Mohan R. Lavi

There is a business one-liner that says, “All things being equal, all things are unequal.” Small and medium enterprises (SMEs) have always been less-than-equal compared to the conglomerates. However, they are a very powerful engine in any economy.

Redefining SME

The International Accounting Standards Board (IASB), which has been working on a project to bring out an accounting standard for SMEs, completed the task recently.

The very definition of SMEs is radically different from common perception — any company which does not have public accountability and which issues general purpose financial statements for external users.

External users could mean private investors, present and potential creditors and credit rating agencies.

The need for an accounting standard for SMEs is to protect them from the rigours of a full-blown IFRS (International Financial Reporting Standard), which thrives on detailed disclosures.

The IASB simplified this on five parameters — exemption, barring options, simplification, fewer disclosures and a simplified redrafting.

EXEMPTION AND NON-OPTIONS

SMEs are exempted from four IFRSs — earnings per share, interim financial reporting, segment reporting and special accounting of assets held for sale (IFRS-5). It is obvious that most of these standards would apply to listed companies and so their exemption seems logical.

Options that are a part of IFRSs that would be not available to SMEs are — options on financial instruments, including classification, the revaluation model for property, plant, equipment and intangible assets, proportionate consolidation for investments in jointly controlled entities, measurement being driven by circumstances in the case of investment property and the options on government grants.

Financial instruments

SMEs should welcome the options on financial instruments since it would preclude them from exposure to the vagaries of some complicated instruments. Recognition and measurement criteria for financial instruments have also been substantially simplified — some financial instruments are measured at cost or amortised cost, easy de-recognition criteria have been listed and hedge accounting has been tailored for SMEs.

Goodwill

Goodwill — which is tested for impairment annually in normal IFRS — is amortised over their useful life. In a pick-up from an Indian accounting standard, amortisation over a 10-year period is advised in case the useful life cannot be measured reliably. Investments in joint ventures and associates can be measured at cost only if they are listed and a published price is available. The IFRS recommends research and development costs of SMEs to be expensed. This could affect entities operating in the pharma space, whose bottomline could take a hit.

Borrowing

There is no option but to expense borrowing costs and property plant and equipment need to be reviewed only if there is an indication that their value has altered — as against an annual review needed according to normal IFRS. All defined benefit plans should be parked in the profit and loss account.

In the case of biological assets, the fair value through profit and loss model is to be applied only if the fair value is determinable without undue cost and effort — the cost-depreciation-model is the alternative.

In the case of equity-based payments, the directors’ best estimate of fair value can be used in case observable market prices are unavailable, which reflects the theme of the IFRS — simplify norms, easier recognition and measurement criteria and essential disclosures.

India SME-IFRS

It would not be too long before India needs to develop an IFRS for SMEs. It is apparent that this standard would need to be tailor-made for India starting with the definition of an SME. The present norms in India determine SMEs based on turnover.

This criterion could be revised and continued since it is unthinkable at this point of time to define all non-public companies as SMEs due to the fact that the provisions of IFRS would need to be injected slowly, as fair value, impairment and such norms could take a toll on the financials.

The IASB has taken six years to bring the IFRS from concept-to-completion stage, which could be some indicator of the intricacies of formulating an accounting standard for SMEs. The critical thing is to make a start.