Accounting Framework for

Small and Medium

Entities (SMEs)

SEMINAR AT ICAP
PRESENTED BY: SHABBIR YUNUS KHAIRULLAH

September 21, 2006 1

 Presentation Outline

• Need for Developing SME Standards

• Local Accounting Framework
• ICAP Initiative
• Differential Reporting
• Status in Other Countries
• Basis of Development
• Proposed Three Tiers
• The New Standards
• Status of the SME Standards

September 21, 2006 2

 Need for Developing SME Standards

• SMEs are more than 75% of the total entities operating in Pakistan
• Significant growth in SMEs in last two decades
• Concept of SMEs introduced in Tax and other regulations
• International Financial Reporting Standards designed primarily for
multinationals and public listed entities
• Differing users of the financial statements
• Differing level of public accountability
• New and revised IAS/IFRS have added complexities to preparation
of financial statements. This is becoming increasingly burdensome
for small and medium business enterprises
• Lack of adequate technical expertise and resources due to smaller
size
• Current framework available only for listed corporate entities

September 21, 2006 3

 Local Accounting Framework

Corporate Listed
The Companies Ordinance, 1984 specifies that “Subject to the
provisions of this Ordinance, such International Accounting
Standards and other standards shall be followed in regard to the
accounts and preparation of the balance-sheet and profit and loss
account as are notified for the purpose in the official Gazette by the
Commission”
Almost all International Accounting Standards have been
notified by SECP for this purpose. A few accounting standards
issued during last couple of years are in the process of notification.
The format of audit report specified in the Companies Ordinance,
1984 requires the auditor of all companies (whether listed or not) to
report that “in our opinion and to the best of our information and
according to explanations given to us, the balance sheet, profit and
loss account, cash flow statement and statement of changes in equity
together with the notes forming part thereof conform with approved
accounting standards”
September 21, 2006 4
 Local Accounting Framework Contd..

Corporate Unlisted and Private

Although the provisions of Companies Ordinance do not specify
listed or unlisted, the notifications for various IASs state that
“following accounting standards shall be followed in regard to
the accounts and preparation of the balance sheet and profit and
loss accounts of listed companies”
The format of audit report specified in the Companies
Ordinance, 1984 is the same for all companies whether listed or
not.
The term ‘approved accounting standards’ has not been
defined any where but it is taken to mean the IASs as notified and
the accounting requirements of various statutes in place.
Partnerships and sole proprietorships
None
September 21, 2006 5
 ICAP Initiative

• Accounting and Auditing Standards Committee (AASC) formed a sub-

committee to look at various initiatives around the world and propose draft
standards for Pakistan till the time an internationally agreed framework is in
place
• The sub-committee comprised of following members of AASC and a nominee of
SECP
– Mr. Abdul Aleem,
– Mr. Syed Iftikhar Anjum,
– Mr. Riaz A. Rehman Chamdia,
– Mr. Nadeem Yousuf,
– Mr. Naresh Kumar,
– Mr. Farrukh Rehman,
– Mr. Shabbir Yunus, and
– Mr. Salman Shoaib
– Mr. Fayyaz Mahmud – Director Professional Services SECP
– Directorate of Technical Services ICAP

September 21, 2006 6

 Differential Reporting

What is differential reporting ?

Differential reporting is the notion that some entities should be

allowed to depart from particular requirements of accounting
standards or entire accounting standards in preparing financial
statements.

September 21, 2006 7

 Differential Reporting

Two Approaches

• Integral Approach: Exemptions are given from compliance

of individual accounting standards.

• Distinct Approach: Separate standards comprising all the

issues that are addressed in the IAS/IFRS but which are
relevant to SMEs.

September 21, 2006 8

 Status in Other Countries

• Countries like Australia, New Zealand, US and UK had taken

initiatives in differential reporting more than 10 years back and
are making further improvements to it

• Mixed trend for both integral and distinct approaches in different

countries

• Both approaches are based on existing financial reporting

frameworks, may it be IFRS or self developed.

September 21, 2006 9

 Status in Other Countries

Integral Approach Distinct Approach

Australia USA
New Zealand UK
Canada Hong Kong
Malaysia Srilanka
South Africa UNCTAD
India IASB*

*International Accounting Standards Board (IASB) is in the

process of developing SME standards based on the Distinct
approach. IASB has started SME Standards project, which is
expected to be completed in 2007.
September 21, 2006 10
 Basis of Development

Based on analysis of:

- user needs
- cost benefit consideration, and
- limitations in accounting expertise available to SMEs

separate set of Standards (distinct approach) was considered

appropriate for application in Pakistan.

September 21, 2006 11

 Basis of Development

In Developing SME standards, the Institute examined:

• The draft Framework for Differential Reporting issued by

Confederation of Asian & Pacific Accountants (CAPA)

• An exposure draft of proposed SME Financial Reporting

Framework (SME-FRF) and Financial Reporting Standard
(SME-FRS) issued by Hong Kong Institute of Certified
Public Accountants (HKICPA).

September 21, 2006 12

 Basis of Development

Prevailing Frameworks for SMEs

• Accounting and Financial Reporting Guidelines for Small and

Medium-Sized Enterprises (SMEGA) issued by
Intergovernmental Working Group of Experts on International
Standards of Accounting and Reporting (ISAR) under the
banner of United Nations Conference on Trade and
Development (UNCTAD), an organ of United Nations

• SLASSE – Sri Lankan Accounting Standards for Smaller

Enterprises issued by the Institute of Chartered Accountants of
Sri Lanka.

September 21, 2006 13

 Basis of Development

• In developing the SME Framework and Standards, the

Guidelines laid down by ISAR were primarily adopted

• The new Financial Reporting Framework for SMEs in

Pakistan identifies three tiers of entities with Tier 2 and 3
being SMEs.

September 21, 2006 14

 Proposed Three Tiers

To provide a comprehensive framework of accounting and

financial reporting that:
• covers all entities of varying sizes
• addresses the degree of public interest involved in such entities,

The proposed three tiers are:

Tier 1: Publicly Accountable Entities

Tier 2: Medium Sized Entities (MSEs)
Tier 3: Small Sized Entities (SSEs).

September 21, 2006 15

 Proposed Three Tiers

In line with international practice, the criteria for classification of

Tiers is based on:

• Public accountability
• Separation of owners/management
• Size

September 21, 2006 16

 Proposed Three Tiers – Tier 1

Tier 1 - Publicly Accountable companies

Includes
– listed companies ;
– it has filed, or is in the process of filing, its financial statements
with the Securities and Exchange Commission of Pakistan or other
regulatory organisation for the purpose of issuing any class of
instruments in a public market;
– it holds assets in a fiduciary capacity for a broad group of
outsiders, such as a bank, insurance company, securities
broker/dealer, pension fund, mutual fund or investment banking
entity;
– it is a public utility or similar entity that provides an essential
public service; or
– it is economically significant on the basis of criteria such as total
assets, total income, number of employees, degree of market
dominance, and nature and extent of external borrowings.
September 21, 2006 17
 Proposed Three Tiers – Tier 1 Contd..

The criteria for economically significant would be as follows:

• Turnover in excess of Rs. 1 billion, excluding other income
• Number of employees in excess of 750
• Total borrowings (excluding normal trade credit and accrued
liabilities) in excess of Rs, 500 million
In order to be called economically significant any two of the
criteria mentioned in (i), (ii) and (iii) above have to be met. The
criteria followed will be based on the previous year’s audited
financial statements. Entities can be delisted from this category
where they do not fall under the criteria as aforementioned for two
consecutive years.
Tier 1 entities should comply with Approved Accounting
Standards i.e. IASs as notified + relevant statute requirements.
September 21, 2006 18
 Proposed Three Tiers – Tier 3

Tier 3 – Small Sized Entities

Small Sized entities are those entities that:
• have paid up capital plus undistributed reserves (total equity
after taking into account any dividend proposed for the year)
not exceeding twenty five million rupees; and
• have annual turnover not exceeding two hundred million
rupees, excluding other income.
In order to qualify as a small entity, both of the above mentioned
conditions must be satisfied.

Tier 3 entities should comply with The proposed Standard on

Accounting and Financial Reporting by Small Size Entities +
relevant statute requirements.

September 21, 2006 19

 Proposed Three Tiers – Tier 2

Tier 2 - Medium Sized Entities

Includes all entities which are not Tier 1 or Tier 3
Should comply with the proposed Standard on Accounting and
Financial Reporting by the Medium Sized Entities + relevant
statute requirements

September 21, 2006 20

 The New Standards

• Tier 2 – Medium Sized Entities (MSEs)

• Tier 3 – Small Sized Entities (SSEs).

September 21, 2006 21

 Draft Standards for Medium Sized Entities

• Comprises of 17 Standards dealing with accounting for the

regularly encountered transactions by this size of entities and a
general framework (about 60 pages).
• ISAR document was based on IASs applicable in 2002
• These guidelines were reviewed and updated to incorporate
subsequent changes in IASs
• The ISAR document included guidelines on 15 topics.
• Two new topics added to these topics being relevant to most
MSEs in Pakistan
– Investments
– Employee benefits
• The Framework covers objectives of financial statements,
underlying assumptions, qualitative characteristics, elements,
recognition and measurement criteria.

September 21, 2006 22

Draft Standards for Medium Sized Entities Contd..

For transactions not covered by these standards, look for guidance

in
• full IAS/IFRS issued by IASB;
• interpretations issued by SIC and IFRIC;
• appendices to standards issued by IASB;
• implementation guidance issued by IASB;
• the definitions, recognition criteria and measurement concepts
set out in the conceptual framework of IASB; and
• pronouncements of ICAP that use a similar conceptual
framework to develop accounting standards; other accounting
literature; and accepted industry practice, to the extent that
these are consistent with IFRS.

September 21, 2006 23

Draft Standards for Medium Sized Entities Contd..

1. Presentation of Financial Statements

2. Cash Flow Statements
3. Property, Plant and Equipment
4. Leases
5. Intangible Assets
6. Inventories
7. Government Grants and Other Government Assistance
8. Provisions
9. Revenue
Contd ……

September 21, 2006 24

Draft Standards for Medium Sized Entities Contd..

10. Borrowing Costs

11. Income Taxes
12. Accounting Policies
13. Foreign Exchange Transactions
14. Events after Balance Sheet Date
15. Related-Party Disclosures
16. Investments
17. Employee Benefits.

September 21, 2006 25

Draft Standards for Medium Sized Entities Contd..

Topics not covered by these standards (generally considered as

not relevant to this size of entities)
• Share based payment,
• Business combinations,
• Insurance contracts,
• Non-Current assets held for sale and discontinued operations,
• Construction contracts,
• Segment reporting,
• Consolidated and separate financial statements,
• Investments in associates,
• Financial reporting for hyperinflationary economies,
• Interests in joint venture,
• Financial instruments (disclosure and recognition),
• Impairment of assets,
• Investment property
September 21, 2006 26
 Draft Standard for Small Sized Entities –Tier 3

• Requires entities to prepare financial statements at least annually

• The minimum set of primary financial statements to include:
(a) A balance sheet;
(b) An income statement; and
(c) Explanatory notes.
• Entities may wish to include other statements e.g. Cash Flow
Statement
• Use of going-concern and a simplified accrual basis of accounting
• Separate classification of current and non-current assets and
current and non-current liabilities
• Disclosure of the movement in owner’s equity during the financial
year

September 21, 2006 27

 Draft Standard for Small Sized Entities –Tier 3
Contd..
• The face of the income statement to include line items that
present the following amounts:
(a) revenue;
(b) the results of operating activities;
(c) finance costs;
(d) tax expense;
(e) net profit or loss for the period
• Property, plant and equipment to be measured at cost less
accumulated depreciation (no revaluation option)
• All leases to be accounted for as operating leases (in line with
tax treatment)
• Basic revenue recognition criteria in line with IAS 18.
• Inventory accounting basic principles in line with IAS 2.
• General impairment guidelines
September 21, 2006 28
 Draft Standard for Small Sized Entities –Tier 3
Contd..

For material transactions or events not covered by this standard,

reference shall be made to the Tier 2 standards.

September 21, 2006 29

 Status of the SME Standards

• Status at the ICAP

• Status at the SECP
• Status at the IASB

September 21, 2006 30

 Status at the ICAP

• The draft MSE and SSE standards were exposed to the members
of the Institute and the stakeholders in January 2006 and again in
May 2006 upon the request of the SECP and some members
• Round Table conferences / discussions were organized by the
Institute in Karachi and Lahore on May 05 and June 26, 2006,
respectively, with the objective of conducting an open discussion
with the members and stakeholders in order to obtain their
feedback on these Standards
• Feedback received from members and stakeholders (through
mail, other discussions and discussions in the Round Table) is
considered by the relevant committees of the Institute and the
Standards have been amended accordingly
• Feedback has also been received from the Institute of Chartered
Accountants of India, Sri Lanka and Bangladesh which have
been duly considered by the ICAP
September 21, 2006 31
 Status at the ICAP

• SECP (the regulator), the SBP and the CBR have been taken
into confidence for issuance of the MSE and SSE standards by
ICAP and the proposed three tier applicability criteria
• The revised standards were submitted to the Professional
Standards and Technical Advisory Committee (PS&TAC) of
the ICAP who approved the same in its meeting held in July 2006
and recommended it to the Council for their approval
• The Council of the ICAP has approved these standards in its
meeting held in July 2006 and the standards are in the process of
being formally issued through a Council Directive. In this regard,
it is expected that TR-5 previously issued by the ICAP will be
withdrawn / amended.
• It is pertinent to mention here that the South Asian Federation of
Accountants (SAFA) has also adopted the SME standards
developed by the ICAP
September 21, 2006 32
 Status at the SECP

• SECP will be submitted a final DRAFT in due course.

• The SECP is yet to introduce necessary amendments in
Companies Ordinance, 1984 to provide legal coverage for use of
these standards in Pakistan.
• The format of Auditors’ Report will have to be changed.
• Necessary amendments in Section 234 of CO84 will also need
to be introduced. This is currently under consideration by the
Corporate Laws Review Commission (CLRC) of the SECP, to
which recommendations have been submitted by the ICAP.

September 21, 2006 33

 Status at the IASB

• A draft of an Exposure Draft (ED) has been compiled by the

IASB’s staff to develop an IFRS for the review of IASB.
• The IASB has not approved this Draft.
• No comments are invited at this stage.
• The IASB expects to publish an ED for public comment later
this year.
• Earliest application will be with effect from periods beginning
on or after January 1, 2008 (which will be applicable to
companies in Pakistan w.e.f the year ending June 30, 2009) .

September 21, 2006 34