This report is the first in a new series of Public Policy Papers, part of the Financial Reporting Faculty’s Information for Better Markets thought leadership initiative.
How, if at all, should financial reporting by SMEs be regulated? In this short report we look at the costs and benefits of regulating SMEs’ financial reporting, at why SMEs may require a different regime from other businesses, and at what research can tell us about these questions. We conclude that the evidence available to date is insufficient to develop policies that are soundly based, and that a substantial programme of research is needed.
It is widely agreed that no single set of financial reporting requirements is appropriate for all types of business entity. It is also widely agreed, although sometimes only implicitly, that the general principle governing what requirements should be imposed and how they should discriminate among different classes of entity ought to be a cost-benefit test.
In developing a framework for analysis, we need to answer a number of questions:
The main grounds for discrimination among firms in setting financial reporting requirements are size, ownership and liability.
There is a complex array of arguments on the regulation of SMEs’ financial reporting, which on a priori grounds might justify full regulation, laissez faire, or anything in-between. To further complicate matters, the right answers will almost certainly differ from country to country and over time, depending on differences in other institutions, markets, levels of technology and education, and what alternatives to financial reporting information are available. This is eminently a topic on which empirical research is needed.
IFRS for SMEs: International Financial Reporting Standard for Small and Medium-Sized Entities was issued by the IASB in 2009. Jurisdictions have responded to the standard in different ways, but it has been adopted or adapted in a number of countries as the basis for accounting requirements for private companies including, sometimes with additional modifications, SMEs.
There is a good deal of interesting and useful research evidence on private company financial reporting, some of it specific to SMEs, but much of it wider in scope or focused on larger private companies. The research includes work on the effects of having an audit. We summarise this evidence in the appendix to the report. Valuable though this research is, it tells us remarkably little about the effects of regulating or deregulating SME financial reporting.
Public policy debates on SME financial reporting requirements are not well informed. In the present state of knowledge a variety of conflicting claims are all possible but essentially independent of the evidence. It might therefore be claimed, with equal plausibility in each case, that:
We believe that there is a need for substantial research on the effects of regulating and deregulating SME financial reporting. The broad objectives would be to compare the costs and benefits of different regulatory regimes and to measure the costs and benefits experienced as a result of changes in regulation.
A version of the report with an appendix on research evidence is also available.
For further information on SME Accounting Requirements: Basing Policy on Evidence, please email email@example.com