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A financial reporting framework made simple for small and micro entities

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Ma. Emilita L. Villanueva

Suits The C-Suite

In 2005, the Philippines adopted the International Financial Reporting Standards (IFRS) — renamed Philippine Financial Reporting Standards (PFRS) — in order to make financial reporting practices in the country consistent with international guidelines. Since that time, entities registered with the Securities and Exchange Commission (SEC) have been required to apply PFRS as their financial reporting framework.

In 2010, the SEC adopted PFRS for Small and Medium-sized Entities (PFRS for SMEs), which eased the financial reporting burden of entities that have less complex structures and transactions. However, feedback from the SMEs is that compliance with PFRS for SMEs is still quite complex and burdensome, particularly for micro and small entrepreneurs.

In response to this feedback, the Association of Certified Public Accountants in Public Practice (ACPAPP) drafted a new accounting framework called PFRS for Small Entities. The framework was endorsed to the Financial Reporting Standards Council (FRSC), the country’s accounting standard-setting body. According to J. Carlitos G. Cruz, President of the ACPAPP Foundation, the framework was in “response to the Government’s efforts to transform the country’s economy to make it more inclusive, and to encourage micro entrepreneurs to comply with reportorial requirements by providing them with simplified financial reporting.” To further facilitate compliance and for ease of reference, the ACPAPP also drafted illustrative financial statements applying the new framework.

After due process, the new framework was approved by the FRSC in December 2017.

SIMILARITIES WITH PFRS FOR SMES
Even though PFRS for SMEs was considered the “simpler” framework (as opposed to full PFRS), PFRS for Small Entities was designed to further simplify it for small and micro businesses. PFRS for Small Entities and PFRS for SMEs, however, take off from the same set of general principles, which include:

• The objective behind the financial statements.

• Key concepts, such as the “recognition of assets, liabilities, income and expenses,” accrual basis of accounting and offsetting.

• The requirement to “present fairly the financial position, financial performance and cash flows of an entity.”

• The key principles for financial statement presentation such as the entity’s ability to continue as a going concern, consistency of presentation and classification of financial statement items from period to period, disclosure of comparative information, materiality and aggregation and disclosures on accounting policies.

• Certain provisions of PFRS for SMEs such as those for related party disclosures, changes in accounting estimates and subsequent events, among others.

KEY DIFFERENCES FROM PFRS FOR SMES
As PFRS for Small Entities aims to simplify a number of requirements under PFRS for SMEs, there are key differences between the two financial reporting frameworks, such as the following:

• PFRS for Small Entities does not have the concept of other comprehensive income and does not require entities to present a statement of comprehensive income.

• For the statement of income, PFRS for Small Entities does not provide for a list of minimum items to be presented in the statement of income, making this new financial reporting framework less prescriptive than PFRS for SMEs, as far as this statement is concerned.

• PFRS for Small Entities has fewer disclosure requirements. One example is that PFRS for Small Entities does not require the disclosure of significant accounting judgments and estimates.

• For changes in accounting policies or correction of prior period errors, PFRS for Small Entities has less onerous requirements. For example, they don’t require small entities to restate prior year’s balances. Any impact from the change in accounting policy or correction of errors will only be reflected in the opening balances of the current year’s financial statements.

• PFRS for Small Entities simplifies the requirements for measuring inventories (i.e., assessing if they are impaired) as it only requires the comparison of cost against the “probable selling price to willing buyers as of reporting date” (i.e., the market value), instead of the “selling price less costs to complete and sell” concept under PFRS for SMEs.

• PFRS for Small Entities also simplifies lease accounting as it does not contain the concept of “finance lease” nor does it require lease expenses or income to be recognized on a straight-line basis over the term of the lease. Under PFRS for Small Entities, lessees and lessors shall recognize lease expense or income in the period when they are incurred or earned, respectively.

• Lastly, PFRS for Small Entities incorporates more policy options for small entities. One example is that small entities are now allowed to measure their investment properties either at cost or at fair value. Another one is that small entities with biological assets can now carry such assets as either at cost or at current market price. PFRS for SMEs, in both cases, only allow such assets to be carried at fair value.

FULL SUPPORT FROM REGULATORS
The new framework had drawn the support of the Board of Accountancy, which approved the framework on 20 February 2018. The SEC has also shown its full support behind this initiative to ease the financial reporting burden on micro and small entrepreneurs. On March 26, through Memorandum Circular (MC) No. 5, the SEC officially adopted the PFRS for Small Entities as “part of the SEC’s rules and regulations on financial reporting.”

To facilitate such an adoption, the SEC amended Part 1 of Section 2 of the Securities Regulation Code (SRC) Rule 68 by providing the specific criteria that entities must meet before they can be categorized as “small entities.” More specifically, entities that have total assets or total liabilities between P3 million to P100 million, do not need to meet the requirements under Part II of SRC Rule 68, are not listed or in the process of listing and are not secondary licensees, shall use PFRS for Small Entities as their financial reporting framework. Exemptions from mandatory adoption of this financial reporting framework were also incorporated in the same section of the amended SRC Rule 68.

EFFECTIVITY OF THE NEW FRAMEWORK
The new financial reporting framework is effective for annual periods beginning on or after Jan. 1, 2019. While early adoption is permitted and highly encouraged, small entities should take note of the full retrospective approach required upon initial adoption. However, this should not hinder small entities from adopting (and even early adopting) this new framework considering its simplified requirements and the minimal costs and effort the adoption will entail.

For small and micro businesses, profit margins are often quite thin and operating the business usually requires significant time and effort for the business owners. The adoption of this new framework reduces the choices for accounting treatments, eliminates non-relevant topics, simplifies recognition and measurement methods, and reduces disclosure requirements. Furthermore, on an overall basis, its usage decreases the undue cost and burden in complying with reportorial requirements. This way, small and micro businesses can worry less about the expense and effort needed to ensure compliance, and instead, allocate valuable resources into the business of growing the enterprise.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co.

 

Ma. Emilita L. Villanueva is a Senior Director of SGV & Co.