CPA REVIEW SCHOOL OF THE PHILIPPINES

MANILA

THEORY OF ACCOUNTS VALIX SIY VALIX FERRER

SMALL AND MEDIUM-SIZED ENTITIES

Definition

The IASB describes “small and medium-sized entities” or SMEs as entities that:

a. Do not have public accountability.

b. Publish general purpose financial reports for external users.

Public accountability

An entity has public accountability if:

a. Its debt or equity instruments are traded in a public market or it is in the process of issuing such
instruments for trading in public market, for example, domestic or foreign stock exchange, over-
the-counter market, local and regional market.

b. It holds assets in fiduciary capacity for a broad group of outsiders as one of its primary
businesses.

This is typically the case for banks, credit unions, insurance companies, securities dealers or
brokers, mutual funds and investments banks.

However, if such entities do so for reasons “incidental to a primary business” the entities are “not
publicly accountable”

SME under Philippine jurisdiction

The definition of SME is set forth in SEC En Bank Resolution dated August 13, 2009 as follows:

SME is an entity:

a. With total assets between P3,000,000 and P350,000,000. OR with total liabilities between
P3,000,000 and P250,000,000.

b. That is not required to file financial statements under SRC Rule 68.1. This SRC Rule 68.1
pertains to “listed entities” whose shares are traded in a public market.

c. That is not in the process of filing financial statements for the purpose of issuing any class of
instruments in a public market.

d. That is not a holder of a secondary license issued by a regulatory agency such as a bank (all types
of banks), an investment house, a finance company, an insurance company, securities broker or
dealer, a mutual fund and pre-need company.

e. That is not a public utitlity.

Micro-business entities
Micro-business entities are entities whose total assets or total liabilities are below the P3,000,000 floor
threshold. Micro-business entities have the option to use any of the following bases of accounting in the
preparation of financial statements:

a. Full PFRS
b. PFRS for SMEs
c. Another acceptable basis of accounting

Exemptions from PFRS for SMEs

The Philippine SEC on October 7, 2010 resolved to exempt from the mandatory adoption of PFRS for
SMEs small and medium-sized entity that meets any of the following criteria:

1. It is subsidiary of a parent company reporting under full PFRS

2. It is a subsidiary of a foreign parent company that will be moving towards IFRS pursuant to
the foreign country’s published convergence plan.

3. It is a subsidiary of a foreign parent company that has been applying the standards for a
nonpublicly accountable entity for local reporting purposes, and is considering moving to full
PFRS instead of the PFRS for SMEs in order to align its policies with the expected move to full
IFRS by its foreign parent company pursuant to its country’s published convergence plan.

4. It has short-term projections that show that it will breach the quantitative thresholds set in the
criteria for an SME, and the breach is expected to be significant and continuing due to its long-
term effect on the entity’s asset or liability size.

5. It is part of a group, either as a significant joint venture or an associate, that is reporting under
full PFRS.

6. It is a branch office of a foreign entity reporting under full IFRS.

7. It has concrete plans to conduct an initial public offering within the next two years.

8. It has a subsidiary that is mandated to report under full PFRS.

9. It has been preparing financial statements using full PFRS and has decided to liquidate its
assets.

Significant and continuing

If an SME that uses the PFRS for SMEs in a current year breaches the floor and ceiling size criteria at the
end of the current year, the entity shall be required to transition to full PFRS in the next year if the ceiling
threshold is breached or another acceptable accounting basis if the floor threshold is breached.

This transition must be made provided the event that caused the change is considered “significant and
continuing”. As a general rule, 20% or more of total assets or total liabilities would be considered
significant.

Effective date

An entity that meets the definition of SME shall apply the PFRS for SMEs for annual period beginning
January 1, 2010. The amount of total assets and liabilities shall be based on the audited financial
statements on December 31, 2009. An SME whose accounting period begins on a date other than January
1, 2010 shall apply the size criteria using the audited financial statements for the immediately preceding
fiscal year.
Transition to PFRS for SMEs

A first-time adopter of the PFRS for SMEs is an entity that presents its first annual financial statements
that conform with the PFRS for SMEs regardless of whether its previous accounting framework was full
PFRS or another set of generally accepted accounting principles.

First-time adoption requires full retrospective application of the PFRS for SMEs in its first annual
financial statements that conform with PFRS for SMEs.

Date of transition

The date of transition to PFRS for SMEs is the beginning of the earliest period for which full
comparative information is presented in accordance with the PFRS for SMEs in its first annual financial
statements that conform with PFRS for SMEs.

Thus, if the first-time adopter presents its first annual financial statements in conformity with the PFRS
for SMEs on December 31, 2013 on comparative basis, the date of transition to PFRS for SMEs is January
1, 2012.

Opening statement of financial position

The opening statement of financial position is the statement of financial position as of the date of
transition to the PFRS for SMEs. In its opening statement of financial position, a first-time adopter shall:

a. Recognize all assets and liabilities whose recognition is required by the PFRS for SMEs.
b. Not recognize as assets or liabilities if the PFRS for SMEs does not permit such recognition.
c. Reclassify items that it recognized under its previous accounting framework as one type of asset,
liability or component of equity, but a different type of asset, liability or equity under the PFRS
for SMEs.
d. Apply the PFRS for SMEs in measuring all recognized assets and liabilities.

The resulting adjustments arising from transactions, other events and conditions before the date of
transition to PFRS for SMEs shall be recognized directly in retained earnings or another category of
equity, if appropriate.

SIGNIFICANT DIFFERENCES BETWEEN PFRS FOR SMEs and FULL PFRS

1. Qualitative characteristics of the financial statements of an SME

1. Understandability 6. Prudence
2. Relevance 7. Completeness
3. Materiality 8. Comparability
4. Reliability 9. Timeliness
5. Substance over form 10.Balance between benefit and cost

The “fundamental” qualitative characteristics under full PFRS are relevance and faithful
representation. The “enhancing” qualitative characteristics are understandability, comparability,
verifiability and timeliness.

2. Measurement of elements
SMEs - Historical cost and fair value
 Full PFRS - Historical cost, current cost, realizable value and present value.

3. Components of financial statements

When the only changes to the equity are a result of profit or loss, payment of dividends, prior
periods errors, changes in accounting policy, a “single statement of income and retained
earnings” can be presented by SMEs instead of a both a statement of comprehensive income and
statement of changes in equity.

Under Full PFRS, a statement of changes in equity is always required. A single statement of
income and retained earnings is prohibited under Full PFRS

4. Statement of financial position

Same line items for SMEs and Full PFRS, except that the following line items are not required
for SMEs:
a. Total of assets classified as held for sale
b. Total of liabilities included in disposal group classified as held for sale.

Moreover, full PFRS requires presentation of investments in associates but not investment in
joint ventures. PFRS for SMEs requires presentation of both investments in associates and
investments in joint ventures as separate line items.

Under full PFRS, a third statement of financial position as at the beginning of the earliest
comparative period shall be prepared:

a. When an entity applies an accounting retrospectively.

b. When an entity makes a retrospective restatement.
c. When an entity reclassifies items in its financial statements.

This “third statement of financial position” is not required under PFRS for SMEs.

5. Other of comprehensive income

Under full PFRS, the components of other comprehensive income are:

a. Gain or loss from translating the financial statements of a foreign operation

b. Remeasurements of defined benefit plans
c. The effective portion of unrealized gain or loss on hedging instruments designated as cash
flow hedge
d. Unrealized gain as loss on equity instruments measured at fair value through other
comprehensive income
e. Revaluation surplus during the year
f. For particular liabilities designated as at fair value through profit or loss, the amount of
change in fair value that is attributable to change in the liability’s credit risk.

Under PFRS for SMEs, the components of other comprehensive income include:

a. Gain or loss from translating the financial statements of a foreign operation.

b. Actuarial gain and loss
c. Change in fair value of hedging instrument that was effective in offsetting the change in the
fair value or expected cash flows of the hedge item.

This is applicable to the hedge of the following:

1. Variable interest rate risk
 2. Foreign exchange risk in a firm commitment or highly probable forecast transaction
3. Commodity risk in a firm commitment or highly probable forecast transaction
4. Foreign exchange risk in a net investment in a foreign operation

6. Asset held for sale and discontinued operation

The PFRS for SMEs does not address noncurrent asset held for sale and discontinued operation.

7. Inventories
An SME shall measure inventories at the lower of cost and estimated selling price less cost to
complete and sell.

If the estimated selling price less cost to complete and sell is lower than cost, the writedown is
recognized as impairment loss.

Under full PFRS, inventories are measured at LCNRV. If the NRV is lower than cost, the
writedown is recognized as component of cost of goods sold.

8. Basic financial instruments of SMEs

1. Cash, demand and fixed term deposits or bank accounts
2. Trade accounts and notes receivable and loans receivable
3. Commercial papers or commercial bills
4. Investments in nonputtable ordinary shares
5. Investments in nonconvertible and nonputtable preferences shares
6. Commitment to receive loan if the commitment “cannot be net settled” in cash
7. Accounts payable in local and foreign currency
8. Loans from bank and other third parties
9. Bonds and similar debt instrument
10. Loans to or from subsidiaries or associates that are due on demand.

The investment in ordinary shares and nonconvertible preference shares is nonputtable:

a. When the entity does not have an option to sell the shares back to the issuer for cash.

b. When there is no arrangement that could result in the shares being automatically sold or
returned to the issuer because of a future event.

9. Conditions for a debt instrument to be classified as basic financial instrument

a. Returns to the holder are a fixed amount or a variable amount that throughout the life of the
instrument is equal to a single fixed amount.

b. No contractual provisions that could result in the holder losing the principal amount and
interest.

c. Contractual provisions that permit the debtor to prepay the instrument are not contingent on
future events.

d. The payment or repayment of principal and interest must be unconditional.

In summary, a debt investment is basic when the creditor is assured of the payment of the
principal and the fixed amount of interest without any conditions.
10. Initial measurement of basic financial instruments
The PFRS for SMEs provides that basic financial instruments are initially measured at the
transaction price, including transaction costs.

However, if the instrument is measured at fair value through profit or loss, the transaction
cost is expensed immediately.

11. Subsequent measurement of basic financial instruments

The PFRS for SMEs provides that basic financial instruments are subsequently measured at
amortized cost, cost less impairment and fair value through profit or loss depending on the
instruments.

a. Basic debt instruments are measured at amortized cost using the effective interest method.

b. Commitments to receive a loan are measured at cost less impairment.

c. Investments in nonputtable ordinary shares and investments in nonconvertible and nonputtable

preference shares are measured at fair value through profit or loss if the shares are publicly
traded, or if the fair value can be measured reliably.

If the shares are not publicly traded or if the fair value cannot be measured reliably, such
investments are measured at cost less impairment.

12. Impairment of basic financial instruments

The PFRS for SMEs provides that for a basic financial instrument measured at cost less
impairment, the impairment loss is the difference between the carrying amount of the asset and
the best estimate of the amount that would be received if the asset were sold.

Under full PFRS, the impairment loss is the difference between the carrying amount and the
present value of estimated future cash flows discounted at market rate of interest for similar
asset.

13. Not basic financial instruments of SMEs

a. Asset-backed securities, such collateralized mortgage obligations, repurchase agreements and
securitized packages of receivables
b. Derivative contracts
c. Hedging instruments
d. Commitments to make a loan to another entity
e. Commitments to receive loan if the commitment can be net settled in cash

The following instruments are not also basic financial instruments:

a. Investments in subsidiaries, associates and joint ventures
b. Financial instruments that meet the definition of an entity’s own equity.
c. Leases
d. Employers’ rights and obligations under employee benefit plans

14. Investments in associates and joint ventures

Full PFRS – Investments in associates and investments in joint ventures are accounted for using
the equity method.
 SMEs - SMEs shall account for investments in associates or joint ventures using the cost model,
the equity method or fair value model and using the same accounting policy for all
investments in associates.

Under the cost model, the investment in associate is initially measured at the transaction price
including transaction cost. Subsequently, the investor shall measure its investments in associate
at cost less any accumulated impairment losses. However, the cost model is not permitted if the
investment in associate has published price quotation in which case, the fair value model is used.
All dividends and other distributions received are recognized as income without regard whether
the dividends are from preacquisition or postacquisition retained earnings of the associate.

Under the equity method, the investment account is initially recognized at the transaction price,
including transaction cost. Subsequently, the investment is adjusted to reflect the investor’s
share in profit or loss and other comprehensive income of the associate .Dividends and other
distributions received from the associate are recognized as reduction of the carrying amount of
the investment.

Under the fair value model, the investment in associate is initially measured at the transaction
price, excluding transaction cost. At each reporting date, the investment is measured at fair
value with changes in fair value recognized in profit or loss. If the fair value model is used, the
investment in associate as not tested for impairment.

15. Investment property

Full PFRS – Investment property is measured at either cost or fair value. There is a choice.

SMEs – Investment property is measured at fair value if the fair value can be measured reliably
without undue cost or effort on an ongoing basis. Otherwise, the cost model is used and the
investment property is accounted for as property, plant and equipment and presented as a
separate class of property, plant and equipment.

16. Property, plant and equipment

Full PFRS - Property, plant and equipment are measured by using either cost model or
revaluation model. There is a choice.

SMEs – Property, plant and equipment are measured using the cost model only.

17. Government grant

a. Under full PFRS, a government is recognized when there is a reasonable assurance that the
entity will comply with the specified conditions. Under the PFRS for SMEs, a government
grant is recognized when the conditions are actually satisfied.

b. Under full PFRS, a government grant is recognized as income over the periods necessary to
match them with the related costs for which they are intended to compensate

The PFRS for SMEs does not allow an entity to match a grant with the expense for which it is
intended to compensate or the cost of the asset that is used to finance.

c. Under full PFRS, grant related to asset may be treated either as deferred income or a reduction
in the carrying amount of the asset. There is no such option under the PFRS for SMEs.
 Under the PFRS for SMEs, the grant is a deferred income until the conditions are actually
satisfied.

18. Borrowing costs

Full PFRS – Borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset must be capitalized as part of the cost of the asset. All other
borrowing costs are expensed.

SMEs – All borrowing costs are expensed immediately when incurred.

19. Impairment of assets

Under the PFRS for SMEs, assets, including goodwill, are tested for impairment when there is an
indication that the asset may be impaired.
Under full PFRS, assets with a finite useful life are tested for impairment when there is an
indication that the asset may be impaired.

Goodwill, intangible asset with an indefinite useful life or an intangible asset not yet available for
use, are tested for impairment annually and when there is an indication that the asset may be
impaired.

20. Intangible assets

a. Under PFRS for SMEs, intangible assets are measured subsequently using the cost model only.
Under full PFRS, intangible assets are measured subsequently using either the cost model or
revaluation model. There is a choice under full PFRS.

b. Under PFRS for SMEs, the useful life of an intangible asset is considered to be finite. As a
matter of fact, if the useful life of an intangible asset cannot be estimated reliably, it is
assumed to be 10 years.

Under full PFRS, the useful life of an intangible asset is either finite or indefinite. If the useful
life cannot be estimated reliably, there is no assumption of 10 years.

c. Under PFRS for SMEs, all intangible assets, including goodwill, are amortized.

Under full PFRS, intangible assets with a finite useful life are amortized over the useful life
and intangible assets with indefinite useful life are not amortized but tested for impairment.

21. Research and development costs

Under PFRS for SMEs, all research and development costs are expensed immediately when
incurred.

Under full PFRS, research costs are expensed immediately when incurred. However,
development costs may be capitalized when specific criteria are met, particularly when
technological feasibility has already been established.

22. Defined benefit liability

Full PFRS – The defined benefit obligation is the net total of:
 a. The present value of the defined benefit obligation at year-end.
b. Minus the fair value of plan assets at year-end

SMEs- defined benefit obligation is the same under full PFRS:

23. Actuarial gains and losses

Full PFRS – Actuarial gains and losses are recognized fully in other comprehensive income.

SMEs – Actuarial gains and losses are fully recognized either in profit or loss or other
comprehensive income.

24. Past service costs

Full PFRS – Vested and unvested service costs are recognized immediately in profit or loss as
component of employee benefit expense.

SMEs – All past service costs are also recognized in full as component of employee benefit
expense in the period in which they occur.

25. Deferred tax asset

Under PFRS for SMEs, a valuation allowance is recognized for a tax asset so that its carrying
amount equals the highest amount that is more likely than not to be recovered.

Under full PFRS, the concept of valuation allowance is not applicable. Instead, a deferred tax
asset is only recognized to the extent that it is probable that there will be sufficient future taxable
profit against which the deferred tax asset can be used.

26. Share-based payment transactions

Under full PFRS, the share options shall be measured at fair value on the date of grant. However,
if the fair value of the share options cannot be measured reliably, the intrinsic value of the share
options is used. The intrinsic value is the excess of the market price of the share over the option
price.

Under PFRS for SMEs, the share options must be measured at fair value on the date of grant .
The intrinsic value is not mentioned as an alternative.

27. Extractive industry

Under PFRS for SMEs, an exploration expenditure may be classified as tangible asset or
intangible asset shall be measured using the cost model only.

Under full PFRS, if an entity’s accounting policy results in the recognition of an exploration and
evaluation asset, such asset shall be measured initially at cost. The exploration and evaluation
asset may be classified as tangible asset or intangible asset and shall be measured subsequently
using either the cost model or fair value model.

28. Business combination

SMEs – Transaction costs are included in cost of business combination. Contingent
consideration is included as part of cost of business combination if it is probable and can be
measured reliably.
 Full PFRS – Transaction costs are excluded from the cost of business combination. Contingent
consideration is recognized regardless of the probability of payments.

29. Consolidated financial statements

Under PFRS for SMEs, a parent need not present consolidated financial statements if:
a. The parent is itself a subsidiary and its ultimate parent or any intermediate parent produces
consolidated financial statements that comply with full PFRS or PFRS for SMEs.
b. The parent has no subsidiaries other than one which was acquired with the intention of selling
or disposing of it within one year.

Under full PFRS, a parent need not present consolidated financial statements if:
a. The parent is itself a wholly-owned subsidiary or partially0owned subsidiary and its other
owners do not object to the parent not presenting consolidated financial statements.
b. The parent’s debt and equity instruments are not traded in a public market.
c. The parent did not file or is not in the process of filing it financial statements with a regulatory
organization for the purpose of issuing any class of instruments in a public market.
d. The ultimate or any intermediate parent produces consolidated financial statements that comply
with PFRS.

30. Special purpose entity – This is an entity created to accomplish a narrow and well-defined
objective such as to effect a lease, to undertake R and D activities or to securitize financial assets.
An entity consolidates an SPE when the substance of the relationship between the entity and the
SPE indicates that the SPE is controlled by the entity.