IFRS for SMEs: One cheer for the accounting profession!

After more than six years of drafting, consultations, redrafting, deliberations, field testing and debates across a number of countries of the world, the International Accounting Standards Board (IASB), the body responsible for international standard-setting for the accounting profession, has issued an International Financial Reporting Standard (IFRS) designed for use by small and medium-sized entities (SMEs). Guyana is a member of the International Federation of Accountants and such standards automatically apply to Guyana.

The accounting regulator in Guyana, the Institute of Chartered Accountants of Guyana is now considering adoption. While it has not pronounced on the new standard it is expected that the standard would be available for use in the 2009 financial statements of all Guyanese SMEs. While not the most satisfactory situation, some members of the accounting profession have opined that even in the absence of such pronouncement, businesses and their auditors should take the lead and apply the new standard immediately.

The release of the new IFRS should be seen as one of the most welcome developments and contribution of the accounting profession in modern times. It simplifies many of the rules governing the preparation, contents and presentation of financial statements for all but a dozen or so of our companies. Up to this time the same rules that applied to the multi-billion dollar company like Demerara Distillers Limited also applied to the small one person operation – a requirement that is expensive, impracticable and nonsensical. The financial sector would be particularly gratified as the new standard removes one of the excuses of the profession about the cost, time and complexity involved in the preparation of financial statements submitted to them in support of credit applications and renewal.

The IFRS for SMEs is a self-contained standard of about 230 pages tailored for the needs and capabilities of smaller businesses. Many of the principles in full IFRSs for recognising and measuring assets, liabilities, income and expenses have been simplified, topics not relevant to SMEs have been omitted, and the number of required disclosures has been significantly reduced.

Main features
The following principal changes to existing accounting rules for SMEs arising from the new IFRS are highlighted:

1. Some topics in IFRSs are omitted because they are not relevant to the typical SMEs. These include: earnings per share; interim financial reporting; segment reporting; and special accounting for assets held for sale. To the extent that they do apply, non-mandatory reference could be made to the existing IFRS’s, which does compromise the stand-alone precept.

2. Some accounting policy options permitted under full IFRSs are not allowed under the SME IFRS because a more simplified method is available under the new standard. These include: financial instrument options including available-for-sale, held-to-maturity and fair value options; the revaluation model for property, plant and equipment and for intangible assets; proportionate consolidation for investments in jointly controlled entities; for investment property, measurement is driven by circumstances rather than allowing an accounting policy choice between the cost and fair value models; and various options for government grants.

I have highlighted the revaluation issue because this has become a common practice in Guyana following our experience with hyper-inflation in the late seventies and eighties.

3. Recognition and measurement simplifications: The main simplifications to the recognition and measurement principles in full IFRSs include the accounting principles and disclosure rules for financial instruments; goodwill and other indefinite life intangible assets which must be amortised over their estimated useful lives (ten years if useful life cannot be estimated reliably); research and development costs which must be recognised as expenses; borrowing costs which must be recognised as expenses; property, plant and equipment and intangible assets; and defined benefit plans the past service cost of which must be recognised immediately in profit or loss while all actuarial gains and losses must be recognised immediately either in profit or loss or other comprehensive income.

4. Substantially fewer disclosures: No longer should the financial statements look like a formidable book written in a language to confuse rather than inform. Pro-forma financial statements compatible with the new IFRS have been developed and published by the IASB and are available on their website.

5. Simplified redrafting: A significant feature of the new standard is that it will only be subject to triennial reviews so that there is more certainty and uniformity in the preparation and presentation of financial statements. No need to worry about annual reviews and changes and the implications for comparative figures. Hopefully as well, instead of spending a whole lot of time on what was essentially non-added value work, auditors will assist their clients in offering advice on internal controls and business issues.

One of the main questions that obviously came to mind in developing the new standard is what will be considered an SME, since there was no agreed or universally accepted definition. SMEs come in many shapes and shades and it would be a challenge for the profession and the law to capture in a single definition the range of such entities. An SME in a developed country could be a major player in a developing one and therefore a definition based on quantitative factors such as number of employees or level of sales was rejected.

An SME is defined in the standard as an entity which publishes general purpose financial statements for external users but does not have public accountability. An entity has public accountability if (a) its debt (borrowings) or equity (shares) instruments are traded in a public market or it is in the process of issuing such instruments for trading in a public market; or (b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. All companies traded on the Guyana Stock Exchange, banks, insurance companies, securities brokers/dealers, unit trusts, etc, would be considered to have public accountability and cannot therefore prepare their financial statements using the IFRS for SMEs.

What about those SMEs that seem to be neither fish nor fowl and how do we deal with the public interest companies for which special reporting requirements are desirable? Where for example does a Guysuco, a GPL or a GT&T come, and are consumers any less important than investors?

The IASB considered whether to include in the definition of public accountability those companies which provide an essential public service such as a public utility. Respondents to the discussion paper however felt that in many jurisdictions such entities could be very small.

Consideration was also given to those entities which were economically significant in their home jurisdiction but the IASB felt that “economic significance may be more relevant to matters of political and societal accountability” and therefore felt that the final decision should be left to the individual jurisdictions.

Time for action
The issue of this standard should be addressed not only by the accounting profession in relation to its clients but by the Ministry of Finance, the Guyana Revenue Authority and the lending community. The Companies Act envisaged that the Minister of Finance would set certain levels of income, assets or staff below which the requirement of the audit of a company could be dispensed with. The act has now been on the law books for eighteen years but no such pronouncement has been done. It is time that this be done.

The Guyana Revenue Authority too has to consider whether it should be insisting that a one-man company with a small turnover and few assets should require an audit but the multi-billion dollar self-employed person does not. Yes, it is a legislative matter but it is up to the GRA to make recommendations based on practice and experience.

The lending community now has an opportunity to decide whether it will continue to accept some of the sloppily and inaccurately prepared financial statements submitted in support of lending applications or whether it will now sit with its clients and the accounting profession and insist on a higher standard of accounting and reporting. The accounting profession locally has generally been very slow and a ditherer on the occasions on which leadership was required. It should now piggy-back on the initiative of its international brotherhood – for that is what it is – and take decisive action on this matter to justify the wide powers it enjoys under statute.

The new IFRS is clearly both an opportunity and a challenge and to use that overdone term, every stakeholder should see and use this to rectify many of the serious mistakes that have been perpetrated and tolerated for decades.

Mistakes that have caused the loss of billions of dollars of revenue to the state, the loss of reputation of a profession that has become associated with tax evasion and aggressive tax planning and the inability of the layperson to read and understand financial statements, an important requirement for a developing capital market.

At the same time, the new IFRS is not a panacea and outstanding issues such as corporate governance, money-laundering, tax evasion and poor and unethical standards of accounting and auditing will remain to be addressed. This new IFRS is however welcomed by Business Page as a useful development. One cheer for the accounting profession!

On the line: Banks DIH Annual Report

Banks DIH, the giant food and beverage company will be holding its 53rd annual general meeting on Saturday, January 17, 2009, close to four months following the end of its financial year of September 30, 2008. As a public company Banks is a reporting issuer for purposes of the Securities Industry Act, 1998 although like other domestic public companies in Guyana it is listed not on the Stock Exchange’s official list but on its Secondary List which consists of those securities that have not sought admission to the official list. Such securities are eligible for trading merely by virtue of being registered with the Guyana Securities Council.

Inclusion on the Official List on the other hand, according to the Stock Exchange website, indicates that that the, “stocks and shares that are listed are freely transferable and validly issued – not non-transferable, or forged, or otherwise tainted; it also means that the issuer meets the requirements of law and regulation in the management of its business and in the disclosure of adequate, timely and accurate information about its business to investors.” This distinction seems harsh, although companies’ silence on the reasons for their unwillingness to seek admission on the official list clearly does not help their cause.

The Barbados connection
The annual report to be put to shareholders at the meeting includes the financial statements of the company as well as the group. The group is made up of the company as the holding company, Citizens Bank Guyana Inc, a 51% subsidiary, and a dormant subsidiary Caribanks Shipping Company Limited, which appears to have little or no assets or income. The company also has two associated companies, ie companies in which it has significant influence but not control. The two such companies are BCL (Barbados) Limited and B&B Farms Inc.

BCL is owned equally by Banks Barbados, Valley Manufacturing Company Limited of Belize, Banks (DIH) Limited in Guyana and Blue Waters in Trinidad, all of whose export development needs BCL seeks to promote. Readers will recall that the Guyana-Barbados link-up was a defensive move by the local company reacting to a perceived hostile take-over about four years ago by the Trinidad conglomerate Ansa McAl. Under the deal the Barbados company was given 20% of the shares in the local company in exchange for 8.59% of the shares in the Barbados company, based on the respective book values of the shares at the time of the share exchange. Two of the directors of Banks Barbados sit on the board of Banks DIH while Mr Azam Khan represents the Guyana interest on the Barbados board.

Note 29 to the financial statements indicates that DIH purchased finished goods valued at $53 million from the Banks Holdings but made no sales to it. On the other hand sales to BCL amounted to $45 million and purchases amounted to $30 million.

The group accounts include mainly a manufacturing entity, a financial services institution and less significantly, laundry and hotel services, a combination which does not make the group accounts easily understandable to the ordinary shareholder. While the company is separately accounted for, any member wishing to ascertain exactly how the very significant banking arm has performed would need to refer to the bank’s annual report which unfortunately is not posted on its website.

One criticism that this column has made of the company’s financial statements – that it does not include the very important statement of cash flows for the company – has been addressed and this is now contained on page 26 of the annual report. This is commendable. Also commendable is the greater level of disclosure about corporate governance although one has to wonder why an enlightened company like Banks DIH cannot have at least one female director in a board of twelve. Where is the gender-consciousness in a company of which perhaps a majority of the employees in the food division are female, as are many of its customers and shareholders?

Inadequate information
The unusually brief Chairman’s report on pages 8 and 9 of the annual report (including picture and graphs) gives very little information on the company’s operations and even in that limited space, Chairman Clifford Reis concentrates mainly on the group results with one paragraph reporting on the profits earned by the banking subsidiary and the longest paragraph dealing with the arrangement with Barbados. The annual report of the Barbados company presents a stark contrast with respect to the discussion which the management shares with its members. Significantly, in the Barbados company, the roles of Chairman and CEO are separate with both persons presenting separate reports to the members. There, the Chairman’s report runs to just two pages while that of the CEO covers more than ten. Structures and culture are different, but the amount and quality of information offered to Banks DIH shareholders is far too sparse to enable any understanding of the performance of the various divisions.

The company v the group

Source: Annual Report 2008

The table shows in the left half the performance of the company for the year ended September 30, 2008 with comparison for 2007. On the right hand side of the table are the group results ended on the same date, with H1 representing the first half of the year and H2 the second half. The first half numbers come from the unaudited half year report published under the Securities Industry Act while the second half numbers are derived from the audited financial statements.

The company’s sales for the year increased by 5.1% over 2007 to reach $13.565 billion. Profit from operations, ie before finance cost and other income including dividends received from Citizens Bank, increased by 6.4%, considerably less than the 27.12% for the group. As a percentage of sales, profit from operations increased marginally from 9.74% to 9.9% but it is not possible to determine how much of this is attributable to the company’s branded products, those it produces under licence and bought in products. After charging taxation of $570 million including a mix of property, withholding and capital gains taxes of $79 million, the company realised a net profit of $850 million (2007 – $793 million) of which dividends paid or to be paid amount to $420 million.

Profit from operations for the group increased by 27% over the preceding year to $1.922 billion with other income net of financing cost resulting in profit before tax of $1.968 billion. After taxation of $710.9 million of which property, withholding and capital gains taxes amount to $107 million, the profit for the group was $1,257 million, an increase of 22% over 2007. H1 accounted for 49% of sales but 55% of profit after tax, while in the second half of the year 51% of the sales produced only 45% of profit after tax. No explanation is given for this apparently anomalous situation but the unaudited first half would have included estimates while the second half of the year coincided with increased costs of raw material and fuel which the company may not have been able to pass on in higher prices.

Profits after tax of Citizens Bank amounted to $437.7 million, an increase of 66% over 2007. Of the amount of $437.7 million only 51% belongs to the group, the rest attributable to the shareholders who own the remaining 49% of the shares in Citizens.

The very important measure of Earnings Per Share for the group jumped by 16% from $0.90 to $1.04 but for the company the increase, which is not stated in the annual report, is a more modest 7.6% after accounting for dividends from its banking subsidiary. Perhaps this explains why the price of the company’s share was almost static throughout the year. Once again we note that there is no information or discussion on this vital factor.

The company continues to honour a commitment it made to shareholders to pay three dividends, which of course carries an administrative cost but also allows for better cash flow management. Total dividends paid and proposed for the year are $0.45 per share compared with $0.42 per share in 2007 – an increase of 7.14%. The payout ratio which measures the share of after-tax profit paid to the shareholders was 49.41% compared with 50.44% in 2007.

The company’s balance sheet remains strong with cash resources of $1.3 billion, an increase of $1.2 billion in 2007 while net trade receivables, a function of sales and credit management increased by 24% on sales which increased by 5%. Total assets of the company grew by 5.53% while those of the group increased by 6.63%.

Mr Reis is one of the private sector voices that can still command attention, and he was known to advocate fearlessly on behalf of his company and the private sector. At this time, his reasoned and constructive views on issues on direct and indirect taxation including VAT would have been particularly useful above the din of often uninformed rhetoric and opinion that seems dominant. The company should be leading in the advocacy for the zero-rating of bottled water (at least locally produced) – one of life’s greatest necessities and what some may even consider a public good. Water from GWI which few would want to drink without boiling is zero-rated, but that of the private producers is taxed at 16%. That policy certainly needs revisiting and offers an opportunity to the company to join with consumers to have the tax removed. This I should add is only one of several areas that need reform sooner rather than later.

Like the other commercial banks, Citizens has had a very good year and its results have embellished the group’s performance. But even banking can be cyclical and the core business of the company – particularly its beverage arm – needs to become more dynamic and be positioned to take up any downturn.

Chairman Reis in his report titled ‘Building on Traditions of Strength’ did not address the future prospects of the company. He referred briefly to the impact of the global financial crisis on remittances and the economy and expressed a commitment to be “optimistic, proactive, and to pursue a vigorous approach towards maintaining and improving the performance of the business.”

The group may need more than just commitment as the world enters the most challenging year of the company’s illustrious history.