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South African Journal of Economic and Management Sciences

versión On-line ISSN 2222-3436
versión impresa ISSN 1015-8812

S. Afr. j. econ. manag. sci. vol.14 no.2 Pretoria ene. 2011




A critical analysis of the contents of the IFRS for SMES a South African perspective



Danie Schutte; Pieter Buys

School of Accounting Sciences, North-West University




The IFRS for SMEs was developed to address the reporting needs of SMEs worldwide. SMEs however do not necessarily have a global focus. Furthermore, SMEs from different parts of the world are exposed to different conditions and environments.
Although the IFRS for SMEs was not intended for a specific user group, the majority of the respondents to the Exposure Draft on IFRS for SMEs were from Europe and other developed countries while only limited respondents from Africa and developing countries were involved.
This study considered the relevance of the contents of the IFRS for SMEs in the South African environment based on user requirements. Since SMEs do not necessarily have functional accounting departments and because they rely on external accountants to compile financial statements, we included accounting practitioners and trainee accountants from the SME sector in our survey. As a result we classified the contents of the IFRS for SMEs, from a South African perspective, into different levels of importance or relevance.

Keywords: accounting, generally accepted accounting practice, international financial reporting standards, small and medium entities.

JEL L25, M40, 41, 48



1 Introduction

Proper and relevant disclosure of financial information has been called for by a number of observers in recent times. According to Wömpener and Köhrmann (2006:2) appropriate reporting of financial measures not only facilitates company performance appraisal, but also enhances transparency. In addition, the adoption of International Financial Reporting Standards (IFRS) is intended to facilitate cross-border investments and access to global capital markets (AICPA, 2008:2). Since many public companies are required to apply IFRS for stock-exchange listing purposes, the adoption of IFRS became a necessity for international business. As a result IFRS was adopted by many listed companies in Europe and elsewhere (ICAS, 2008:1).

A different scenario, however, prevails at non-listed and/or small and medium entities (SMEs). Dixon, Thompson and McAllister (2002:27) argued that matters pertaining to large firms are not necessarily applicable to SMEs. In 1995 the American Institute of Certified Public Accountants (AICPA) rated certain generally accepted accounting principles (GAAP) requirements, from the perspective of SMEs, as low on decision, relevance and usefulness (Zanzig & Flesher, 2006:4). In addition, the emphasis on global financial reporting standards due to international harmonisation and business might not be a priority for SMEs because only a small percentage of the SME sector has a global focus. Van Mourik (2007:193) concluded that globalisation and inter-nationalisation are products of multinational companies. According to the Organisation for Economic Co-operation and Development (OECD) approximately one per cent of SMEs can be considered global. SMEs' involvement in globalisation is often limited to those that engage in some form of exporting to economies that are geographically close to each other and culturally similar (OECD, 1997:89). It is therefore suggested that the accounting and related disclosure functions of SMEs are limited to transactions encountered by SMEs in individual countries.

Nonetheless, the International Accounting Standards Board (IASB) developed a global accounting standard for use by the SME sector. In developing the IFRS for SMEs, one of the objectives was to develop, in the public interest, a single set of high quality, understandable and enforceable global accounting set of standards for the SME sector. The IASB (2007:11) was committed to take into account the special needs of SMEs, and in deciding the content of the proposed IFRS for SMEs, the IASB focused on the types of transactions and other events and conditions typically encountered by SMEs with approximately 50 employees (IASB, 2007:6). SMEs worldwide do however not necessarily engage in similar activities; UK SMEs are mainly involved in the agricultural, business and construction sectors; South African SMEs are prominent in community, social and personal services and the finance, real estate, wholesale and agriculture sectors; and in Kenya SMEs are mainly involved in agricultural activities (ACCA, 2000:1-4). Due to these differences it is suggested that the different conditions and transactions encountered by different countries are not conducive to a global set of accounting standards for the SME sector. Accordingly, in order to assess the relevance of the IFRS for SMEs, the contents of the proposed IFRS for SMEs should be compared to transactions and events disclosed by SMEs from different countries.


2 Theoretical framework

2.1 Development of an accounting reporting standard for SMES

The debate around Big GAAP and Small GAAP, or accounting practices pertaining to large and small entities, has been an ongoing issue since the 1800s. In 1886 the Senate Select Committee in Interstate Commerce based in the United States (US) considered the question whether corporations should be required to adopt a uniform system of accounts (Ho & Shying, 2007:1). Since then a number of commentators supported such a uniform set of accounts for reasons of comparability, while commentators opposing uniformity based their arguments on the fact that the benefits derived from information should exceed the cost of providing it. In 1995 the Private Company Financial Reporting Task Force of the AICPA concluded that the benefits for SMEs in complying with GAAP outweigh the costs (Zanzig & Flesher, 2006:4). Elsewhere, many national standard-setters have introduced differential reporting for SMEs, resulting in diverse practices by standard-setters, preparers and users of SME financial statements (Cordery & Baskerville, 2006:2).

The development of a global, uniform set of financial reporting standards for SMEs commenced in 2004 when the IASB published a discussion paper on the preliminary views on financial reporting standards for SMEs. In 2007 the IASB published a document for public comment entitled "The Exposure Draft (ED) of International Financial Reporting Standard for Small and Medium-sized Entities" (IFRS for SMEs) which incorporated approximately 15 per cent of the reporting standards applicable to large and listed entities (SAICA, 2007a:2).

Approximately five years after the initial discussion paper the IASB formally adopted the ED on IFRS for SMEs as an International Financial Reporting Standard (IASB, 2009a:1). The IFRS for SMEs was therefore a result ofa five-year development process during which the IASB considered 162 letters of comment on the ED (IASB, 2009b:1).

In 2004 the Hong Kong Institute of Certified Public Accountants expressed their concern with the IASB's preliminary views on accounting standards for SMEs and suggested that the IASB should conduct a survey to ascertain to what extent the accounting standards for SMEs would result in compliance cost saving for SMEs (HKICPA, 2004:1).

The European Accounting Association Financial Reporting Standards Committee commented that the financial reporting regulations of the IASB are influenced by the user needs of a traditionally Anglo-American corporate governance tradition, and, since the Continental model applies to most of Europe, the IFRS for SMEs will not address the reporting needs of SMEs in Europe (EAAFRSC, 2004:20; Joos & Lang, 1994; Zeghal & Mhedhbi, 2006).

The Association of Finnish Accounting Firms (2007:1) commented to the IASB that the ED on IFRS for SMEs had a very strong focus on the needs of capital markets and investors and that the needs of small unlisted companies were ignored. They concluded that, because the ED on IFRS for SMEs was mere a scaled-down version of IFRS for listed companies, its focus was still too much on the IFRS for listed companies, and therefore still too complex. The Institute of Chartered Accountants in Australia (2007:1) also commented to the IASB that the ED on IFRS for SMEs is too complicated for SMEs in the Australian context. In addition the Institute of Chartered Accountants in Australia (2007:1) concluded that the recognition, measurement and disclosure needs ofthe key stakeholders of SMEs were not taken into consideration by the IASB. The following additional points were revealed by RSM International (2008:22-30) in connection with the comments received by the IASB:

• The European Union (EU) commented that the ED was not applicable for the bulk of SMEs in the EU;

• The Institute for Chartered Financial Analysts commented that the proposed IFRS for SMEs would create non-comparable information;

• The Italian Organismo Italiano di Contabilita and The Hundred Group of Finance Directors suggested that fair value accounting is not applicable to SMEs;

• The Accounting Standard Board of the UK commented that the ED is only applicable to larger companies in the SME sector;

• More simplifications were called for by, among others, the Mouvement des Entreprises de France and ICAC (Spain); and

• The Dutch Accounting Standards Board commented that the ED did not address the needs of the users of SME financial statements.

On 7 August 2007, in the midst of the aforementioned development process, South Africa became the first country in the world to formally adopt the IASB's ED on IFRS for SMEs, without any changes to the ED's original text, as the Statement of GAAP for SMEs (Carte, 2007:1). However, two months after the adoption of the ED on IFRS for SMEs the South African Institute of Chartered Accountants commented to the IASB that: i) significant simplifications are needed, ii) the scope should be more clearly defined and iii) the requirements in the proposed IFRS for SMEs are too onerous given the level of accounting knowledge of preparers and the needs of the users of the financial statements (SAICA, 2007b). The comments by the South African Institute of Chartered Accountants could be indicative of the fact that the adoption of the ED on IFRS for SMEs in the South African context was premature. The possibility that the ED on IFRS for SMEs was implemented too early in the South African context was further supported when the South African Institute of Chartered Accountants suggested, in addition to IFRS and IFRS for SMEs, a third level of reporting for non-public interest entities (SAICA, 2008:1) which resulted in the commissioning of a South African working group to draft a proposed financial reporting framework for non public entities and to address the concerns that were raised against IFRS for SMEs (Lombard, 2008:20; SAIPA, 2009:1).

2.2 Users of SME financial statements

The main purpose of financial statements is to address the needs of the users thereof (FERF, 2006:4). Although the IFRS for SMEs was not developed for a specific group of users (Lombard, 2008:19), the IASB acknowledged a wide range of users of SME financial statements as well as distinct information needs compared to users of financial statements prepared in accordance with full IFRS (IASB, 2009c:18). The extent to which the IFRS for SMEs will address the information needs of all the user groups of SME financial statements remains, however, uncertain. Anacoreta and Silva (2005:17) could not identify statistically significant patterns from the responses received in connection with the IASB's preliminary views on international accounting standards for small and medium-size entities. This led them to conclude that the significant intrinsic issues of the IASB questions are not distinctive enough to shape a pattern of answers or group of respondents. In response to the ED on IFRS for SMEs the European Accounting Association's Financial Reporting Standards Committee suggested that user groups of large public-interest enterprises and SMEs are not the same, and advocated that user groups may even differ between larger SMEs and smaller SMEs (EAAFRSC, 2008:29). Deaconu, Nistor and Popa (2009:8) examined SME stakeholders' needs and their inference upon SME financial reports. Their research contained the following main user groups of SME financial statements:

• Public or tax authorities;

• Financial creditors (banks);

• Shareholders; and

• Managers.

Although tax authorities are key recipients of SME financial statements (Sian & Roberts, 2009:302), accounting standards are, due to different tax jurisdictions worldwide, not intended to meet the reporting needs of tax authorities in different countries (IFAC, 2006:17; IASB, 2009c:20). Apart from tax authorities, the most frequent users of small company financial reports include owner-managers and providers of finance (Saracina, 2005:2). Providers of finance include banking institutions and investors while internal users of financial statements are mainly concerned with the management of businesses. According to the European Commission (2010:8) financial statements constitute only one of many factors that are considered in the credit-granting process by banking institutions. The European Commission (2010:8) concluded that the adoption of the IFRS for SMEs, if compared to prevailing national accounting practices, will not provide additional benefits to banks. Moreover, banks usually do not depend on published financial statements since they have the right or power to demand the information they require (EAAFRSC, 2008:37). While bankers require financial statements for accuracy and comparability purposes, and since investors consider trend lines and year-over-year comparisons to be important, relatively little is known about the actual views and needs of owner-managers (EAAFRSC, 2004:2). Schiebel (2008:1) concluded that the ED on IFRS for SMEs is biased towards the opinions of auditors and accountants, implying that the views of internal users of SME financial statements were not considered by the IASB. Even though Saracina (2005:2) listed owner-managers as frequent users of SME financial statements, Sian and Roberts (2009:289, 301) concluded that many SME owners have limited or no formal accounting training, they rely on external accountants to prepare their financial statements and accordingly they are often left bewildered by the complexity of the information provided. In addition, Sian and Roberts (2009:301) concluded that SME owners utilise computerised accounting programs, and not the financial statements, to interpret data for managerial purposes. The omission of the views of owner-managers, as internal users of financial statements, was also confirmed by the IASB's (2009c:20) statement that it is not the purpose of the IFRS for SMEs to provide information to owner-managers to help them make management decisions. The evidence therefore suggests that the views of internal users of SME financial statements were omitted due to no formal accounting training, as well as limited interest by this group of users due to no reliance on financial statements for managerial purposes.

Furthermore, as far as external users are concerned, Schiebel (2007:17) reported that only eight percent of respondents to the ED on IFRS for SMEs were external users of SME financial statements. Accordingly, even though the IFRS for SMEs is intended for non-publicly accountable entities that publish general purpose financial statements for external users, the benefits of the IFRS for SMEs for the different user groups remain to be tested.

2.3 Worldwide empirical analysis

In respect of global research, Schiebel (2007:17) concluded that the IASB did not conduct serious worldwide empirical analyses in deciding the contents of the ED on IFRS for SMEs. The summary of responses to the ED on IFRS for SMEs in Annexure A suggests that a substantial number of responses was received from within the UK. Furthermore, if the responses are grouped per continent it is evident that 58 per cent of the responses were from Europe alone (refer to figure 1 below).

Even though the majority of the responses to the ED on IFRS for SMEs was from Europe, the process of adopting IFRS in Europe alone appears to be burdensome. According to ACCA (2004:1) individual member states of the European Union will move at different speeds to take their national standards for unlisted companies towards IFRS, resulting in a too slow convergence process for some member countries. A possible explanation for the low level of response by the Americas might be attributable to the fact that listed companies in the US are required to compile financial statements in accordance with US GAAP and not IFRS. In addition, SMEs in the US are not legally required to file statutory financial statements in accordance with GAAP or any other relevant reporting standard (Epstein & Jermakowicz, 2007:1). The continent with the lowest number of responses was Africa with eight percent of the total responses received. Compared to the continent with the highest number of responses, Europe (58 per cent), where the convergence process to IFRS was reported to be too slow, it is suggested that the process in Africa will be even more burdensome due to unique challenges such as lower levels of development.

2.4 Different levels of development

The concept of applying global reporting standards to SMEs in developing countries is believed to be more difficult than elsewhere (United Nations, 2008:2). Oberholster (1999: 232) suggested that the unique challenges and the heterogeneous nature of developing countries are not necessarily accommodated when International Accounting Standards are adopted by these countries. Simpson (2008:1) also suggested that the IASB did not take into account the uniqueness and challenges of SMEs in developing countries and advocated that the term SME in the ED on IFRS for SMEs is aligned to the US definition of an SME and therefore not necessarily relevant to developing countries. Sacho and Oberholster (2008:128-130) concluded that the implementation of IFRS is not necessarily a "one-sizefits-all" solution for the accounting needs of developing countries. They argued that developing countries do not have historically developed accounting standards and are often required by global market players to apply IFRS, which, according to them, might result in distorted and incongruous results. Although there is no uniform definition available to distinguish developing countries from developed countries, the United Nations developed the Human Development Index (HDI) to measure the level of human development for a specific country. Countries with low to medium HDIs are classified by the United Nations