How Relevant is Size for Setting the Scope of The IFRS for SMEs?

Albu, Catalin Nicolae Article How Relevant is Size for Setting the Scope of The IFRS for SMEs? Journal of Accounting and Management Information Systems (JAMIS) Provided in Cooperation with: The Bucharest University of Economic Studies Suggested Citation: Albu, Catalin Nicolae (2013) : How Relevant is Size for Setting the Scope of The IFRS for SMEs?, Journal of Accounting and Management Information Systems (JAMIS), ISSN 2559-6004, Bucharest University of Economic Studies, Bucharest, Vol. 12, Iss. 3, pp. 424-439 This Version is available at: https://hdl.handle.net/10419/310532 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Cătălin Nicolae ALBU 1 The Bucharest University of Economic Studies, Romania ABSTRACT The International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs) is currently considered for adoption by national regulators in many emerging economies and a few developed countries. The cost-benefit approach is advanced as useful to investigate how the scope of the IFRS for SMEs should be set. Size is used in many jurisdictions as criterion to set financial reporting obligations, but it is questioned if it represents an appropriate criterion for the scope of the IFRS for SMEs. The aim of this paper is therefore to empirically investigate the applicability and consequences of using various criteria to set the scope of IFRS for SMEs, and to discuss the implications of using size instead of other criteria. Data consists of a sample of 194 questionnaires completed by accountants employed by Romanian SMEs. I find that the choice between size and other criteria is related to placing greater emphasis on preparers or users, or on costs versus benefits. Also, findings suggest that while size is correlated with users-based criteria, the level of agreement between various criteria for setting the scope of the standard is medium. Therefore, in order to capture the cost-benefit tension two criteria might be used in deciding the scope of the standard. IFRS for SMEs, emerging economies, Romania, quantitative criteria JEL code: M41, M48 1 Correspondence address: Bucharest University of Economic Studies, Romania, Faculty of Accounting and Management Information Systems, 6 Piaţa Romană, sector 1, Bucureşti, 010374, Tel: +40 21 319 1900/365, Email: catalin.alb[email protected]  How relevant is size for setting the scope of the IFRS for SMEs Vol. 12, No. 3 425 INTRODUCTION The International Accounting Standards Board (IASB) issued in 2009 the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs) (IASC Foundation, 2009a), as a response to “strong international demand from both developed and emerging economies for a rigorous and common set of accounting standards for smaller companies” (IFRS Foundation, 2010). Recent surveys about the IFRS for SMEs adoption reveal that over 80 countries have adopted or announced plans to do so (IFRS Foundation, 2012). While in many developed countries the potential adoption “has been associated with certain distrust” (Quagli & Paoloni, 2012: 42), many emerging economies embrace the IFRS for SMEs with high expectations in terms of improving the quality of financial reporting and of attracting foreign capital (United Nations, 2011; Bohusova & Blaskova, 2012; Quagli & Paoloni, 2012). Therefore, much of the existing literature on the IFRS for SMEs is placed in the context of emerging economies (Nerudova & Bohusova, 2008; Albu et al., 2010; Pasekova et al., 2010; Siam & Rahahleh, 2010; Strouhal, 2011; Bunea et al., 2012; Albu et al., 2013a; Uyar & Güngörmüş, 2013). Albu et al. (2013a) investigates the suitability of the IFRS for SMEs for emerging economies, the implementation approach and the scope of the standard. Prior literature also inventories the difficulties associated with international standards implementation in general, including the lack of competencies, the reduced level of compliance, the lack of local institutions to support IFRS implementation (Albu et al., 2011; Bohusova & Blaskova, 2012; Uyar & Güngörmüş, 2013). These findings suggest that the cost-benefit approach in analyzing the potential implementation of the IFRS for SMEs is more complex and subjective in emerging economies. Costs might be higher than in developed economies, and the lack of competencies of local professions represent an important factor; however, benefits in terms of improving the reporting system, at entity, industry or national level are also critical for these countries. Criteria used to set the scope of the standard are also important, affecting the cost-benefit relationship. This research is motivated by the increasing number of emerging economies embracing the IFRS for SMEs and by the importance of the cost-benefit analysis in deciding the scope of the standard. Size is used in many jurisdictions as a criterion to set financial reporting obligations, but it is questioned if it affects the suitability of the standard for various types of SMEs (Eierle & Haller, 2009). The aim of this paper is to empirically investigate the applicability and consequences of using various criteria to set the scope of IFRS for SMEs, and to discuss the implications of using size instead of other criteria. I administer a questionnaire-based survey to accountants in Romanian SMEs. A total of 194 usable answers were received. Therefore, responses take into consideration professional accountants’ perceptions Accounting and Management Information Systems Vol. 12, No. 3 426 about the SMEs and accounting for SMEs in terms of users, use of financial statements, types of funding and international exposure. This research extends the sample and the analysis of Albu et al. (2013b) which already suggested that size is a moderate indicator of the existence of users, and that by using size as a criterion to set the scope of the standard some SMEs would fall out of the scope while the standard might be beneficial for them, and that others will have to incur the cost without having direct benefits. I relate in this paper the various criteria to be used to set the scope of IFRS for SMEs to the cost – benefit analysis and to SMEs stakeholders. More precisely, I find that the choice between size and other criteria is related to placing greater emphasis on preparers or users, or on costs versus benefits. Also, findings suggest that while size is correlated with users-based criteria, the level of agreement between various criteria in setting the scope of the standard is medium (of approx. 60-70%). Also, the level of agreement between the decision based on size or on user-based criteria does not significantly differ if different size thresholds are established (larger SMEs versus all SMEs except for micro-entities). These findings are useful for future research in order to further investigate the suitability of the IFRS for SMEs for various settings and types of entities. Also, they might be of interest for preparers, users, and regulators when investigating and making decisions about accounting standards and their suitability. The rest of the paper is structured as follows: after a literature review in Section 1, I present the research methodology in Section 2. This is followed by the research results in Section 3. The last section completes the paper, presenting its main conclusion, findings and research limitations. 1. LITERATURE REVIEW IFRS for SMEs development has been based on user needs, costs and SMEs capabilities (IFRS Foundation, 2012). The adoption decision has to take into consideration the implications on the same levels. Consequently, the cost – benefit relationship and the analysis of all stakeholders become very important in the context of SMEs when analyzing the suitability of the IFRS for SMEs. Research in this area is rather fragmented, both in terms of issues analyzed and geographical coverage. Litjens et al. (2012) find that preparers consider costs and benefits of IFRS for SMEs separately, not concurrently. While the cost-benefit relationship is important when judging the reporting requirements, it becomes apparent that costs are more obvious and easier to be assessed than expected benefits. In this regard, Albu et al. (2013a) suggest that a significant emphasis on costs when analyzing the suitability of the IFRS for SMEs moves the emphasis in the financial reporting process from users to preparers. How relevant is size for setting the scope of the IFRS for SMEs Vol. 12, No. 3 427 Users and preparers are the most investigated categories of SMEs stakeholders. Quagli and Paoloni (2012) investigate users’ and preparers’ answers to the “Questionnaire on the public consultation of the IFRS for SMEs” at the European Union (EU) level. They find that preparers manifest stronger opposition to the IFRS for SMEs, while users are more favorable. However, the respondents come from developed countries and the emerging economies of the EU are not represented 1 . Using interviews, Albu et al. (2013a) find that in four emerging countries all stakeholders manifest a medium support for IFRS for SMEs’ possible implementation, variations concerning mainly the implementation approach (mandatory adoption, voluntary adoption or convergence). On the other hand, Uyar and Güngörmüş (2013) find evidence regarding the lack of training as a major obstacle to the implementation in Turkey, a country in which the adoption decision has been made. When investigating the stakeholders’ perception about the IFRS for SMEs implementation, the implementation approach and the scope of the standard have to be taken into consideration. Existing literature suggests variations in stakeholders’ opinions, possibly caused by the differences in the economic development of a country (developed vs. emerging), the size, international exposure and other features of SMEs under discussion, the experience of respondents, and the implementation approach (Bunea et al., 2012; Quagli & Paoloni, 2012; Albu et al., 2013a). Therefore, stakeholders’ attitude should be nuanced. While the impact of the country’s origin and the implementation approach has been tentatively investigated (Quagli & Paoloni, 2012; Albu et al., 2013a), prior findings concerning how the possible scope of the standard relates to stakeholders (and especially users and preparers) are rather fragmented. Jarvis and Collis (2003) suggest that even if the banks and managers/owners are the main users of financial reporting by smaller entities, agency relationships exist between them and stewardship plays an important role. On the other hand, Eierle and Schultze (2013) underline that in smaller entities financial statements are used for decision making by managers, mainly because of the cost-benefit relationship. They suggest that standard setters should not ignore the requirements of managerial information in the process of standard setting. The scope of the IFRS for SMEs as issued by the IASB is defined to be entities that “do not have public accountability and publish general purpose financial statements for external users” (IASC Foundation, 2009a: par. 1.2.). In IASB’s view “size is not a barrier. Any company of any size is eligible to use the IFRS for SMEs, provided it does not have public accountability” (IFRS Foundation, 2010). However, “in deciding which entities should be required or permitted to use the IFRS for SMEs, jurisdictions may choose to prescribe quantified size criteria” (IASC Foundation, 2009b: BC70). Accounting and Management Information Systems Vol. 12, No. 3 428 Size is usually measured by the number of employees, sales and total assets. The use of quantified criteria like these ones in deciding the scope of standards creates clarity for all stakeholders (Jarvis and Collis, 2003). Quantitative criteria for differential reporting are already used in various jurisdictions (Jarvis and Collis, 2003) and seem to be the preferred approach for deciding the scope of a possible implementation of the IFRS for SMEs (Bunea et al., 2012; Quagli & Paoloni, 2012). On the other hand, size is not necessarily associated with accountability (IASC Foundation, 2009b: BC63), and the quantitative approach, even if it seems objective, may be distorted 2 (Bunea et al., 2012). Additionally, little research exists on how size affects the cost-benefit ratio in differential reporting (Jarvis & Collis, 2003). Eierle and Haller (2009) discuss based on prior literature how size is a proxy for the social and economic importance of a firm, a proxy for the number and heterogeneity of users and user needs. They suggest that larger SMEs may incur higher costs for financial reporting. When empirically investigating if the economic size has implications for accounting and regulatory issues, ambiguous results were obtained. The study reveals that international activities and IFRS knowledge are size-sensitive, but even smaller SMEs might have international exposure. Also, while cost-benefit assessment differs between different size clusters, size is not a factor determining the cost-benefit considerations. On the other hand, Di Pietra et al. (2008) suggest that there are significant differences between user groups of smaller and larger SMEs. The authors cite Kirsch and Meth (2007) arguing that smaller SMEs might have only banks as external users, and banks not necessarily base their decision on general purpose financial statements. While there is some empirical research supporting this statement (Di Pietra et al., 2008), interviews conducted in emerging economies suggest that financial statements are useful for bankers only for credit decisions, but also for various macroeconomic statistics about the entities in an industry, region or country (Albu et al., 2013a). While in a credit decision they may receive additional data from entities, data is not available for other analysis or statistics. In terms of compliance, Aljifri and Khasharmeh (2006, cited in Litjens et al., 2012) find that the level of international standards’ adoption is positively correlated with size, while Dang (2011) documents that the association between the size of business and compliance with accounting standards is not significant. Other authors propose to take into consideration the international exposure too, given that international standards are intended firstly to contribute to the improvement in the comparability. Paoloni (2006 cited in Di Pietra et al., 2008) argues that only entities operating in an international market would benefit from the IFRS for SMEs application. In the same vein, Eierle and Helduser (2013) investigate SMEs’ need to provide internationally comparable accounting information. They find that SMEs involved in international financial and lending How relevant is size for setting the scope of the IFRS for SMEs Vol. 12, No. 3 429 operations are more likely to report internationally comparable accounting information as compared to the entities involved in international commercial contracts. Consequently, there still are concerns about the practical implications of using size as a criterion for differential reporting (Di Pietra et al., 2008) and research is needed in this area. This study intends to address this gap in the current literature, by investigating how various criteria will influence the width of the scope of a possible implementation of the IFRS for SMEs. 2. RESEARCH METHODOLOGY In order to investigate the scope of standard under various criteria, information about SMEs was collected through questionnaires. A questionnaire was sent to professional accountants working in SMEs, using various channels of communication (personal contacts, local professional bodies support etc.). The research was carried between March and May 2012. While questionnaire-based survey may offer insightful information about SMEs accounting, they are difficult to be distributed and collected, especially in emerging economies. A number of 212 completed questionnaires were received, but 18 were discarded because they were incomplete in a sense that impeded statistical analyses. Therefore, the sample consists of 194 usable questionnaires. The sample description follows: Table 1. Descriptive demographics of the sample Size 3 Number of entities % of sample Micro-entities (0-9 employees) 94 48.45 Small entities (10-49 employees) 42 21.65 Medium-sized entities (50-249 employees) 58 29.9 Total 194 100 The questionnaire comprised general questions about business characteristics, such as size (turnover, number of employees, total assets), the local, regional, national or international orientation of their activity, the users of the financial statements, the source of finance, the usefulness of the financial statements for decision making for users, and some information about their current accounting model. All variables were binary ones, coded for example with 1 if the respondent indicated that the company has the analysts as users of its financial information, and with 0 if the entity does not have analysts as users. 51.54% of the entities in the sample conduct activities locally or regionally, 17.01% nationally, while 31.45% also have international business activities. Accounting and Management Information Systems Vol. 12, No. 3 430 The questionnaire did not include any question or reference to the IFRS for SMEs in order to not influence the answers to other questions. It is acknowledged in literature (Bunea et al., 2012; Uyar & Güngörmüş, 2013) that accountants might have a reduced level of knowledge about the IFRS for SMEs and this might create a bias in their responses to other questions. More than that, the scope of the questionnaire was not to gather data about their perception on the suitability of the IFRS for SMEs for their entity, but to collect data about the SMEs and their accounting system. All entities under research are based in Romania, an emerging economy, member of the EU since 2007. SMEs currently apply national accounting regulations based on the European Directives. Even if the IFRS for SMEs received a negative signal from the EU in terms of adoption, other scenarios (voluntary adoption or convergence) might be still investigated and of interest, since other emerging economies might gain competitive advantages by implementing the standard (Albu et al., 2013). The Romanian environment is characterized by a preference for banking financing, a code-law system and a strong relationship between accounting and taxation (Fekete et al., 2011). 3. RESEARCH RESULTS Various criteria for setting the scope of the IFRS for SMEs were investigated based on my sample, and the implications of using the size instead of other criteria are discussed. Based on the prior literature, these criteria can be related to size, to the existence of external users, and to the international exposure of the businesses. If the scope is decided based on size, it has to be decided if only micro-entities are excluded or smaller SMEs too. 29.9% of the businesses in my sample would be concerned by the application of IFRS for SMEs if only larger SMEs would be included in the standard’s scope (see Table 1). If only micro-entities are excluded, this proportion increases to 51.55% of the sample entities. In terms of involvement in international contracts, 31.45% of entities are involved and might be interested in providing internationally comparable accounting information. In order to analyze the users of SMEs, agglomerative cluster analysis was performed 4 . 96 entities were included in the first cluster (49.5% of the sample), and 98 in the second cluster (50.5% of the sample). The description of the two class centroids and central objects follows in Table 2: How relevant is size for setting the scope of the IFRS for SMEs Vol. 12, No. 3 431 Table 2. SMEs clusters based on the perceived existence of users for financial statements Item Tax authority Creditors Customers Suppliers Analysts Managers Owners Competitors Employees Press Public Class 1 centroid (Class 1 central object) 1.000 (1) 0.292 (0) 0.021 (0) 0.083 (0) 0.010 (0) 0.865 (1) 0.885 (1) 0.000 (0) 0.010 (0) 0.000 (0) 0.031 (0) Class 2 centroid (Class 2 central object) 0.745 (1) 0.867 (1) 0.765 (1) 0.908 (1) 0.306 (0) 1.000 (1) 1.000 (1) 0.459 (0) 0.296 (0) 0.337 (0) 0.531 (1) Accounting and Management Information Systems Vol. 12, No. 3 438 Bohusova, H. & Blaskova, V. (2012) “In what ways are countries which have already adopted IFRS for SMEs different”, Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, vol. LX: 37-43 Bunea, S., Săcărin, M. & Minu, M. (2012) “Romanian professional accountants’ perception on the differential financial reporting for small and medium-size enterprises”, Accounting and Management Information Systems, vol. 11, no. 1: 27-43 Dang, D.S. (2011) “Compliance with accounting standards by SMEs in transitional economies: evidence from Vietnam”, Journal of Applied Accounting Research, vol. 12, no. 2: 96-107 Di Pietra, R., Evans, L., Chevy, J., Cisi, M., Eierle, B. & Jarvis, R. (2008) “Comment on the IASB’s Exposure Draft ‘IFRS for Small and Mediumsized entities”, Accounting in Europe, vol. 5, no. 1-2: 27-48 Eierle, B. & Haller, A. (2009) “Does size influence the suitability of the IFRS for SMEs? Empirical evidence for Germany”, Accounting in Europe, vol. 6, no. 1-2: 195-230 Eierle, B. & Helduser, C. (2013) “What drives SMEs need to provide internationally comparable accounting information? Empirical evidence from Germany”, working paper, University of Bamberg Eierle, B. & Schultze, W. (2013) “The role of management as a user of accounting information: implications for standard setting”, Accounting and Management Information Systems, vol. 12, no. 2: 156-190 Fekete, S., Cuzdriorean-Vladu, D., Albu, C.N. & Albu, N. (2011) “Is indeed SMEs accounting influenced by taxation? Some empirical research from Romania”, 5th Accounting and Auditing Convergence Convention, 21-23 September, Cluj Napoca, Romania IFRS Foundation (2012) IFRS for SMEs Fact Sheet, updated September 2012, available at www.ifrs.org. IFRS Foundation (2010) A guide to the IFRS for SMEs, available at www.ifrs.org IASC Foundation (2009a) IFRS for Small and Medium Sized Entities, available at www.ifrs.org. IASC Foundation (2009b) Basis for conclusions on the IFRS for Small and Medium Sized Entities, available at www.ifrs.org Jarvis, R. & Collis, J. (2003) “International Financial Reporting Standards and differential reporting”, 26th ISBA National Small Firms Policy and Research Conference, 12-14 November, Egham, UK Litjens, R., Bissessur, S., Langendijk, H. & Vergoossen, R. (2012) “How do preparers perceive costs and benefits of IFRS for SMEs? Empirical evidence from the Netherlands”, Accounting in Europe, vol. 9, no. 2: 227-250 Nerudova, D. & Bohusova, H. (2008) “The empirical study of the SMEs position in the process of IFRS for SMEs application in the Czech Republic”, Economics and Management, vol. 13: 163-169 How relevant is size for setting the scope of the IFRS for SMEs Vol. 12, No. 3 439 Pasekova, M., Bialic-Davendra, M., Müllerová, L. et al. (2010) “IFRS for SMEs: Current Issues in Reporting of SMEs in the Czech Republic, Slovak Republic, Poland and Ukraine”, AMIS 2010 – Proceedings of the 5th Accounting and Management Information Systems International Conference, Bucharest, 16-18 June 2010, pp. 793-801. Quagli, A. & Paoloni, P. (2012) “How is the IFRS for SME accepted in the European context? An analysis of the homogeneity among European countries, users and preparers in the European Commission questionnaire”, Advances in Accounting, incorporating Advances in International Accounting, vol. 28: 147-156 Siam, W.Z. & Rahahleh, M.Y. (2010) “Implications of applying the International Financial Reporting Standards (IFRS) for small and medium-sized enterprises on the accounting environment in Jordan”, Journal of Accounting – Business and Management, vol. 17, no. 2: 21-33 Strouhal, J. (2011) (Ed.) Harmonization of SMEs’ Financial Reporting in Emerging CEE Countries, Stevens Point: WSEAS Press. Sucher, P. & Jindrichovska, I. (2004) “Implementing IFRS: a case study of the Czech Republic”, Accounting in Europe, vol. 1: 109-141 United Nations (2011) “International accounting and reporting issues. 2011 Review”, Report by the Secretariat of the United Nations Conference on Trade and Development Uyar, A. & Güngörmüş, A.H. (2013) “Perceptions and knowledge of accounting professionals on IFRS for SMEs: Evidence from Turkey”, Research in Accounting Regulation, vol. 25: 77-87 Vellam, I. (2004) “Implementation of IFRS in Poland: Can True Convergence be achieved in practice?”, Accounting in Europe, vol. 1: 143-167 Veneziani, M. & Teodori, C. (2008) “The International Accounting Standards and Italian non-listed companies: perception and economic impact. The results of an empirical survey”, 31st Annual Congress of the European Accounting Association, 23-25 April, Rotterdam, the Netherlands 1 With one exception - 1 of the 81 preparers in the sample comes from Poland. 2 Bunea et al. (2012) argue that the number of employees might be manipulated via various types of employment contracts, and total assets is influenced by the measurement basis used in accounting. 3 Additional criteria of size (total assets and turnover) are used in the EU. A SME should have less than 50 million € in turnover, and balance sheet total should be less than 43 million € (Commission Recommendation 2003/361/EC). 4 Agglomerative cluster analysis is a technique that does not require the specification of any desired number of clusters.