IFRS too complex to SMEs?

By Sanath Fernando, Partner Ernst & Young

WHEN small and medium sized businesses aspire for the big time, sound financials are a must. Many companies are mandated to use IFRS or equivalent Sri Lanka Accounting Standards irrespective of the size, whether or not such companies have resources and money that are required to implement those standards.

This is why the authors of IFRS, IASB has provided a subset of rules called IFRS for SMEs with a view of reducing the financial reporting burden of the SMEs. This same standard has now been adopted by the Institute of Chartered Accountants of Sri Lanka effective 1st January 2012.

The key feature in IFRS for SMEs is that many requirements have been simplified. For example, accounting requirements for assets (property, plant and equipment; investment property; intangible assets and borrowing costs) have been simplified keeping in mind the skill sets of SMEs, and also bringing more alignment in cost and benefits of adopting standards. Some of the features of IFRS for SMEs are as follows:

Property, Plant and Equipment

Property, plant and equipment (PPE) under IFRS for SMEs are measured at costs, less accumulated depreciation and impairment losses. Under full IFRS, an entity may opt to use the revaluation model for PPE where the assets are carried at fair value, less accumulated depreciation and impairment losses. “Fair value” is defined as the market value of the asset, normally determined by professional appraisers. By limiting the measurement to the cost model, SMEs need not spend on obtaining professional market revaluation to ensure that the carrying amounts of these assets do not differ materially from the fair value of the assets at the end of each reporting period. And since no fair value changes in these assets are recorded in the books of the entity, there is also less volatility in financial reporting, arising from property related fair values.

Investment Property

Investment property is property (land or building, or part of a building or both) held by the owner or the lessee under a finance lease to earn rentals or for capital appreciation or both.

In IFRS for SMEs, if the fair value of investment property can be measured reliably, without undue cost or effort on the part of management, an entity can opt to carry such property at fair value, with changes recognized in profit or loss. Otherwise, the property is deemed to be an item of PPE and is accounted for using the cost-depreciation-impairment model. This assessment is determined on a property by property basis, considering the underlying circumstances of each property, which is a much simplification of requirements under full IFRS.

Intangible assets

In full IFRS, goodwill and intangible assets are considered as having indefinite useful lives. They are not amortized but mandatorily subject to detailed annual impairment testing. Carrying out such impairment testing requires special skills and competences which SMEs do not posses. Goodwill is also generally not recognized as collateral by most lenders, so that the benefit of accurately assessing these given the resources involved, is less useful to SMEs.

Under IFRS for SMEs Intangible assets, including goodwill, are considered to have finite lives and are amortized over their estimated useful lives. If an entity cannot reliably estimate the useful life of an intangible asset, this lifespan is presumed to have a maximum amortization period of 10 years. Moreover, impairment testing is required only when there is an indicator of impairment.

Borrowing Costs

All borrowing costs are expensed in profit or loss in the period in which they are incurred. In contrast, under full IFRS, borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset are capitalized. Thus SMEs do not need to compute the borrowing costs to be capitalized. However in some industries, such as real estates, expensing borrowing costs may be disadvantageous as the costs will be recognized in profit or loss in the period in which they are incurred which may lead to greater volatility in earnings.

Overall

Since most SMEs aspire to eventually grow into large companies, it would be prudent to comply with comparable global financial reporting requirements. IFRS for SMEs is drafted with unique characteristic of SMEs in mind and hence cater to the needs of SMEs without making financial reporting burden to them. In the long run, this will ease SMEs transition from being an SME to a major player in any industry. Sri Lanka Accounting Standards for SMEs can be accessed in www.icasrilanka.com under Technical/Accounting Standards tab.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The view and opinion expressed above are those of the author and do not necessarily represent the views of Ernst & Young.