The New Accounting Standard for Small Entities

An SME-dedicated standard for Singapore small businesses is in the pipeline


The Singapore Accounting Standards Council (ASC) issued a Statement of Intent for the adoption of the Financial Reporting Standard for Small Entities (FRS for Small Entities) in June 2010. It is likely that the ASC will issue the FRS for Small Entities in the last quarter of 2010 and eligible companies may adopt the Standard for financial periods beginning on or after 1 January 2011.

According to the ASC's Statement of Intent, a company would qualify as a "Small Entity" if it is not publicly accountable and satisfies two out of three criteria:

  1. Total annual revenue is not more than S$10 million;
  2. Total gross assets is not more than S$10 million; and
  3. Total number of employees is not more than 50 people.

If the company is considered as a group of companies, the criteria should be applied on a consolidated basis.

Companies in Singapore are all familiar with the Singapore Financial Reporting Standards (SFRS). The SFRS have served Singapore well and contributed to a progressive financial reporting regime that has put Singapore on the world map as one of the leading business centres. How different is the FRS for Small Entities from the SFRS? How will this new accounting standard benefit smaller businesses in Singapore? Should small companies adopt this new standard? These are probably some of the questions that many readers may have. We briefly examine these issues in this article.

The main features and benefits at a glance
In short, the FRS for Small Entities is a simplified version of the full SFRS. The simplifications are aimed at making accounting requirements less complex for smaller companies. The intention is to alleviate the compliance costs that many smaller companies face when preparing financial statements under the full SFRS. "Undue cost or effort principle" is added in some sections. In other words, the "undue cost or effort" principle implies that cost is always a key element to be considered. For example, the FRS for Small Entities excludes topics and disclosure requirements that are irrelevant to the typical SME. Excluded topics include earnings per share, interim financial reporting, insurance contracts, segment reporting and assets held for sale. In addition, it eliminates some accounting options and simplifies the recognition and measurement principles and significantly reduces disclosure requirements. Users of the new standard will also note that it is written in a more concise and readable manner as compared to the full SFRS.

Should existing SFRS-compliant small companies adopt this new standard?
In Singapore, the majority of the smaller entities are owner-managed. Many of such entities have limited resources and are highly cost-conscious. While the FRS for Small Entities purportedly reduces the compliance costs of financial reporting, existing small businesses that are already reporting under the SFRS need to carefully weigh the additional effort and costs that may arise from transitioning from the SFRS to this SME-dedicated standard. For example, time and effort will have to be spent to modify the current accounting software to align the reporting requirements to the FRS for Small Entities. Additional training costs to re-educate finance and accounting staff to the requirements of the new accounting standard, together with other incidental conversion costs, may need to be incurred as well. It is thus imperative that smaller companies - those meeting the eligibility conditions of the SME-dedicated standard - fully understand and evaluate the costs and benefits involved before making a decision to convert to the FRS for Small Entities. It would probably be wise for companies that are comfortable reporting under the full SFRS to continue adopting the full SFRS.

How about a new start-up?
The situation, however, may be quite different for a new start-up that satisfies the eligibility threshold criteria to adopt the FRS for Small Entities. Unlike existing SFRS-compliant companies, a new start-up would not have to grapple with change management issues that arise from a transition to the SME-dedicated standard. They can immediately enjoy the benefits of simplified accounting and reduced disclosure requirements. For a new start-up, the major benefits from adopting the FRS for Small Entities are the substantial reduction in disclosure requirements. As compared to the full SFRS, several disclosure requirements have been omitted for two key reasons. Firstly, the purpose of the FRS for Small Entities is to simplify the process of preparing the financial statements. Therefore, the more complex and lengthy disclosure requirements are omitted. Secondly, since smaller companies are mainly owner-managed, there is no purpose to include disclosures which are not relevant to their owners. The full SFRS are fundamentally designed for the information needs of the capital markets. Certain disclosures in the full SFRS are thus more relevant to external shareholders who invest in publicly listed companies, but are of little relevance to owners of smaller companies which are not publicly accountable.

Future IPO plans do matter
What if you are a thriving small business that is aspiring to launch an IPO to drive your next phase of development? Would adopting the FRS for Small Entities be a wise choice? At the date of this article, relevant regulatory authorities have not made any public pronouncements as to whether a company could still prepare financial statements based on the FRS for Small Entities if it intends to go public. Theoretically though, the FRS for Small Entities is not recommended for IPO-aspiring companies as this SME-dedicated standard is targeted at smaller companies with no public accountability. The act of raising capital through an IPO puts you in a position of public accountability, and this would disqualify you from adopting the FRS for Small Entities. Hence, if you are a thriving small business with IPO plans, it is more practical to continue with the full SFRS.

The consolidated financial statements of the parent must be prepared with a consistent application of SFRS across all the entities being consolidated. If the parent uses SFRS, the subsidiary will not be able to use FRS for Small Entities where there are differences in accounting policies between the two.

Eligibility threshold considerations
The recent global financial crisis has hit many multinational companies badly and some small businesses in Singapore. As the economic outlook improves, these companies would experience significant increase in their sales and business activities. The sales of these companies fluctuate with the boom-and-bust cycle of the global economy, much like a "roller-coaster". Would such fluctuations in business activity affect the small company's eligibility to apply the FRS for Small Entities consistently over time? What if fluctuating business fortunes affect a small company's eligibility to apply the SME-dedicated standard year after year? The ASC envisaged this and intends to provide a transitional relief for "marginal entities" that fall in and out of the eligibility threshold criteria due to year-on-year fluctuation in financial and operational results. In the Statement of Intent, the ASC has proposed that a company be disqualified from using the FRS for Small Entities if it fails to satisfy the prescribed eligibility threshold criteria for two consecutive years. Hence, the prospective trend and stability of business activity is yet another important factor that small business owners have to consider before jumping on the bandwagon of the simplified standard. It would be costly to implement the new standard, only to be disqualified later for failing to meet the threshold criteria for two straight years.

Separately, the ASC has also explained in its Statement of Intent that the three eligibility criteria are set after considering the position taken by the Steering Committee for Rewriting the Companies Act. The proposed eligibility threshold criteria are expected to be consistent with the "Small Company" definition to be recommended by the Steering Committee. It is also expected that the revised audit exemption threshold would be increased from the current S$5 million of annual revenue to the threshold set by the ASC in this SME-dedicated standard. However, it is still unclear whether the shareholders' structure requirements would be further relaxed. If the audit exemption threshold is increased, more Exempt Private Companies (EPC┬╣) may opt out from having their financial statements audited. There could be an increase in EPCs preparing unaudited financial statements - prepared either under the full SFRS or FRS for Small Entities.

The countdown begins
The countdown to the ASC's issuance of the FRS for Small Entities has begun. What remains to be seen is whether financial statement users will embrace the simplified standard as an equivalent to the full SFRS in terms of accounting rigour and disclosure quality.

An Exempt Private Company (EPC) is defined under Section 4(1) of the Singapore Companies Act as a company which has not more than 20 shareholders; shares are not held by another company and the company's annual revenue is not more than S$5 million.

Selected key differences between FRS for Small Entities and full SFRS:

FRS for Small Entities Full SFRS
Financial Statements Same requirement as full SFRS. However, the FRS for Small Entities permits a company to present a "Statement of income and retained earnings" in place of statement of comprehensive income and a statement of changes in equity if only changes to its equity (during the period for which financial statements are presented) arise from profit or loss, payment of dividends, corrections of prior period errors, and changes in accounting policy. A statement of changes in equity is required for each component of equity, reconciliation between the carrying amount at the beginning and the end of the period.
Investments in associates and joint ventures FRS for Small entities provide three options in accounting for investments in associates or joint ventures:
  1. The cost model (cost less any accumulated impairment losses);
  2. The equity method, and
  3. The fair value through profit or loss model.
Investments in associates are accounted for using the equity method. The cost and fair value models are not permitted except in separate financial statements. Investments in joint ventures could be accounted for using the proportionate consolidated method or the equity method. The cost and fair value models are not permitted.

Investment properties

Investment properties are carried at fair value if this fair value can be measured without undue cost or effort. Company can choose cost method or fair value method for subsequent measurements.
Non-financial assets and goodwill The cost model is the only permitted model for all. Intangible assets, including goodwill, are assumed to have finite lives and are amortised over a period not exceeding ten years. For tangible and intangible assets, there is an accounting policy choice between the cost model and revaluation model. Goodwill and other intangibles with indefinite lives are reviewed for impairment and are not amortised.
Revaluation of property, plant and equipment and intangible assets Property, plant and equipment and intangible assets must be measured only by costs less any accumulated depreciation and any accumulated impairment losses. Companies have a choice of adopting the cost model or revaluation model for property, plant and equipment and intangible assets.
Borrowing costs All borrowing costs are recognised as expenses as incurred. The capitalisation model is not an option. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are to be capitalised.

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