IFRSs for SMEs in the Kenyan Context

CATHOLIC UNIVERSITY UNIVERSITY OF EASTERN AFRICA

Faculty of Commerce

Department of Accounting and Finance

Unit: Accounting for Partnerships

Unit Code: CAC423

Presented by: Terrence Chanzu

Registration Number: 1008783

Presented to: Mrs. Esther Mbuthia

Assignment: IFRSs for SMEs in the Kenyan Context

What

is the International Financial Reporting Standard for Small - and Medium-Sized Entities (IFRS for SMEs)?

IFRS for SMEs is a modification and simplification of full IFRS aimed at meeting the needs of private company financial reporting users and easing the financial reporting burden on private companies through a cost-benefit approach. IFRS for SMEs is a self-contained global accounting and financial reporting standard applicable to the general-purpose financial statements statements of, and other financial reporting by, entities that in many countries are known as small- and medium-sized entities. Full IFRS and IFRS for SMEs are promulgated by the International Accounting Standards Board (IASB). What

is meant by small - and medium-sized entities (SMEs)?

IFRS for SMEs is intended to be used by SMEs, which are entities that publish general purpose financial statements statements for external users and do not have public accountability. accountability. An entity has public accountability under the IASB's definition if it files, or is in the process of filing, its financial statements with a securities commission commission or other regulatory organization for the purpose of issuing any class of instruments in a public market; or it holds assets in a fiduciary capacity for a broad group of outsiders. Examples of entities that hold assets in a fiduciary capacity include banks, insurance companies, brokers and dealers in securities, pension funds and mutual funds. It is not the IASB's intention to exclude entities that hold assets i n a fiduciary capacity for reasons incidental to their primary business (for example, travel agents, schools and utilities) from utilizing IFRS for SMEs. Practically speaking, IFRS for SMEs are often viewed as an accounting framework for entities that are not of the size nor have the resources to use full IFRS. In Kenya, the term "SME" would e ncompass ncompass many private companies, partnerships and sole proprietorships. The term "SME" is not a familiar one in Kenya. What kinds of entities in the country would be SMEs, as that term is used by the IASB?

The IASB's IFRS for SMEs is geared toward private company reporting. In fact, when developing the standard, the IASB focused on the nee ds of a typical mid-size private company. company. Given the IASB's definition of a SME, many private companies would fit the definition of the type of entity for which the IASB developed IFRS for SMEs.

What has the

International Accounting Standards Standards Board accomplished by issuing IFRS for SMEs?

The types and needs of users of SME financial statements are often different from the types and needs of users of  public company financial statements and other entities that would likely use full IFRS. Full IFRS were designed to meet the needs of equity investors in companies in public capital markets. Users of the financial statements of  SMEs (or private companies in Kenya) don't generally have those same needs. Rather, users of the financial statements of SMEs are more focused on shorter-term cash flows, liquidity, balance sheet strength, interest coverage and solvency issues. Also, full IFRS impose a burden on SME preparers in that full IFRS contains topics and detailed implementation guidance that generally are not relevant to SMEs. This burden has been growing as IFRS have become more detailed. As such, a significant need existed for an accounting and financial reporting standard for SMEs that would me et the needs of their financial statement users while balancing the costs and benefits from a preparer perspective. IFRS for SMEs was designed to meet that need. With the issuance of IFRS for SMEs, many SMEs around the world, including private companies companies in Kenya, will have the option of using a much simplified, IFRS-based accounting framework to prepare their financial statements.

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What

significance does the issuance of IFRS for SM Es have in Kenya?

Kenyan businesses are not "required," like public companies, to use a particular basis of accounting when preparing their financial statements. The factors that drive a private company's choice of which financial accounting and reporting framework to follow in pre paring its financial statements depend upon each company's objectives and the needs of their financial statement users. Currently, private companies companies in Kenya can prepare their financial statements in accordance with GAAP as promulgated by the Financial Accounting Standards Standards Board (FASB); another comprehensive basis of accounting (OCBOA), such as cash- or tax-basis; or full IFRS, among others. Now, with the issuance of IFRS for SMEs, private companies have an additional option. Which

entities in Kenya can use IFRS for SMEs?

The IASB intends IFRS for SMEs to be used by entities that meet their definition of a SME (publish general purpose financial statements for external users and do not have public accountability). accountability). Practically speaking, this means that many private companies in Kenya can prepare their financial statements in accordance with IFRS for SMEs. Of  course, a variety of factors will drive that decision, such as the needs of financial statement users and possible regulatory reporting requirements. Are there any barriers to Kenyan businesses using IFRS for SMEs?

In May 2008, the AICPA governing Council voted to recognize the IASB as an accounting body for purposes of  establishing international financial accounting accounting and reporting principles. This amendment to Appendix A of AICPA Rules 202 and 203 gives AICPA members the option to use IFRS as an alternative to GAAP. As such, a key professional barrier to using IFRS and therefore IFRS for SMEs has been removed. CPAs may need to check with their state boards of accountancy to determine the status of reporting on fi nancial statements prepared prepared in accordance with IFRS for SMEs within their individual state. Any remaining barriers may come in the form of  unwillingness by a private companys financial statement users to accept financial statements prepared under IFRS for SMEs, and a private companys expenditure of money, time and effort to convert to IFRS for SMEs.

Are IFRS and IFRS for S MEs considered generally accepted accounting principles?

Yes. The AICPA's governing Council recognizes the IASB as an accounting body for purposes of establishing international financial accounting accounting and reporting principles. Full IFRS and IFRS for SMEs are not another comprehensive basis of accounting. accounting. Rather, they are generally accepted accounting principles.

Why

would a private company in Kenya choose to p repare its financial statements in accordance with IFRS for

SMEs?

The reasons why a private company would prepare IFRS for SMEs-based financial statements are varied, depending upon the objectives of the company and the needs of i ts financial statement users. Some private companies may find the simplified IFRS for SMEs an attractive alternative to the more complicated and voluminous GAAP. Those private companies may find IFRS for SMEs to be a more relevant and less costly financial accounting and reporting standard than international GAAP. 2

Other examples of why a private company in Kenya may decide to use IFRS for SMEs include the following: y

The private company is owned by a foreign parent

y

The private company has a foreign investor

y

The private company is a supplier to foreign companies

y

The private company has a foreign venture partner.

An ever increasing amount of private companies are looking to conduct business outside the Unites States and obtain foreign financing. Using a common global financial accounting and reporting standard, like IFRS for SMEs, increases comparability between companies and improves the efficiency of conducting business across borders. Users of private company financial statements prepared in accordance with IFRS for SMEs would benefit from a common global standard. In conducting business with private companies in different countries, lenders, venture capitalists and other users would just need to understand and work with one financial accounting and reporting standard. Many foreign countries maintain a simplified version of their national GAAP. With the issuance of IFRS for SMEs, companies now have a similar option to use accounting standards tailored for smaller, private entities. Does the AICPA support the use of IFRS fo r SMEs in Kenya?

The AICPA welcomes the introduction of IFRS for SMEs in Kenya. Private companies companies should be allowed to choose the financial accounting and reporting framework that best suits their objectives and the needs of their financial statement users. IFRS for SMEs represents another valuable financial accounting and reporting option for private companies to consider using, depending upon their u nique circumstances. circumstances. What

are some key differences b etween GAAP and IFRS for SMEs?

IFRS for SMEs is an approximately 230 page, significantly reduced and simplified version of full IFRS. In cr eating IFRS for SMEs, the IASB eliminated many accounting topics that are not generally relevant to private companies (for example, earnings per share and segment reporting). reporting). Being based on full IFRS and missing many accounting topics, IFRS for SMEs therefore differs from GAAP in a variety of areas. Some of the key differences under IFRS for SMEs are: y

Disclosures are simplified in a

y

LIFO is prohibited.

y

Goodwill and indefinite life intangible assets are amortized over a period not exceeding ten years.

y

Depreciation is based on a

y

A simplified temporary difference approach to income tax accounting.

y

Reversal of impairment charges, if certain criteria are met, is allowed.

y

Accounting for financial assets and liabilities makes greater use of cost.

What

number of areas including pensions, leases and financial instruments.

components approach.

does one do when an entity has a transaction not addressed in IFRS for SMEs?

If IFRS for SMEs does not specifically address a transaction, other event or condition, an entity's management shall use its judgment in developing and applying an accounting policy that results in i nformation that is: a)

Relevant to the economic decision-making needs of users, and

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b)

Reliable, in that the fi nancial statements: statements: i.

Represent faithfully the financial position, financial performance and cash flows of the entity;

ii.

Reflects the economic substance of transactions, other events and conditions, and not merely the legal form;

iii.

Are neutral (in other wor ds, free from bias);

iv.

Are prudent; and

v.

Are complete in all material respects.

In making the judgment described above, management should refer to, and consider the applicability of, the following sources in descending order: c)

the requirements and guidance in IFRS for SMEs dealing with similar and related i ssues, and

d)

The definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses and the pervasive principles in Section 2, Concepts and Pervasive Principles, of IFRS for SMEs.

In making the judgment described above, management may also consider the requirements and guidance in full IFRS dealing with similar and r elated issues. What are some of the

key challenges that a private company in Kenya would face in using IFRS for SMEs?

Some key challenges that may be present in choosing to use IFRS for SMEs include understanding the differences between IFRS for SMEs and GAAP; the willingness of financial statement users to accept financial statements prepared under IFRS for SMEs; working with and accepting a more principles-based set of accounting standards compared to the more rules-based GAAP; the impact on taxes and tax planning strategies; and the impact on financial reporting metrics.

What

resources are or will b e available to help me understand and implement IFRS for SMEs?

The final IFRS for SMEs (together with the basis for conclusions, illustrative financial financial statements, and a presentation and disclosure checklist) can be obtained without charge from the IASB Web site (iasb.org/IFRS+for+SMEs iasb.org/IFRS+for+SMEs). ). The IASC Foundation is developing training modules associated with the different sections of IFRS for SMEs. These modules are expected to be available for free by late 2009. The AICPA is developing a publication that will provide a technical comparison between IFRS for SMEs and GAAP. Such a tool would be valuable to anyone thinking about adopting or reporting on IFRS for SMEs and trying to understand how IFRS for SMEs compares to GAAP. In addition, the AICPA will be developing CPE courses related to IFRS for SMEs. Visit www.ifrs.com to stay abreast of other AICPA resources that become available to help you better understand and implement IFRS for SMEs. Benefits

The IFRS for SMEs responds to strong international demand from both developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized businesses that is much simpler than full IFRSs. In particular, the IFRS for SMEs will: y

Provide improved comparability for users of accounts

y

Enhance the overall confidence in the accounts of SMEs, and 4

y

Reduce the significant costs involved of maintaining standards on a national basis.

y

Financial institutions make loans across borders and operate multi-nationa multi-nationally. lly. In most

y

Jurisdictions, over half of all

y

Bankers rely on financial statements in making lending decisions and i n establishing terms and interest

SMEs, including the very small ones, have bank loans.

rates. y

Vendors want to evaluate the financial health of buyers in other countries before they sell goods or services on credit.

y

Credit rating agencies try to develop ratings uniformly across borders. Banks and other institutions that operate across borders often develop similar ratings. Reported financial

y

Information is crucial to the r ating process.

y

Many SMEs have overseas suppliers and use a suppliers financial statements to assess the prospects of a viable long-term business relationship.

y

Venture capital firms provide funding to SMEs across borders.

y

Many SMEs have outside investors who are not involved in the day-to-day management management of the entity.

The IFRS for SMEs will also provide a pl atform for growing businesses that are preparing to enter public capital markets, where application of full IFRSs is required. The IFRS for SMEs is separate from full IFRSs and is therefore available for any jurisdiction to adopt whether or not it has adopted the full IFRSs. It is also for each jurisdiction to determine which entities should use the standard. It is effective immediately on issue.

References: 1.

www.ifrs.com

2.

http://www.iasb.org/IFRS+for+SM http://www.iasb.org/IFR S+for+SMEs/IFRS+for+SMEs.htm Es/IFRS+for+SMEs.htm

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