Question

C. You are the financial controller of ABC plc which prepares consolidated financial statements in accordance with International Financial Re porting Standards (IFRS). Your managing director, who is not from finance area, has some questions related to financial reporting on small and medium enterprise (given below):

i. Why do small and medium entit ies , need not comply with the detailed requirements of IFRS ?

ii. Is it true that there are different accounting rules which are available for small and medium sized entities?

iii. Can ABC plc take advantage of them? Explain.

Required:

Provide answers to the questions raised by the managing director by evaluating the key points of IFRS for small and medium sized entities (SMEs) .

Answer 1

Why do small and medium entit ies , need not comply with the detailed requirements of IFRS ?

Answer

The principal aim when developing accounting standards for small to medium-sized enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful information which should provide a high quality and understandable set of accounting standards suitable for SMEs.

In July 2009, the International Accounting Standards Board (the Board) issued the IFRS for SMEs Standard (the SMEs Standard). This standard provides an alternative framework that can be applied by eligible entities in place of the full set of International Financial Reporting Standards (IFRS®).

The SMEs Standard is self-contained, incorporating accounting principles based on extant IFRS Standards which have been simplified to suit the entities that fall within its scope. There are a number of accounting standards and disclosures that may not be relevant for the users of SME financial statements. As a result the standard does not address the following topics:

earnings per share
interim financial reporting
segment reporting
insurance (because entities that issue insurance contracts are not eligible to use the standard), and
assets held for sale.
In addition, there are certain accounting treatments that are not allowable under the SMEs Standard. Examples of these disallowable treatments are the revaluation model for property, plant and equipment and intangible assets, and proportionate consolidation for investments in jointly controlled entities. Generally, there are simpler methods of accounting available to SMEs than those accounting practices, which have been disallowed.

Additionally the standard eliminates the 'available-for-sale' and 'held-to maturity' classifications of International Accounting Standard (IAS®) 39, Financial instruments: recognition and measurement. All financial instruments are measured at amortised cost using the effective interest method except that investments in non-convertible and non-puttable ordinary and preference shares that are publicly traded or whose fair value can otherwise be measured reliably are measured at fair value through profit or loss. All amortised cost instruments must be tested for impairment. At the same time the standard simplifies the hedge accounting and derecognition requirements. However, SMEs can choose to apply IAS 39 in full if they so wish.

The standard also contains a section on transition, which allows all of the exemptions in IFRS 1, First-time Adoption of International Financial Reporting Standards. It also contains 'impracticability' exemptions for comparative information and the restatement of the opening statement of financial position.

As a result of the above, the SMEs Standard requires SMEs to comply with less than 10% of the volume of accounting requirements applicable to listed companies complying with the full set of IFRS Standards.

ii. Is it true that there are different accounting rules which are available for small and medium sized entities?

Answer- True

Since its establishment in 1982, ISAR has been addressing a variety of accounting and
reporting issues with a view to promoting reliable and comparable financial and non-financial
reporting by enterprises around the world.
In the late 90s, UNCTAD member States at ISAR sessions started raising the issue of
accounting and financial reporting needs of SMEs. It was becoming quite evident that IASs were
becoming too complex and voluminous for SMEs to apply in an effective manner. The quest for
simple, user-friendly accounting and financial reporting guidelines for SMEs started to gain
momentum during ISAR’s deliberations on emerging issues. The topic became a main agenda
item at the eighteenth session of ISAR in July 2000. ISAR was a pioneer in addressing this
challenging topic at a global level; particularly taking into consideration that over a decade ago a
differential reporting system was not a commonly accepted notion.
To meet the financial reporting needs of SMEs, ISAR proposed that a three-tiered
structure be adopted, as follows:8
• Level 1: This level applied to listed enterprises whose securities were publicly traded and
those in which there was a significant public interest (PI). These enterprises would be
required to apply the accounting and financial reporting standards (IASs and IFRSs) issued
by IASB;
• Level 2: This level applied to significant business enterprises that did not issue public
securities and in which there was no significant PI. ISAR developed a single set of
requirements derived from the IASs issued by IASB, but embodying only requirements for
the most regularly encountered transactions. This level still allowed the option to follow
the full set of IASs and IFRSs issued by IASB;
• Level 3: This level applied to the smallest entities (microenterprises) that were often owner
managed and had few employees. The approach proposed is a simple accruals-based
accounting closely linked to cash transactions. National regulators could permit derogation
for newly formed businesses or new entrants to the formal economy to use cash
accounting for a limited time.
Specifying the boundaries between the three levels required knowledge of the specific economy in which the enterprises operate. ISAR recommended that there should be a system with
at least three levels. The way these levels were defined had to be determined by each member
State that chose to apply this approach, taking into account the prevailing economic, legal and
social circumstances, particularly the member State’s enterprise structure.
At the end of 2003, ISAR published Accounting and Financial Reporting Guidelines for
Small and Medium-sized Enterprises in two sets – SMEGA level 2 and SMEGA level 3, in all six
languages of the United Nations.
SMEGA level 2
The guidelines developed for level 2 SMEs were derived from the IASs applicable in
2002. The guidelines were based on a set of IASs that SMEs were likely to encounter. The text of
the guidelines was composed of the “black letter” text of the IASs selected. Amplifications were
made where it was felt to be appropriate. Standards that were relevant only to a specialized area,
as well as complex standards, were excluded from the proposed guidelines. If SMEs in level 2
were to encounter transactions that could not be addressed within the proposed guidelines, they
could refer to the full IASs for guidance. Compliance with SMEGA level 2 did not mean
compliance with the IASs. A summary on the derivation of the guidelines from the IASs was
given in appendix 3 of SMEGA level 2. The guidelines were made as simple as possible in view
of the fact that their implementation was going to require extensive communication and education
tasks in familiarizing preparers and users of accounts.
SMEGA level 3
As noted above, level 3 guidelines were developed to meet the needs of those enterprises
that did not produce general-purpose financial statements nor financial statements designed to
meet the needs of a wide range of users. The level 3 guidelines were developed using a “bottomup” approach rather than being integrated into the “top-down” approach which characterizes the
IFRS for SMEs. The “bottom-up” approach starts with a realistic consideration of the needs of
users and preparers of the financial statements of smaller enterprises. SMEGA level 3 is set out in
the 2009 publication (originally published in 2003 and revised in 2009) SMEGA – Accounting and
Financial Reporting Guidelines for Small and Medium-sized Enterprises Level 3 Guidance.9
This
guidance applies to the smallest entities that are often owner managed and have few employees.
SMEGA level 3 proposes a simple accruals-based accounting, based on that set out in IASs, but
closely linked to cash transactions.
In October 2009, at its twenty-sixth session, ISAR welcomed with appreciation the
publication of IASB’s IFRS for SMEs. It noted the positive impact of ISAR’s work on IASB’s
project. The twenty-sixth session of ISAR agreed on the need to consider withdrawing SMEGA
level 2 as a result of the publication of the IASB’s publication. ISAR also requested the UNCTAD
secretariat to continue compiling feedback on practical implementation of the revised SMEGA
level 3. ISAR further requested the UNCTAD secretariat to conduct studies on the practical
implementation of IASB’s IFRS for SMEs, with a view to facilitating sharing of experiences
gained in different regions of the world.

The IASB described SMEs as entities that:
 Do not have public accountability;
 Publish general-purpose financial statements for external users. Examples of external users
include owners who are not involved in managing the business, existing and potential
creditors, and credit rating agencies.
Furthermore, an entity has public accountability if:
 Its debt or equity instruments are traded in a public market or it is in the process of issuing
such instruments for trading in a public market (a domestic or foreign stock exchange or
an over-the-counter market, including local and regional markets);
 It holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary
businesses. This is typically the case for banks, credit unions, insurance companies,
securities brokers/dealers, mutual funds and investment banks.

No. Type of entity Financial reporting framework
1. Listed companies, PI entities and   Full IFRS
government-owned enterprises

2. Economically significant companies – IFRS for SMEs or full
companies that are not public   IFRS if the
companies or quoted on the stock company chooses
exchange with a turnover of K 20   to use it
billion and above


3. Micro and small entities – entities Zambian financial reporting
with turnover of less than K 20 standard for
billion*   micro and small entities

iii. Can ABC plc take advantage of them? Explain.

Answer- Yes

They’re closer to their customers.
It is one of the most obvious advantages. Medium and especially small businesses will deal more directly with their customers, which will enable them to meet their needs more accurately and to offer a more individualized service, and even establish some bond with their users. Once you know the business, the client’s link with the SME will often be simpler than with a large company.

They’re more flexible.
Because of their size and simpler structure, they will have a greater capacity to adapt to changes. In addition, it will help them to be closer to their customers, which will allow them to know the variations in the market before anyone else. For example, they will have greater capability to reduce their supply in times when there is no usual demand.

They are able to better detect and take advantage of small market niches.
As long as your eyes are wide open, an SME will have a greater capability to detect and satisfy very specific needs of its customers than a large company may or may not detect, or will not have an interest in covering, by being a bit too small for it.

They can make decisions faster
In SMEs, decision-making will normally fall on a person or a small group. This will make them much more agile by making resolutions than large companies, where decisions often require complex decision-making mechanisms involving a lot of people and teams.

It is easier to link the staff to the company
Greater proximity to management and a more global vision of the business (in large companies each employee’s work is less comprehensive and more specialized) will make it easier to emotionally connect the worker with the company’s objectives. This will often increase your motivation, and therefore your productivity.

Everyone knows each other
Within a small or medium-sized company it is easier to form bonds and know the qualities of others. This can be used to increase performance and improve teamwork. In addition, in certain situations, such as problem solving, it will be much easier to share the tasks among the people who are more knowledgeable or better qualified to solve them.

Communication will be easier
By being closer, it will be easier for the different members of the company to communicate with each other. This will enable new ideas to flow and problems to be solved as a team