“Small and Medium-sized Entities [SMEs]” has different meanings in different territories. The definition in the context of the IFRS for SMEs is entities that do not have public accountability but that publish general purpose financial statements. Every entity has some form of accountability, if only to its owners and the local tax authorities. 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. The definition is therefore based on the nature of an entity rather than on its size.
An IFRS for SMEs has clear benefits for investors, lenders and those seeking to raise finance through the transparency afforded by a consistently applied, global set of financial reporting standards. Such benefits are not confined to the financial statements of entities with securities traded on public capital markets.
This post provides short guidance in understanding accounting framework of the IFRS for Small and medium-sized entities [SMEs] who attempt to adopt the IFRS. This is the first post of IFRS for SMEs series that I will be keep adding week-by-week ahead.
Disclosures and Disclaimer:
This post series is not intended as a study of all aspects of the exposure draft of the proposed International Financial Reporting Standard for Small and Medium-sized Entities and does not address the proposed standard‘s disclosure requirements. The guide is not a substitute for reading the proposed standard when dealing with points of doubt or difficulty. No responsibility for loss to any person acting or refraining from acting as a result of any material in this post can be accepted. You should not act on the basis of this post series without seeking professional advice.
This post series looks at the key areas covered by the IFRS for SMEs and explains, as simply as possible, the basic requirements. If you are a small and medium-sized business and have little [or no] knowledge of full IFRS, but you have a reasonable understanding of basic accounting concepts and terminology, then yes, please go ahead.
What Are the Aims of the IFRS for Small and Medium-sized Entities [SMEs]?
First aim of the IFRS for SMEs is to provide a standard for entities in countries that have no national GAAP. IFRS for SMEs will provide an accounting framework in such countries for entities that are not of the size nor have the resources to adopt full IFRS.
Second aim is to provide countries that already have an established national GAAP with an alternative, IFRS-based set of standards that will be recognized and understood across different territories. This will ease transition to full IFRS for growing entities once they become publicly accountable.
How does “IFRS for SMEs” differs to the Full Set of IFRS?
The volume of accounting guidance has been reduced by more than 85% compared with the full set of IFRSs. The material omitted from full IFRS includes much of the implementation guidance. Also omitted are the detailed explanation and requirements relating to the more complex circumstances not usually applicable to SMEs. The IFRS for SMEs does not just reduce disclosure requirements; it simplifies recognition and measurement requirements as well.
Next is accounting framework of the IFRS for SMEs. Read on…
Any entity that publishes general purpose financial statements for external users and does not have public accountability can use the IFRS for SMEs. An entity has ‘public accountability’ if it files or is in the process of filing its financial statements with a securities commission or other regulatory organization for the purpose of issuing any class of instruments in a public market or if it holds assets in a fiduciary capacity for a broad group of outsiders. Banks, insurance entities, securities brokers and dealers and pension funds would be examples of entities that hold assets in a fiduciary capacity for a broad group of outsiders.
The Historical Cost
Historical cost is the main accounting convention. Items are usually accounted for at their historical cost. However, the IFRS for SMEs permits the revaluation of intangible assets, property, plant and equipment, and investment property to fair value. IFRS for SMEs also requires certain categories of financial instrument and other biological assets to be valued at fair value. All items, other than those carried at fair value through profit or loss, are subject to impairment.
Financial statements are prepared on an accruals basis and on the assumption that the entity is a going concern and will continue in operation in the foreseeable future (which is at least, but is not limited to, 12 months from the balance sheet date).
The principal qualitative characteristics that make the information provided in financial statements useful to users are understandability, relevance, materiality, reliability, substance over form, prudence, completeness, comparability, timeliness and achieving a balance between benefit and cost. Information is material if its omission or misstatement could influence the economic decisions of users made on the basis of the financial statements.
Materiality depends on the size of the omission or misstatement judged in the particular circumstances.
The Fair Presentation
Financial statements should show a true and fair view, or present fairly the financial position, of an entity’s performance and changes in financial position. This is achieved by applying the appropriate IFRS for SMEs and the principal qualitative characteristics outlined in Section 1.3 above.
Entities are permitted to depart from the IFRS for SMEs only if management concludes that compliance with one of the requirements would be so misleading as to conflict with the objective of the financial statements. The nature, reason and financial impact of the departure should be explained in the financial statements. The override does not apply where there is a conflict between local company law and the IFRS for SMEs.
The First-time Adoption of the IFRS for SMEs
The first-time adopter of the IFRS for SMEs is 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 generally accepted accounting principles.
First-time adoption requires full retrospective application of the IFRS for SMEs effective at the reporting date for an entity’s first IFRS financial statements. There are six specific exemptions, one general exemption and four exceptions to the requirement for retrospective application.
A first-time adopter of the IFRS for SMEs does not change the accounting that it followed previously for de-recognition of financial assets and financial liabilities, hedge accounting, estimates and assets classified as held for sale and discontinued operations.
The six optional exemptions are to the requirement for retrospective application:
- The exemptions relate to business combinations;
- Fair value as deemed cost for property, plant and equipment;
- Cumulative translation differences;
- Compound financial instruments;
- Share-based payment transactions; and
- Deferred income taxes
The general exemption is on grounds of impracticability. “Impracticable” is defined in the glossary to be “when the entity cannot apply it after making every reasonable effort to do so“.
Comparative information is prepared and presented on the basis of the IFRS for SMEs. Adjustments arising from the first-time application of the IFRS for SMEs are recognized directly in retained earnings (or, if appropriate, another category of equity) at the date of transition to the IFRS for SMEs.
Selection of accounting policies
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.
Where the IFRS for SMEs does not specifically address a transaction, other event or condition, management uses its judgment in developing and applying an accounting policy. This information must be relevant to the users’ needs and reliable. ‘Reliability’ means that the financial statements represent faithfully the financial position, financial performance and cash flows of the entity, reflect the economic substance of transactions, and are neutral, prudent and complete in all material respects.