HK prepares to adopt new rules specifically for SMEs
Small private companies that use the city's full financial reporting standards, the same set of rules used by publicly-listed companies, are struggling to meet the reporting requirements as standards become more complex.
'For many years, accounting standards were quite simple but, with globalisation, companies' increasing assets and liabilities, and the greater use of exotic transactions, the city's financial reporting standards have grown more complicated over the last decade in order to meet the needs of the public capital markets,' says Paul Pacter, director of Standards for Small and Medium-Sized Entities at the International Accounting Standards Board (IASB) in London, and a director at Deloitte Touche Tohmatsu in Hong Kong. 'That complexity has been pushed down on to small and medium-sized enterprises (SMEs).'
Primarily targeted at the reporting needs of listed companies and financial institutions, the reporting regulations take a long-term view of corporate activities, focusing on future earnings forecasts, long-term cash and debt flow, and company value. Yet these elements are rarely of any relevance to SMEs.
'SMEs say the full accounting standards are a burden, and even more pertinent is that the lenders, customers, venture capitalists and investors, who use their financial statements, cannot make good use of them. The information is not relevant to a SME,' says Pacter, adding that users of SME financial statements are interested in short-term cash flows, liquidity, balance sheet strength, the historical trends of cash flows and interest coverage.
Though there is a set of locally developed accounting standards specifically for SMEs, Ringo Chiu, an audit partner at accounting firm Grant Thornton, says the gamut of technical restrictions severely hinders small companies from using it. 'None of our clients are using these rules because they are just too restrictive,' he says.
Relief is likely to be on its way as the Hong Kong Institute of Certified Public Accountants (HKICPA), the city's only statutory licensing body of certified public accountants, is expected to adopt the IASB standard for SMEs as a financial reporting option by the end of the month.
'The new standard was built from the foundation of the full International Financial Reporting Standards then simplified so those SMEs who have been using the full standard will find the transition straightforward. It will be more of a relief than a challenge,' says Pacter.
The new rules have been tailored to meet the needs of those who provide capital to SMEs. The new regulations will omit elements like earnings per share, interim financial reporting and segment reporting, and focus on what is most important to a SME: access to capital.
'The new rules can save businesses and the community the use of unnecessary resources,' Chiu adds. Many of the principles for recognising and measuring assets, liabilities, income and expenses have also been simplified. There are also fewer disclosures; roughly 300 in contrast to the 3,000 required under the full standards. In adopting these rules, the majority of the city's estimated 700,000 companies will benefit from better quality reporting, with a positive long term impact on business.
'Good reporting makes capital available to companies at a lower price. It is ultimately in society's interest to have capital flow to businesses that are profitable. Good financial reporting helps capital markets direct capital to where it is most appropriate,' Chui says.
Since the IASB launched the International Financial Reporting Standards for SMEs in July last year, about 60 jurisdictions have either adopted or stated their intention to adopt the new standards. The standards for SMEs were first developed by the board in response to strong international demand from developed and emerging economies for a common set of accounting standards for smaller businesses. 'A set of standards which is more easily understood by smaller businesses, their potential investors, customers and suppliers can only help organisations to survive in these tough trading conditions,' says Brendan Murtagh, president of the Association of Chartered Certified Accountants.