchange Commission (SEC) have been using accounting standards, referred to as Philippine Financial Reporting Standards (PFRS), that are considered virtually converged with full IFRS.

SMEs, however, are allowed to use what is referred to as Financial Reporting for Non-Publicly Accountable Entities (NPAEs) that is not aligned with the basic reporting framework of the full IFRS and that provides temporary reportorial relief from PFRS.

IFRS for SMEs are based on the fundamental principles of full IFRS but, in many cases, have been simplified to make the accounting requirements less complex and reduce the cost and effort required to produce the financial statements. In order to achieve this, the IASB has eliminated some accounting options available under full IFRS to simplify accounting for SMEs in certain areas.

In the context of IFRS for SMEs, “small and medium-sized entities” include entities that do not have public accountability and publish general purpose financial statements. Public accountability is defined “to cover entities with, or seeking to have, securities traded in a public market or that hold assets in a fiduciary capacity as their main business activity.” Using this definition, the entities covered by this standard are based on their “public” nature rather than on size.

However, our SEC, in adopting this international accounting standard in the local reporting environment, has included additional criteria in the definition of an SME. SEC mandates that entities with total assets of P3 million-P350 million, or total liabilities of P3 million-P250 million, will be covered by the new reporting standards for SMEs. Entities with total assets and total liabilities of less than P3 million are not covered by this standard.

The Philippine Financial Reporting Standards Council has yet to decide on the effectivity of this standard for local reporting purposes.

The new standards include the following topics: concepts and pervasive principles; the financial statements to be provided in a complete set of SME financial statements; financial instruments; inventories; investments in associates and in joint ventures; investment property; property, plant, and equipment and intangible assets and related impairment; business combinations; leases; provisions and contingencies; distinguishing between liabilities and equity; revenue; government grants; borrowing costs; share-based payment arrangements; employee benefit arrangements; income tax; foreign currency translation and hyperinflationary environments; subsequent events; related party disclosures; specialized activities; and first-time adoption of IFRS for SMEs.

For transactions not addressed in the standard, management is expected to use its judgment to determine its accounting policy. Alternatively, if such a transaction is covered in full IFRS, management may opt to refer to this but is not mandatory.

Under IFRS for SMEs, some key areas where measurement options have been simplified include: cost model for property, plant and equipment and intangible assets. No revaluation model option; jointly controlled entities can be accounted for using the cost, equity or fair value model. No proportional consolidation option; revaluation model for investment property. No cost model option; actuarial gains and losses on employee benefits must be recognized in full either through profit or loss or through other comprehensive income. No option for corridor approach.

A first-time adopter (or user) of IFRS for SMEs is defined as “an entity that presents its first annual financial statements that conform to the IFRS for SMEs, regardless of whether its previous accounting framework was full IFRS or another set of accounting standards.”

The general requirement when initially adopting IFRS for SMEs is to apply the standard retrospectively to all prior periods.

However, first-time adopters qualify for certain mandatory exceptions and optional exemptions from the general requirement for retrospective application. Such exemptions and exceptions may be applied only once.
Basic transition steps for adopting IFRS for SMEs include: presenting at least one year of comparative financial information prepared on the basis of IFRS for SMEs; making an explicit and unreserved statement of compliance with IFRS for SMEs in the notes to the financial statements; and explaining in the notes the impact of the transition from previous GAAP to IFRS for SMEs, among others.

SMEs are encouraged to start evaluating how converting to IFRS for SMEs will affect their organization and the users of their financial statements. Management may want to consider the following factors: training in IFRS for SMEs of company personnel; information needed for conversion and its effect on current IT infrastructure; if new controls or control changes are needed to maintain an effective internal control environment; the impact on contracts with customers and suppliers; the effect on measures to determine management compensation; and the timing and extent of coordination with external auditors.

The entities that will be required or permitted to use the IFRS for SMEs will be decided by the legislative and regulatory authorities and standard-setters in individual jurisdictions. It is never too early to start considering the merits of adopting IFRS, particularly for those on the C-Suite track.

Maria Madeira R. Vestil is a partner of SGV & Co. She is the subject matter resource partner for IFRS for SMEs.

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co