Domini Stuart examines the pros and cons of applying International Financial Reporting Standards to small businesses – and finds mainly cons.

    When big rules don’t work for small companies

    The Australian Accounting Standards Board (AASB) has released Invitation to Comment ITC 12 Request for Comment on a Proposed Revised Differential Reporting Regime for Australia and IASB Exposure Draft of A Proposed IFRS for Small and Medium-sized Entities (SMEs) . The closing date for AASB submissions is 1 September, 2007.

    “Anyone under the impression that we already have International Financial Reporting Standards (IFRS) for SMEs probably came to that conclusion after struggling through the pages of the new standards in preparing or auditing 30 June 2006 financial reports,” says Wayne Basford, a partner at BDO Kendalls. “You must be aware, however, that IFRS was only really written for listed companies and that in Europe, IFRS has only been applied to consolidated group accounts of listed entities. Throughout the European Union, the vast majority of companies have continued to prepare their individual financial reports under local National Generally Accepted Accounting Principles (GAAP).

    “Australia has ‘led’ the world by applying IFRS to SMEs years ahead of the SME project that is intended to ease the burden of applying the standards – particularly in respect of certain areas of complicated fair value issues.”

    In this case, a stance of international leadership may not be as desirable as it sounds.

    Continuing confusion

    In November 2006, Paul Pactor of the International Accounting Standards Board (IASB) and head of the SME project visited Melbourne and Sydney to attend round table discussions with Warren McGregor, the Australian representative of the IASB, representatives of the AASB, the major auditing firms and preparers of financial statements.

    “Time and time again the discussion highlighted the current confusion in Australia as to who should prepare a general purpose financial report, and if you do not prepare a general purpose financial report, then which standards should be applied,” says Basford.

    At the moment, all reporting entities must prepare reports that comply with all AASB Standards. This is true for both companies reporting under the Corporations Act 2001 and non-corporate entities. ASIC has stated that companies considered to be ‘non-reporting entities’ which are required to prepare financial reports should comply with the recognition and measurement requirements of accounting standards.

    One of the significant changes proposed by the AASB is the removal of the reporting entity concept. If the changes go ahead, the application of AASB Standards will no longer depend on whether entities are reporting entities, but rather whether an entity prepares general purpose financial reports.

    Australia has adopted IFRS, which applies to general purpose financial reports rather than reporting entities. The board adds that under the current differential reporting regime in Australia, various interpretations have been developed around the reporting entity concept with mixed success.

    Keith Reilly, national head of professional standards at Grant Thornton, remains unconvinced.

    “Unlike the IASB, which argues that the IFRS for SMEs framework only applies to those that produce general purpose financial reports, the AASB has made the tentative decision that any company required to prepare a financial report under the Corporations Act is automatically producing a general purpose financial report and therefore, that the IFRS for SMEs Framework automatically applies. But I see no good reason to force non-reporting entities into an IFRS for SMEs framework.”

    Reilly also points out that the AASB’s ‘tentative decision’ flies in the face of opinion. When ED148 proposed a new definition of a reporting entity within AASB 101, a record 184 submissions were received. Of these, 96 per cent argued that that the reporting entity concept should remain.

    “The ramifications of these changes are fundamental to financial reporting in Australia and would radically alter the obligations of both directors and auditors,” says Ivan Shapiro, partner at Moore Stephens. “Many companies which are currently preparing special purpose financial reports would find themselves facing a far more stringent regime, with a much greater burden in terms of disclosure requirements. That would inevitably result in resourcing issues and directors having to sign off on financial statements so complex that even the financially literate might feel out of their depth.”

    As a director of both SMEs and listed companies, Jim Service is very conscious of the added costs. “We’re not talking a few dollars here and there,” he says. “If IFRS for SMEs is widely applied, we’re talking millions of dollars for no known benefit.”

    Service fears that that the new, far more complex reports would actually be less informative. “A case can be made that publicly listed companies, companies that are borrowing public money and government organisations need to have this level of reporting. But if the reports are of interest only to a very small group of owners – in a small family company, for instance – what is the point of producing something they’re never going to use?

    “AASB is accountant-driven – they’re not looking at this from the user point of view. Also, there’s no question that the introduction of IFRS will have a very positive impact on their business. I’m an accountant myself so I’m not wishing to sound harsh, but I do nevertheless believe there’s a conflict of interest here which is not being recognised.”

    Small gets bigger

    A glimmer of good news for larger SMEs came with the passing by Parliament of the Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007, which increases the thresholds for proprietary companies that must prepare and lodge financial reports with ASIC.

    Under the new thresholds, a proprietary company will be defined as being “large” if it satisfies two of the following tests:

    • Has revenue of $25 million (previously $10 million).
    • Has assets of $12.5 million (previously $5 million).
    • Has 50 employees.

    Michael Coleman, national managing partner of risk and regulation at KPMG, and chair of AICD’s Reporting Commitee, says this change should remove the reporting burden from a number of smaller companies.

    “Directors should take comfort that through the combination of government action and the proposed change to IFRS for SMEs, the reporting obligations for SMEs should be more realistic. The move is in the right direction, if not quite where we want to be.”

    However, while Service welcomes these substantial increases to the limits, he says the legislation is missing the point. “The issue isn’t size, it’s whether you’re taking public money,” he says. “Other than that, accounts should be for the people who use them. If they’re nothing to do with the public, why should you have to treat them as though they are? “Europe is doing all this much more effectively, so why should we burden small businesses with costs and complexity that could affect their competitiveness?”

    Service stresses that this issue is extremely important for directors. “We need to take it seriously – to continue making representations at a political level as well as a technical one,” he says. “The Government says it wants to reduce cost and red tape; this is a good opportunity to follow that through.”

    Counting the costs

    As an unlisted public company limited by guarantee, the AICD has to apply the full set of IFRS standards. This is true for all such companies, regardless of their size.

    The AICD adopted IFRS from 1 July 2005 and rearranged systems to cope with the change and adopted IFRS retrospectively and prepared new financial statements for 2005. However, in order to fix opening balances. AICD also had to prepare financial statements for 2004, this involved preparing financial statements for 2004, 2005 and 2006.

    The reports took three or four weeks longer than usual to prepare, adding nearly a 30 per cent increase in audit fees to the cost. The reports were also six pages longer than previously even after the information was compressed to save as much space as possible.

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