Proceedings of 30th International Business Research Conference
20 - 22 April 2015, Flora Grand Hotel, Dubai, UAE, ISBN: 978-1-922069-74-0
The Potential Effect of the Implementation of the IFRS For
Smes on the Credit Decision for Small Entities
Nermine Ahmed Mamdouh*
Small and medium-sized enterprises form a dominant part of the overall Economy in most
countries, both in developed and in developing countries. Due to the importance of these entities
and its role in the development of the economy, the International Accounting Standards Board
(IASB) has issued a full set of standards specially designed for the small and medium entities
(IFRS for SMEs) in July 2009. The main objective of launching these standards is to meet the
SMEs financial statements users' needs that are extremely different from the listed companies
financial statements users' needs. With regard to the users of financial statements for SMEs,
banks are the most important main users of the SMEs financial reports as these reports represent
a major importance to the banks to take the credit decision. SMEs confront a difficulty in obtaining
the finance necessary to develop their activities. So, it is expected that the implementation of the
IFRS for SMEs will have a positive effect on the SMEs access to their necessary finance
particularly from banks. The research extensively review the relevant literature in order to discuss
the IASB objective in issuing the IFRS for SMEs, the problems faced by the SMEs in accessing
the finance necessary, and the potential effect of the IFRS for SMEs in helping the SMEs in the
access of the needed finance. The literature revealed that the application of the IFRS for SMEs
can potentially help in increasing the banks' trust in the SMEs' financial position and their ability to
repay the loan. In addition, it was concluded that the availability of financial information for SMEs
may reduce the likelihood of refusal to grant credit and decrease the interest rate on credit and
consequently its capital cost.
Field of Research: Financial Reporting
1. Introduction
The SMEs are considered the most vital and important sector in the economy of most
developed and developing countries; they serve as a backbone for the economy
development and growth; and represent a crucial factor for employment, modernization,
innovation and entrepreneurial spirit.
They represent more than 99% of the operating entities in most countries and provide from
40% to 80% of employment and responsible about more than half of the GDP in the world
(Aamir and Farooq, 2010).
Furthermore, recent studies show that the SMEs development is closely linked with the
Economic Growth. Beck et al. (2005) find a robust, positive relationship between the relative
size of the SME sector in a country and its Economic Growth. According to Ayyagari et al.
(2007), in high-income countries, formal SMEs contribute about 50 % of GDP on average.
Ciubotaru (2013) pointed that SMEs contribute in raising the living standards of the society
through stimulating the economic activity, the diversity of products offered to consumers and
creating new jobs. The development of the economic activity as well as the job creation
enhance, in their turn, other areas of activity such as: health care, educational or social
services.
*
Miss. Nermine Ahmed Mamdouh ,Department of Accounting, Faculty of Commerce, Alexandria University,
Egypt. E-mail: nermine_mamdouh@hotmail.com, Telephone number: 00201005400345
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Proceedings of 30th International Business Research Conference
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In addition, in many economies, the majority of jobs are provided by SMEs. For example in
OECD countries, SMEs with less than 250 employees employ two-thirds of the formal work
force (Beck et al., 2008).
However, despite the great importance of the SMEs sector, they suffer from a great
deficiency manifested in their accounting and financial practices and little is known about
their financial and accounting practices because these entities are not listed in the Stock
Exchange Market and their financial reporting practices are not regulated (Allee and Yohn,
2009).
Due to the SMEs role in the economy and their financial reporting weakness, the
International Accounting Standards Board (IASB) has issued a full set of standards specially
designed for the small and medium entities (IFRS for SMEs) in July 2009.
One of the main objectives of launching such standards is to satisfy the SMEs financial
statements users' needs. With regard to the users of financial statements for SMEs, banks
are considered the most important main users of the SMEs financial reports as banks rely
heavily in making their credit decision on the financial statements and are interested
necessarily in its quality and reliability to assess the entity's financial potential and capacity
to repay the loan.
In addition, the SMEs confront higher barriers in accessing the finance necessary to develop
their activities.
So, this paper's objective is to examine the potential effect of the implementation of IFRS for
SMEs on the SMEs ability to access the necessary finance from banks. The remainder of
the paper is organized as follows. The second section discusses the reasons that called the
IASB to issue the IFRS for SMEs and its objectives in issuing such standards. The third
section discusses the banks usage of the SMEs' financial statements and its importance in
making the banks' credit decision. The fourth section manifests the importance of the
implementation of the IFRS for SMEs as a set of high quality international standards and the
effect of its implementation on the SMEs' access to its needed finance. Finally, the fifth
section summarizes and concludes the paper.
2. The introduction of the IFRS for SMEs: Reasons and objectives
The fundamental role of the financial reporting and the accounting practices is to provide the
decision makers with information useful in making economic decision. However, it was
found that the SMEs accounting practices are unable to help in the decision making process
as these practices suffer from a severe deficiency and poor quality because of the lack of
accounting knowledge, the cost and the time constraints, and finally the lack of financial
reporting standards for the SMEs (IASCF, 2009).
The SMEs accounting practices especially in the developing countries are merely regulated
and influenced by the governmental accounting regulations or the tax authorities and not
derived by its primary and necessary role that it should play in the decision making and the
performance evaluation (Lalin and Sabir, 2010; Dang-Duc,2011) .
Furthermore, the majority of the SMEs are owner-managed which represents an obstacle for
the SMEs financial reporting quality as these owner-managers are usually themselves the
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Proceedings of 30th International Business Research Conference
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preparers of the accounts and the financial statements. However, most of the ownermanagers are not financially literate and they don't value the financial reporting importance.
Also, the involvement of owner managers don't warrant the same comprehensive effort by
the directors to communicate financial information to multiple and diverse shareholders
because most owner managers are already involved in the day-to-day operations of the
businesses (Wichman, 1983; McMahon, 1998; Sian and Roberts, 2009; Maesko and
Manyani, 2011).
Moreover, the SMEs are not obligated to prepare a complete set of financial statements
because they are not regulated by a set of accounting standards. They are only interested in
preparing the income statement as they consider it as the most important statement to help
them in measuring their profitability and for the tax purposes. But the owner-managers who
lack the sufficient accounting knowledge cannot value the importance and the necessity of
the statements related to the entity financial position, its cash flow and other complicated
accounting issues. In addition, the SMEs may fail to prepare a full set of financial statements
even with well-maintained books of accounts because the preparation of financial
statements requires more complex accounting skills and education and this is lacking in the
majority of SMEs in the developing countries and even in the well developed countries
(McMahon, 1998; Atik, 2010; Maesko and Manyani, 2011).
Furthermore, the majority of the SMEs adopted the cash basis of accounting, for the reason
that cash accounting is easy and straight forward as compared to the accruals accounting
which is complex because they are not following a set of standards that obligate them to
follow the accrual basis (Maseko and Manyani, 2011; Atik, 2010).
All these facts can pave the way to explain the SMEs poor accounting practices and
financial reporting.
In consequence, some countries tried to address the deficiency in the SMEs accounting
practices by having severe and complicated regulations even that outweigh the SMEs
capabilities and resources. For example, some countries decided to obligate all the entities
to implement the full IFRS even the SMEs (Ex: Malta, Kenya and Cyprus).
However, the practical implementation of the full IFRS by the SMEs showed that the SMEs
have faced numerous challenges and obstacles in implementing those standards, which
results that the costs of preparing the financial statements using the full IFRS outweighed its
benefits (Stainbank and Tafuh, 2011).
First, the set of the full IFRS is increasingly becoming longer and more complex because
those standards were initially designed to meet the needs of the investors in big-size
companies listed in public capital markets. The full IFRS cover a wide range of issues,
contain a sizeable amount of implementation procedures and include disclosures
appropriate for public companies which are not convenient with the SMEs nature. The highly
and increasingly complex nature of these standards make the task of practical
implementation of full IFRS for the SMEs that lack expertise, resources and accounting
knowledge a very challenging and difficult task (Alp and Ustundag, 2009).
Second, one of the major technical issues which have become an important feature of the
full IFRS is the fair value measurement requirements. In obtaining the fair value information,
there may be needed a simulation for a hypothetical market or complex mathematical
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Proceedings of 30th International Business Research Conference
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modeling. Such alternatives are likely to be more consistently and accurately computed by
professionals which represents a burden and cost for the SMEs (Alp and Ustundag, 2009).
In addition to the challenges faced by the SMEs while implementing the full IFRS, the SMEs
should be treated differently than public companies, in other words the small enterprise is
not simply a smaller version of a large enterprise (Briciu et al., 2009; Aamir and Farooq,
2010).
Albu et al. (2010) indicated the aspects of difference between the SMEs and the large
public accountable entities subject to the application of the full IFRS as follow: (a) the users
of the entity’s financial statements and their information needs; (b) how the financial
statements are used; (c) the depth and breadth of accounting expertise available to the
entity; and (d) the SMEs ability to bear the costs of following the same standards as the
large public accountable entities.
Concerning the users of the financial statements, the IASB's conceptual framework
identifies the key users of financial statements as investors, lenders, suppliers and other
trade creditors, employees, customers, government (and their agencies) and the public.
However, not all of these users are likely to be important for the SMEs. The literature
identifies the main users of the financial statements of the SMEs as banks, owner-managers
and non-manager-owners, and tax authorities (Lungu et al., 2007; Deaconu et al., 2009;
IASB, 2009).
Comparing between the user's needs of listed companies and those of the SMEs, the users'
needs of listed companies financial statements are to invest in equity shares or provide
long-term debt for the companies, so they need much longer time horizon to forecast
earnings, share prices, the company's cash flows in long-term, profit or loss and the
corporate value. But for the users of SMEs financial statements, their needs are completely
different; they are interested in short- term cash flows, liquidity, solvency, financial position
and performance of the firm in prior years, interest coverage, and trends of profit and loss in
prior years (IASB, 2009; IASCF, 2009).
Concerning the costs burden imposed on the SMEs in implementing the full IFRS, these
costs include: the cost of hiring professional accountants able to implement such standards,
the cost of training its accountants and the time constraint. It is a well known fact that the
SMEs lack the financial resources to bear such high costs to be capable of producing such
high quality financial statements (Evans et al., 2005; Maingot and Zeghal, 2006).
To conclude, the SMEs found that applying the full IFRS in preparing its financial statements
is time consuming, too complex and too costly to follow, and lack relevance for the its nature
and needs.
Due to the challenges and problems discussed above, differential reporting for SMEs
emerged, based on the idea that different types of entities are subject to different financial
reporting requirements, designed to achieve high quality financial statements, meet users'
needs and achieve more benefits than costs (Bunea et al., 2012).
Several recent papers like Campbell and Morris (2006); Deaconu et al. (2007); Alp and
Ustundag (2009); Cirkveni, (2011); and Madawaki, (2012) concluded that there is a need
and a necessity for launching a special set of accounting standards specially designed for
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Proceedings of 30th International Business Research Conference
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the SMEs in order to encourage the SMEs to use a set of high quality standards in preparing
their financial statements; and thus this will enhance the harmonization and comparability of
the information between the SMEs' financial reports; the SMEs' financial statements will
gain validity in the international markets due to its high quality; increase the trust for
enterprises in the domestic and foreign markets; provide quality standards which are easy to
understand; target the specific needs of SMEs; reflect the needs of the users and observe
the cost- benefit ratio; simplify the preparation of financial statements; easier access to
foreign investment; easier access to finance provided by creditors and banks which will
result in lower cost of capital.
Due to the need of SMEs for reporting standards and due to the complexity of the full IFRS
which was not suitable to the nature and characteristics of SMESs, the IASB formally
developed an international differential reporting model for the SMEs by launching a set of
accounting standards more suitable for the SMEs derived from the full IFRS with appropriate
modifications directed by the users' needs of the SMEs' financial statements and cost
benefit considerations. The final and official version of the IFRS for SMEs was launched on
the 9th of July, 2009.
Compared with full IFRSs, the IFRS for SMEs is less complex in five types of modifications.
First, IFRS Topics that are not relevant to SMEs have been omitted; these topics are:
Earnings per share, Interim financial reporting, Segment reporting, Insurance, Special
accounting for assets held for sale. Second, many of the principles for recognizing and
measuring assets, liabilities, income and expenses in full IFRS are simplified under IFRS for
SMEs, for example: Unlike the full IFRS, the principle of reducing the cost and the effort has
been introduced and used in many sections. It is primarily used in order to provide relief in
cases where the fair value measurement might be considered too burdensome for SMEs.
Third, where full IFRSs allow accounting policy choices, the IFRS for SMEs allows only the
easier option. Fourth, the number of required disclosures has been significantly reduced
under IFRS for SMEs, the full IFRS requires more than 3000 disclosures but the IFRS for
SMEs requires less than 300 disclosures. Finally, the standard has been written in a clear
and easily translatable language without complex details that are incorporated in the full
IFRS. To further reduce the reporting burden for SMEs, revisions to the IFRS for SMEs will
be limited to once every three years (Müllerova et al., 2010).
The main objective for publishing the IFRS for SME is to meet the financial reporting needs
of entities that: (a) don't have public accountability and (b) publish general purpose financial
statements for external users (IASB, 2009).
The IFRS for SME is expected to improve the information content and the format of the
financial statements presented by the SMEs (Maesko and Manyani, 2011). It can play an
essential role in helping SMEs gain access to capital. This is because it improves the quality
of reporting as compared with many existing national accounting requirements. At the same
time, it reduces the burden on entities in jurisdictions. Furthermore, it provides enhanced
comparability, understandability, transparency for users of accounts both locally and
internationally. It provides also greater information relevance, which is also beneficial for
management and market efficiency. This improves the overall confidence in the financial
statements of the SMEs which will lead to better investment decisions and ensures a more
optimal allocation of resources across the global economy (Jacob and Madu, 2009; Neag et
al., 2009).
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Proceedings of 30th International Business Research Conference
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In summary, the IFRS for SMEs objective can be:




Providing quality standards which are easy to understand and apply and which are
adequate for all SMEs throughout the world.
Targeting the specific needs of SMEs.
Not to exit the IASB conceptual framework that assures the high quality reporting
standards.
Reducing the burden of financial reporting for the SMEs willing to apply the IASB standards.
3. Banks as a main user of the SMEs financial statements
Banks are considered as a main user of the SMEs' financial statements because the
financial information is a key input in the banks' credit decision and one of the challenges
confronting banks is to acquire information required to assess the credit risk of the borrower.
There is evidence that banks rely heavily on the financial statements in making their credit
decision and the financial statements reliability is a prior variable to approve the loan grant
(Kitindi et al., 2007; Kim and Elias, 2008; Kim, 2009).
The main uses for the SMEs' financial statements by banks are to determine the entity's
capacity to repay the loan and to assess its profitability and liquidity (Nerudova and
Bohusova, 2008).
Allee and Yong (2009) found that firms with audited financial statements are significantly
more likely to be granted credit than those without audited financial statements. In addition,
they found a negative association between interest rates and accrual-based financial
statements. As the financial statements may reduce the information asymmetries associated
with assessing firm risk and provide a positive signal to potential creditors about the quality
of firm management which will result in improving the perceptions about the firm
creditworthiness. Finally, by including accounting numbers in debt covenants, the availability
of accounting information potentially facilitates the ability of lenders to monitor firm behavior,
reduces the riskiness of extending the firm credit.
Unless fairly detailed information on small firms is available, banks would hesitate to take
the risk and may prefer to lend to relatively larger firms to comply with regulation, leaving
smaller firms significantly constrained for capital. Improving the quality of financial
information is an important requirement for enhancing the flow of funds to the SME sector,
as the quality of information also influences decisions on loan finance (Thampy, 2010).
Additionally, former studies can confirm that the quantitative analysis of annual financial
statements is still the backbone of bank internal rating processes. In all sizes of institutions,
standard balance sheets can serve as a basis for the rating procedure (Wu and Zhang,
2014).
All of these findings called for improving the SMEs' financial statements as they are
considered one of the main sources of the information needed by banks to take their
decision of granting the finance needed by the SMEs.
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Proceedings of 30th International Business Research Conference
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4. The SMEs' challenges to the access to their needed finance:
The availability of external finance for the SMEs is a topic of significant research interest to
academics and an issue of great importance to policy makers around the globe (Berger and
Udell, 2006; Strouhal et al., 2010).
Despite the importance of the SMEs for the job creation and the production, most of the
SME literature points to the fact that SMEs face higher barriers to external financing than
large firms; and are less likely to have access to formal finance (Beck et al., 2008; De la
Torre et al., 2010).
The financial and institutional deficiencies might prevent SMEs from growing to their optimal
size. Beck and Demirgüç-kunt (2006) showed that small firms consistently report higher
growth obstacles than medium-size or large firms. Beck et al. (2005) showed that size, age
and ownership are the most reliable predictors of firms’ financing obstacles. The authors
found that older, larger and foreign-owned firms report lower financing obstacles. The
relationship is not only statistically but also economically significant. The probability that a
small firm lists financing as a major obstacle (as opposed to moderate, minor or no obstacle)
is 39% compared to 36% for medium-size firms and 32% for large firms. Beck et al. (2008)
concluded that smaller firms in countries with underdeveloped financial and legal systems
use less external finance, based on data from a firm-level survey in 48 countries.
Banks are considered as the dominant channel for providing funds to industry as most of the
SMEs are not able to access the capital markets for funds. However, the finance from banks
to SMEs is very limited and is not sufficient to satisfy all the SMEs' needed financial
resources.
Figure 1 shows that, in non-OECD countries, bank’s primary target is the large enterprises
that represent only 1 % of total firms. By contrast, micro-firms and small firm that represent
together around 85% are not from the banks' priorities in their lending plans (OECD, 2011).
Figure 1: Business Landscape in non-OECD Countries
Banks' Primary
Target
1%
5%-10%
20%-25%
65%-75%
Corporations and large
Enterprises
Medium Enterprises
Small Enterprises
Micro- Enterprises
Source: OECD, 2011.
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Proceedings of 30th International Business Research Conference
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Banks don't prefer to lend the SMEs, especially for the long-term loans, for a number of
reasons: First, the most important reason is that small business borrowers tend to be more
informational opaque than their larger brethren and thus pose greater challenges to lenders
(Kim and Elias, 2008). By opaqueness, the literature means that it is difficult to ascertain if
firms have the capacity to pay and the willingness to pay. This opaqueness particularly
undermines lending from institutions because of the unavailability and unreliability of their
financial statements (Berger and Udell, 2006).
Second, the lack of collateral, as banks require a large number of collateral due to the high
credit risks of this type of entities. This represents a high burden on the entity' owners due to
their inabilities to bring such a large number of collateral for the reason of their limited
financial resources.
In addition, some of the intrinsic and the inherent characteristics of the SMEs like the
heterogeneity in their activities, their informality, their low managerial capacity, their familyowned nature, difficulties in proving their creditworthiness; small cash flows; inadequate
credit history; high risk premiums translated in higher interest rates, underdeveloped bankborrower relationships and high transaction costs (Beck and Demirgüç-kunt, 2006; Strouhal
et al., 2010).
Stephanou and Rodriguez (2008) ranked the significance of the main obstacles cited by
banks for the SMEs' financing. The obstacles are ranked from the most important to the
least important as follow: The quality of financial information; The informality of the entity;
The lack of payment history; The low capacity to pay; The weak financial structure of the
entity; The quality of management; The lack of guarantees; The internal bank risk policies;
The lack of specialization in market segment; The government regulations; The low
profitability for this type of loan.
In summary, it can be concluded that the SMEs face high barriers in accessing their needed
finance from banks and they are in need for significant changes in their financial reporting
and accounting practices to solve their opaqueness problem and increase the banks' trust in
their creditworthiness and their financial position to prove their ability to repay the loan to
improve their financing status.
5. The relation between the IFRS for SMEs implementation and the
credit decision for the SMEs
The main objective for the SMEs in using a set of international reporting standards in the
preparation of the financial statements is to increase its quality and reliability which will
enhance the decision making process for the SMEs' financial statements users.
Due to the reliance of the SMEs' stakeholders on the information presented in financial
statements, the changes to the form and content of the financial statements may also affect
how stakeholders perceive the financial position of the entity (Evans et al., 2005).
Since banks have become the most important external user of the SMEs financial
statements; then, the use of international set of standards for the SMEs' financial statements
would help the banks in their credit decision as they could provide them with more reliable
and comparable accounting information(Albu et al., 2010).
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Proceedings of 30th International Business Research Conference
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According to recent studies, the reasons why SMEs increasingly draw up their financial
statements according to IFRS include the hope of gaining international investors, the wish
for a closer link between internal and external accounting, an improved insight into the
economic status for clients and providers, the opening of the international accounting
standards board’s financial reporting standards to non-capital market oriented enterprises,
and last the most important objective is to have easier access for finance from banks and an
improved credit rating ( Zuelch and Burghardt, 2010)
Surveys produced by Abdel-khalik et al. (1983) find that the banks have perceived that the
financial statements based on a set of high quality standards are more useful. The banks
also exhibit greater confidence in standard-based financial statements compared to taxbased financial statements, and they perceive lower default risk when borrowers provide
standard-based financial statements. In addition, lenders frequently face problems with
borrowers when financial statements are prepared with departures from standards, and
bankers respond by further restricting loan agreements. The entities supplying non-standard
financial statements are asked for more additional information than those supplying
standard-based financial statements.
Joshi and Ramadhan (2002) reached that 84% of the companies using the international
Accounting standard think that these standards are improving their ability to borrow from
banks and the effectiveness of their financial reporting.
Esptein (2009) emphasized the fact that universal financial reporting standards will facilitate
the finance access for SMEs, lower cost of capital, increase market liquidity.
Zuelch and Burghardt (2010) and Wu and Zhang (2014) examined whether the choice of the
financial reporting system can influence the credit rating of an enterprise. It aims to argue
that SMEs reporting according to IFRS can – in some cases – benefit from better credit
conditions. The findings show that bank internal ratings can be a motivation for SMEs to
change the system of financial reporting to international standards.
The IASB mentioned in the IFRS for SMEs that it is expected for the SMEs applying this set
of standards in preparing their financial statements to have better access to capital; and the
financial institutions and the creditors can manage their capital in easier way (IASB, 2009).
The IASB tried to downsize the IFRS for the benefit of SMEs but with following the IFRS
framework to assure the high quality and the transparent financial statements but with taking
the users' needs in consideration and removing the immaterial items from financial
statements to get clearer picture of the entity. For example, banks are not interested in
Earning per share and capitalized leases which were removed from the IFRS for SMEs. In
addition, banks are not interested in the fair value method for assets evaluation because of
its low degree of reliability; hence, its use is minimized in the IFRS for SMEs.
Furthermore, the IFRS for SMEs depend on concepts and pervasive principles like
understandability, relevance, reliability, substance over form, prudence, completeness,
comparability, timeliness, which identifies the level of transparency in financial statements
(Balci, 2011).
Quagli and Paolini (2012) aimed to analyze the answers to the “questionnaire on the public
consultation of the IFRS for SMEs” promoted by the European Commission. The
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researchers concluded that users of the SMEs' financial statements especially banks are
favorable for the new standards as they think that its application will improve their decisions
by enhancing the financial information quality.
In summary, the SMEs usage of a set of high quality international standards would help
them in accessing their needed finance as banks would have access to reliable and
transparent information that help them in increasing their trust in the SMEs' financial position
and their ability to repay the loan.
The IFRS for SMEs is based on the users' needs considerations taking in account the
banks' needs and eliminating the unneeded topics that are not relevant for the SMEs'
financial statements users' needs specially banks.
6. Conclusion and Recommendations:
It can be concluded that the IFRS for SMEs is the set of standards that can offset most of
the deficiencies existing in the SMEs sector from the financial reporting perspective.
First, The IFRS for SMEs is a set of high quality reporting standards tailored for the SMEs'
financial statements users' needs and for the SMEs' capabilities, following in the same time
the IFRS framework that assure high quality and reliable financial information.
Second, the recent studies concluded that the SMEs face great challenges in their access to
external finance from banks mainly for the reason of their information opaqueness. Applying
the IFRS for SMEs would help in solving this opaqueness resulting in increasing the banks'
trust in the SMEs' financial position and their ability to pay the loan. In addition, it may lower
the likelihood of refusal to grant credit, result in higher credit rating and reduce the interest
rate on credit and consequently its capital cost.
These results are concluded on a theoretical basis by examining the set of the IFRS for
SMEs and the literature review.
It is recommended to study the IFRS for SMEs real implementation effects in countries that
already applied this set of standards. So the coming paper is devoted to study empirically
the effect of the IFRS for SMEs on the creditor's lending decision.
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