CPA REVIEW SCHOOL OF THE PHILIPPINES Manila FINANCIAL ACCOUNTING AND REPORTING — VALIX/SIY/VALIX/ESCALA/SANTOS/DELA CRUZ SMALL AND MEDIUM-SIZED ENTITIES Definition The IASB describes “small and medium-sized entities” or SMEs as entities that: a. Donot 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. Itholds 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 investment 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. SME is an entity: a. With total assets between P3,000,000 and P350,000,000, OR with total liabilities between 3,000,000 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. 4. 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 utility. 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. PERS for SMEs ¢. Another acceptable basis of accounting 6776Page 2 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. Itis 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, Itisa 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 IFRS instead of the IFRS 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, Ithas 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. Itis part of a group, either as a significant joint venture or an associate, that is reporting under full PERS. 6. Itisa branch office of a foreign entity reporting under full IFRS. 7. Ithas concrete plans to conduct an initial public offering within the next two years. 8, Ithas a subsidiary that is mandated to report under full PFRS. 9. Ithas 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. First-Time adopter [A first-time adopter of the PFRS for SMEs is an entity that presents the first annual financial statements that conform with the PFRS for SMEs regardless of whether the previous accounting framework was full PERS or another set of generally accepted accounting principles. First-time adoption requires full retrospective application of the PFRS for SMEs effective at the reporting date for an entity's 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 carliest period for which full comparative information is presented in accordance with the PFRS for SMEs. ‘Thus, if the first-time adopter presents the first annual financial statements in conformity with the PFRS for SMEs on December 31, 2020 on comparative basis, the date of transition to PFRS for SMEs is January 1, 2019. 6776Page 3 ‘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 the 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 the previous accounting framework as one type of asset, Ubi or component of equity, but a different type of asset, liability or equity under the PFRS for SMEs. 4. 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. Components of financial statements — Basically similar to full PFRS When the only changes to the equity are a result of profit or loss, payment of dividends, prior periods errors, changes in accounting policy, an SME is permitted but not required to present a “single statement of income and retained earnings” instead of 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 2. Statement of financial position Same definition of current assets, noncurrent assets, current liabilities and noncurrent liabilities 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. Full PFRS requires presentation of investments in associates but not investment in joint ventures. PERS for SMEs requires presentation of both investments in associates and investments in joint ventures as separate line items, Paragraph 4.2 of PERS for SMEs is amended to include as a separate line item investment property carried at cost less accumulated depreciation and impairment. income 3. Other of comprehensi ‘Under full PFRS, the components of other comprehensive income include: Reclassified to profit or loss a. Translation gain or loss of foreign operation b. Unrealized gain o loss on derivative contract as a cash flow hedge ©. Unrealized gain or loss on debt investment measured at FVOCI Rela: fied to retained earnings a. Unrealized gain or loss on equity investment measured at FVOCI b. Remeasurements of defined benefit plan c. Revaluation surplus 4. Change in fair value attributable to the credit risk of financial liability designated at FVPL. Under PFRS for SMEs, the components of other comprehensive income include: Reclassified to retained earnings a. Translation gain or loss of a foreign operation, b. Actuarial gain and loss ~ reporting actuarial gain and loss as OCI is optional because this may be recognized in profit or loss, ©. Revaluation surplus of property, plant and equipment. Reclassified to profit or loss 4. Change in fair value of hedging instrument. 6776Page 4 |. Natural and functional presentation of statement of comprehensive income Same under Full PFRS and PFRS for SMEs. Asset held for sale and discontinued operation ‘The PFRS for SMEs does not address noncurrent asset held for sale and discontinued operation. . Full PFRS and PFRS for SMEs have the same provisions with regard to notes to financial statements, related parties, events after the end of reporting period, accounting changes and prior period errors. ). 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. . Basic financial instruments of SMEs Cash, demand and fixed term deposits or bank accounts ‘Trade accounts and notes receivable and loans receivable ‘Commercial papers or commercial bills — unsecured and short-term debt investment Investments in nonputtable ordinary shares Investments in nonconvertible and nonputtable preference shares Commitment to receive a loan if the commitment “cannot be net settled” in cash Accounts payable in local and foreign currency Loans from bank and other third parties . Bonds and similar debt instrument 10. Loans to or from subsidiaries or associates that are due on demand. eer aveene A commitment to receive a loan is a firm commitment by the bank to provide credit to the entity. ‘The entity has the option to borrow or the bank may require the entity to borrow. 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. .Not basic financial instruments of SMEs fa. Asset-backed securities, such collateralized mortgage obligations, repurchase agreements and securitized packages or receivables Derivative contracts Hedging instruments Commitment to receive loan a loan if the commitment can be net settled in cash ‘The following instruments are outside the scope of PFRS for SME: poe Investments in subsidiaries, associates and joint ventures Financial instruments that meet the definition of an entity's own equity. Lenses Employers’ right and obligation under employee benefit plans Contract for contingent consideration in a business combination Insurance contract Share-based payment transaction Reimbursement asset remeeese 6776Page 5 10, Conditions for a debt instrument to be classified as basic financial instrument a, Retums 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. ¢. Contractual provisions that permit the debtor to prepay the instrument are not contingent on future events. 4. 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. 1 - Initial measurement of basic financial instruments The PFRS for SMEs provides that basic financial instruments (basic financial assets and financial liabilities) are initially measured at the transaction price, including transaction cost. However, if the instrument is measured at fair value through profit or loss, the transaction cost is expensed immediately. 12, Subsequent measurement of basic financial instruments a. Basic debt instruments are measured at amortized cost using the effective interest method. , 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 without undue cost or effort. If the shares are not publicly traded or if the fair value cannot be measured reliably without ‘undue cost or effort, such investments are measured at cost less impairment. 13, Impairment of basic financial instruments All amortized cost instruments must be tested for impairment. ‘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 reccived 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. For basic financial instrument measured at amortized cost, both full PFRS and PFRS for SMEs provide that the impairment loss is the difference between carrying amount and the present value of cash flows using the original effective rate. 14, Investments in associates Full PFRS ~ Investments in associates are accounted for using the equity method, SMEs - SMEs shall account for investments in associates using any of the cost model, the equity method or fair value model and using the sarae 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 the investment in associate at cost less any accumulated impairment loss. However, the cost model is not permitted if the investment in associate has a published price quotation in which case, the fair value model is used. All dividends received are recognized as income withoul regard whether the dividends are from preacquisition or postacquisition retained earnings of the associate, Under the equity method, the investinent account is initially recognized at the ransaction 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 received from the associate are recognized as reduction of the carrying amount of the investment, If the equity method is used, the investment in associate is tested for impairment. 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 is not tested for impairment. 6776Page 6 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. The fair value model is by circumstance not by choice. The cost model is used when the fair value cannot be measured reliably without undue cost or effort. Paragraph 4.2 of PFRS for SMEs provides that investment property measured using cost model is, presented as a separate line item “ investment property at cost less accumulated depreciation and impairment”.. 16, Property, plant and equipment PFRS for SMEs and full PERS are now the same with respect to matters related to property, plant and equipment such as measurement, depreciation method, useful life, residual value, impairment and revaluation. Paragraph 17.5 of PFRS for SMEs is amended to allow now the revaluation of property, plant and equipment of an SME. 17. Government grant a. Under full PFRS, a government grant 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. Grant received before the recognition criteria are met is recognized as liability. A government grant that does not impose conditions on the SME is recognized in income when the grant proceeds are receivable. b. Under full PFRS, a government grant is recognized as income over the periods necessary to match with the related cost for which it is intended to compensate. The PFRS for SMEs does not allow an entity to match the grant with the expense for which it is intended to compensate or the cost of the asset that it 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. 18. Borrowing costs Full PFRS — Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset must be cepitulized as part of the cost of the asset. All other borrowing costs are expensed. SMEs - All borrowing costs are expensed immediately when incurred. 19. 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 revaluation model, There is a choice under full PFRS. g either the cost model or b, Under PFRS for SMEs, the useful life of an intangible asset is considered to be finite. Ifthe useful life of an intangible asset cannot be estimuted reliably, the useful life is determined by the best estimate of management but not exceeding 10 years. Under full PFRS, the useful life of an intangible asset is cither finite or indefinite. 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. 6776Page 7 20. Research and development costs ‘Under PFRS for SMEs, all research and development costs are expensed immediately when incurred. Under full PFRS, research costs arc expensed immediately when incurred. However, development costs may be capitalized when specific criteria are met, particularly when technological feasibility has already been established. 21. Impairment of assets Under the PFRS for SMEs, intangible assets, including goodwill, are tested for impairment when there is an indication that the asset may be impaired. Under full PFRS, intangible 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: 22, Provision and contingencies Same principles for both PFRS SMEs and full PFRS. 23, Defined benefit liability a, Full PFRS — The defined benefit obligation is the excess of the present value of the defined benefit obligation at year-end over the fair value of plan assets at year-end. ‘SMEs - The defined benefit obligation is the same under full PFRS. b. Actuarial gains and losses Full PFRS - Actuarial gains and losses are recognized in other comprehensive income. SMEs - Actuarial gains and losses are recognized either in profit or loss or other comprehensive income. c. Past service costs Full PFRS and SMEs ~ All past service costs are recognized immediately in profit or loss as component of employee benefit expense. 24, Deferred tax asset and liability PERS for SMEs and fuli PFRS are now the same in accounting for income tax. 25. Lease accounting PFRS for SMEs and full PFRS 16 are the same with respect to lessor accounting. However, with respect to lessee accounting, there seems to be a significant difference. Under PFRS for SMEs, the lessee shall classify the lease as operating or finance based on the transfer of risks and rewards incidental to ownership ‘Under the new standard PFRS 16, a lessee is required to account for the lease as a finance lease. However, the lessee may apply the operating lease model if the lease term is one year or less, or if the underlying asset is of low value in accordance with the new lease standard. 26. EQUITY : PFRS for SMEs and full PFRS are practically the same with respect to : a. Issuance of equity instrument b. Treasury shares ¢. Compound financial instrument d. Equity swap e. Dividends 6776Page 8 27. 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. 28, Specialized activities of an SME include: a. Agriculture b. Service concession c. Exploration and evaluation of mineral resources PFRS for SMEs and full PFRS are practically the same for agriculture and service concession. 29. Exploration and evaluation of mineral resources Under full PFRS, the exploration and evaluation asset whether tangible or intangible shall be measured subsequently using either the cost model or revaluation model. Under PFRS for SMEs, the intangible exploration and evaluation asset is measured using the cost model only. However, the tangible exploration and evaluation asset is measured using either cost model or revaluation model. 30, Reconciliations required 1, Reconciliation of equity under the previous accounting basis to the equity under PFRS for SMEs both at the: a. Date of transition to PFRS for SMEs b. End of the latest reporting period 2. Reconciliation of profit or loss under the previous accounting basis to the profit or loss under PFRS for SMEs at the end of the latest reporting period. END 6776