What do the changes in Australian financial reporting mean for SMEs?

By Zilla Efrat

Unlisted company annual reports are not a mere exercise in compliance, but an important decision-making tool for a variety of stakeholders. This is the finding of Annual Reports of Unlisted Australian For-Profit Entities, a study commissioned by CPA Australia and conducted by Swinburne University of Technology’s business school.

The research also compared the current Tier 2 Reduced Disclosure Regime (RDR) against the International Financial Reporting Standard for SMEs (IFRS for SMEs), finding there was no significant difference in the usefulness of the information provided in financial statements prepared using either framework.

This finding is timely, given that the IFRS for SMEs is currently being reviewed by the International Accounting Standards Board (IASB) and that the RDR framework currently used in Australia will be replaced by the Simplified Disclosures Standard (AASB 1060) from 1 July 2021.

“On the evidence from our comparative case studies, the Australian Accounting Standards Board (AASB) decision not to introduce the IFRS for SMEs standard accounting framework is vindicated – for large proprietary companies,” says Dr Janine Muir CPA, a lecturer in accounting at Swinburne University of Technology’s business school and one of the researchers involved in the study.

RDR vs IFRS for SMEs

Although Australia has decided not to adopt IFRS for SMEs, Ram Subramanian, CPA Australia’s senior manager for reporting policy, says Singapore, Hong Kong and Malaysia have all adopted the standard, as have around 83 other countries.

Initially, Subramanian was somewhat surprised by the research’s finding on the comparison between the two frameworks. “Then I gave it some thought. Ultimately, users don’t necessarily see the frameworks themselves. They only see the end product, the financial statements,” he says.

“If the frameworks are doing their jobs correctly, then either one can be used. “It says to me that both the frameworks serve their purpose from a user-needs perspective.”

If the benefits are the same from a user’s perspective, Subramanian believes policymakers and standard setters should consider which framework is more cost effective for SMEs to apply.

“At this stage, we don’t know whether using a different framework might be cheaper over the long term. But, as they say, a bird in the hand is worth two in the bush. There’s a view that it’s working, and we should just carry on with what we are used to.”

 

"The evidence from our research strongly indicates the financial report is the most important component of the annual report when making important decisions."

 

However, Subramanian notes the RDR framework is based on full recognition and measurement requirements of the IFRS-based Australian Accounting Standards.

“IFRS for SMEs, as a standalone document, is basically a filtered version of the 3000 odd pages of IFRS with reductions in not just disclosures, but recognition and measurement requirements as well. It comes to 250 odd pages,” he says.

“So, applying a simpler set of requirements should, in theory, be easier. That’s why some people argue that, over time, IFRS for SMEs will serve the needs of the market better than the larger RDR framework currently being applied and its replacement based on the Simplified Disclosure Standard.”

CPA Australia has expressed support for IFRS for SMEs in the past. “We haven’t reiterated that in recent times, simply because the AASB has discounted IFRS for SMEs as an option, but we still believe that it should be considered in the future,” says Subramanian.

“Some commentators view the requirement for reporting demanded of some unlisted entities as nothing more than a compliance exercise,” says Muir.

“They doubt the usefulness of these reports, including the financial report to stakeholders, including equity holders and providers of debt. But the evidence from our research strongly indicates the financial report is the most important component of the annual report when making important decisions.

“Our research shows that the annual reports of unlisted companies are being used for making decisions after they are produced – evidence that will be welcomed by CPA Australia members as further affirmation of the importance of the work they do.”

In fact, the research has found that the financial report is considered to be the most important piece of information in the annual report, in particular the financial statements.

These, for the current and comparative years, as well as the notes to the financial statements, are considered more important to users’ most important decision than the directors’ declaration.

When making their most important decision, the top three pieces of information used in the annual report are the financial report (40 per cent), directors’ report (29 per cent) and auditor’s report (28 per cent).

Information from outside of the annual report – for example, that on the company’s website – is considered only moderately important by the research’s respondents.

According to the study, analysing and providing recommendations are the most common reasons for using the annual report. This is followed by making equity investment decisions and monitoring or assessing the performance of those responsible for governance or managing the entity and for regulatory compliance decisions.

Where to from here

The report recommends that, as a matter of policy, regulators and standard setters better connect with annual report users to understand their information needs as a prerequisite to determining the reporting requirements for unlisted for-profit entities.

It also recommends that the IASB broaden the scope of its Disclosure Initiative – Subsidiaries project to all SMEs, and also focus on the interaction of that project and the project involving the comprehensive review of the IFRS for SMEs.

“We believe the report might provide the IASB with some meaningful research-based findings, which it can use for the purpose of developing the IFRS for SMEs standard,” says Subramanian.

A call for more detailed reports

Jeffrey Luckins FCPA, audit and assurance director at accounting firm William Buck, favours neither the RDR nor IFRS for SME-based frameworks.

“The difficulty of introducing IFRS for SMEs is that it creates a whole new framework for financial reporting and will generate confusion among readers of those financial reports as to the extent to which measurement standards have been implemented and the type of disclosures applicable,” he says.

“I think it will actually add layers of complexity and will give you less information than the Tier 2 general-purpose financial report.

“That might be fine, depending on the entity. But if stakeholders rely on information in the financial report, that tells you that Tier 2 general purpose financial reporting is actually required, not a watered-down version.

“The whole point of special-purpose financial reporting is that, if you are a key stakeholder, you actually have the power, authority and the ability to obtain the direct information you require, which is not going to be in the financial report anyway.”

Luckins says special-purpose financial reports are normally prepared with the aim of minimising the disclosures required and thus tend to be of marginal value to stakeholders.

“If you are an unlisted for-profit entity wanting to raise your profile, attract investment, key relationships and new customers, the ideal approach would be to produce a high-quality general-purpose financial report and request the auditor issue an enhanced audit report which addresses the key audit matters for a greater level of assurance among readers of the report. Effectively, the unlisted for-profit company now has a high-quality financial report to raise its credibility and its potential to be successful in all its endeavours.”

Luckins calls for more detailed financial reporting, not short-cut reports.

“If you are a pre-IPO company, it’s a little bit like an employee wanting to get promoted. The best way to get promoted is to actually do the job of the person above you in the role you want to get promoted into. Then people can see you are worthy of the promotion from your demonstrated actions and ability.

“Pre-IPO companies need to act like they are already listed to demonstrate to investors and the like that they have the operational, governance and reporting functions in place. The best way for them to do this is to implement an audit and risk committee which includes independent members, issue a general-purpose financial report and request an enhanced audit report from their auditor,” he says.