Advanced Financial Accounting Theory and Practice

Executive Summary

This report analyses whether Australian SMEs should adopt the IFRS issued to them by the IASB. SMEs have had a fundamental impact on most of the economic fabrics of different countries (Arnold et al., 1984, p. 75). Given the recent difficulties facing SMEs in most developing nations such as Australia, there was need for the IASB to come in and address the issue. This led to the establishment of a new IFRS that was tailor-made for small and medium-sized enterprises. The report will discuss the pros and cons of the IFRS for SMEs and make a recommendation as to whether the Australian SMEs should adopt it. In order to achieve this, the implications of financial information to the SME sector will also be critically analyzed.

Introduction

Small and Medium-sized Enterprises commonly referred to as SMEs have become an important part of the economic fabric of most nations throughout the globe. This is because they bring substantial contributions to the employment sector. For example, they create business entrepreneurs as well as creating employment for people who work in the business enterprises. A broad spectrum of definitions can be used to define SMEs based on organizational and national guidelines. The definition can be centered on the company assets, company sales, or the physical headcount of employees. For instance, “The World Bank defines SMEs as those enterprises with a maximum of 300 employees, $15 million in annual revenue, and $15 million in assets” (Dalberg Global Development Advisors, 2011, p. 2). Nevertheless, SMEs are commonly defined as “enterprises that employ fewer than 250 persons, and which have an annual turnover not exceeding 50 million, and/or an annual balance sheet total not exceeding 43 million” (Dalberg Global Development Advisors, 2011, p. 3). The important thing about SMEs is to understand what they are and what they entail.

In this regard, a new IFRS (International Financial Reporting Standard) was issued by the IASB for the SMEs in 2009. This was meant to authorize the SMEs to initiate modifications on the measurements and recognitions with regard to the IFRS. This paper is therefore an analysis of the implications of the financial information on the SMEs, and a discussion on whether the Australian SMEs should adopt the IFRS.

The Financial information implications of the SME sector

Just like most of the developing nations, Australia has a big number of the small and medium-sized enterprises. In actual terms, more than 95% of all the businesses operating in Australia comprise of the small and medium-sized enterprises. As such, the SMEs play a significant role in the Australian economy. This has in turn led to a great demand for the financial information of the SMEs. Financial information in this case entails knowledge of the financial ratios and the reports, which are extracted from the financial statements prepared by the SMEs, which include the balance sheet and the income statement. The two are prepared by SMEs that are not listed in the stock markets of their respective nations. Those that are listed are expected to prepare consolidated income statement and balance sheet. The income statement shows the net profit or net loss of the enterprise within a specific period. In addition to this, it gives an indication of the revenue earned as well as the expenditure of the enterprise. This information is of importance to the decision-makers of small and medium-sized enterprises. The enterprise’s financial position at a specific time is shown by the balance sheet. This is because the balance sheet gives an assessment of the enterprise’s ability to increase owners’ wealth, while it remains solvent by conveying the assets and liabilities of the enterprise.

According to the statutory requirements, SMEs are not entitled to prepare cash flow statements as part of their reports. “Research has indicated that SMEs have no interest on the cash flows that are reported on its assets and earnings” (English, 2001). Other financial reports such as budgets, which may not be statutory, are also important for the SMEs. “Financial indicators extracted from financial statements are also considered useful by a number of studies on small businesses” (English, 2001).

It is therefore important to note that the financial information generated from the SMEs’ financial statements is fundamental when it comes to making short and long-term decisions of the SMEs. For instance, the financial information could be used to surrogate information required in getting external funds from money lending institutions. This is because before any money-lending institutions awards credit to an enterprise, they have to assess its credit worthiness. The credit worthiness is assessed from the information obtained in the financial statements of the enterprise. In addition to this, the financial information could be used in capital budgeting techniques especially for the long-term projects of the enterprise. It is also important to note that the financial information of the SMEs does not have financial advantages (Kemp, 2009). The financial information could have financial benefit only if it is used in making financial decisions.

A discussion of whether Australia should adopt IFRS for SME

In July 2009, the small and medium-sized entities (SMEs) were issued with a new International Financial Reporting Standard (IFRS), which was specifically designed for them. The standard was named ‘self-contained’ because it involved a development process that took close to five years to establish. The process entailed consulting all the SMEs operating throughout the globe in order to ensure that every SME was incorporated in the standard. The new standard was developed because of the demand for a simpler IFRS than the full IFRS. The new IFRS was custom-made for those businesses that do not have public accountability such as the SMEs. The new IFRS for the SMEs came as an alternative way for the reporting of the SMEs in addition to the full IFRS and other reporting standards such as GAAP.

The IASB does not have the power to force any enterprise or company to adopt its standards (Weygandt, 2008). The power to choose the standard accounting standard is normally bestowed on individual nations. As such, it is the obligation of the nations’ government regulators and legislators, in addition to the national professional accountancy body, to resolve the issue and provide the appropriate standard to be adopted. This should be after determining the eligibility of the country’s enterprises and companies. “Australia is one of the few countries that has not adopted IFRS for SMEs as an alternative to the complex IFRS accounting standards that the International Accounting Standards Board has designed for listed companies” (Reilly, 2009, p.1). Australia has instead established its own standard of accounting and reporting known as the Reduced Disclosure Regime (RDR). The RDR is an integration of the IFRS for the SMEs and the Australian Accounting Standards Board (AASB). In the RDR, the IFRS for SMEs is the basic standard while the AASB is adopted for the disclosure requirements, which are deemed necessary.

Given the complexity of the existing accounting standards there was a need for simplified accounting standards that could stand alone (Weygandt, 2008). “The goal of the new IFRS standards was therefore, to create simplified and self-contained accounting standards that could be used by the smaller and non-listed enterprises to report their financial statements” (Reilly, 2009, p.2). “According to the new IFRS the objective of financial statements of a small or medium-sized entity is to provide information about the financial position, performance, and cash flows of the entity” (Jermakowicz and Epstein, n.d, p. 73).

Despite the fact that the IFRS is a big package of close to 250 pages, the simplicity of the accounting standard is amazing. This is evidenced by the specimen accounts that are in the package for demonstration. This is an indication that there is some degree of similarity in the IFRS for SMEs and other accounting standards such as GAAP with regard to the prepared financial statements. Therefore, another benefit of the IFRS for SMEs is its ability to save both time and cost (Birt et al., 2009). This is because it takes less time to prepare financial statements using the standard while at the same time providing an easy time for the audit process of the financial reports. This accounting standard has also minimized the text volume by adopting a simplified standard structure. It is organized topically starting with the pervasive principles and concepts arranged in a logical manner.

However, there are disadvantages of the IFRS for SMEs that could deter its adoption by most of enterprises and countries. First, the process of adopting the accounting package proves to be more costly than that of producing an accounting standard. As such, Australia would have to put this into consideration before deciding to adopt the standard. Nevertheless, several issues have to be discussed by the relevant bodies and legislators who have to assess the relevance and appropriateness of the accounting standard to Australian SMEs (Burns and Dewhurst, 1996). Matters such as confusion in the business operations with regard to accounting reporting should be factored because this will create the need for training of entrepreneurs on the new IFRS.

Another limitation of the IFRS for SMEs is that once an enterprise adopts it, it does not have the ability to change to another accounting standard of their preference such as the full IFRS. For instance, the IFRS for SMEs could require that property, plant, and equipment be measured using the historical method. In the event that the enterprise wishes to use another method of valuation, it will not be possible.

Conclusion

From the above discussion, Australia has to weigh the pros and cons of the IFRS for SMEs before adopting it. It should be noted that the IFRS for SMEs is bound to bring no impact on the reporting practices of financial information for the Australian SMEs. However, given the simplicity of the new IFRS, it is advisable the Australian SMEs adopt the standard.

References

Arnold, J. et al. (1984). Small business: an area ripe for practice development. Journal of Accountancy 158 (2): 74-79.

Birt, J., Chamlers, K., Beal, D., Brooks, A., Byrne, S., and Oliver J. (2008). Accounting, Business Reporting for Decision Making. Australia. Wiley Publishing.

Burns, P., and Dewhurst, J. (1996). Small business and Entrepreneurship, 2^nd Edition. Basingstoke: Macmillan Business.

Dalberg Global Development Advisors. (2011). Report on Support to SMEs in Developing Countries through Financial Intermediaries. PDF file.

English, J. (2001). How to organize & operate a small Business in Australia, 8^th edition. Australia: Allen & Unwin.

Jermakowicz, E., and Epstein, B. (n.d). IFRS for SMEs- An Option for U.S. Private Entities? PDF file.

Kemp, S. (2009). Is IFRS for SMEs the answer to complexity or is it a white elephant. PDF File.

Reilly, K. (2009). Reporting under IFRS for SMEs. Web.

Weygandt, J. (2008). Financial Accounting, Sixth Edition. New York: John Wiley & Sons, Inc.