REPORTING WITH DIFFERENTIAL
FOR SMALL BUSINESS ENTERPRISES
Yu Jia, 202724318
ADMS 4510 M, Winter 2002
Differential Reporting, Hargitai
ADMS 4510 Winter 2002: 202724318, Yu Jia.
Table of Content
Abstract ........................................................................................................................................................ 2
Introduction ................................................................................................................................................. 3
The Opinions on Small Business Reporting ...................................................................................... 5
Big GAAP vs. Little GAAP ...................................................................................................................... 5
GAAP is GAAP ......................................................................................................................................... 5
The Users ..................................................................................................................................................... 6
The Users and their Needs .................................................................................................................... 6
Information Asymmetry Theory .............................................................................................................. 9
Foreign Practices......................................................................................................................................11
UK .............................................................................................................................................................11
Australia ...................................................................................................................................................13
New Zealand ...........................................................................................................................................14
US .............................................................................................................................................................15
International .............................................................................................................................................15
Size Issue ....................................................................................................................................................16
Recent Developments in Canada .........................................................................................................17
Background ..............................................................................................................................................17
The Exposure Draft ................................................................................................................................19
The Differential Reporting Framework .................................................................................................20
Eligible Entities and Size Issues .......................................................................................................20
Options .................................................................................................................................................21
Trade-off and Professional Judgment ................................................................................................22
Summary and Conclusion ......................................................................................................................24
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Abstract
The objective of this paper is to review the arguments and reasoning behind my
conviction that financial reporting for small business enterprises (SBEs) should
be allowed with differential within GAAP. It is my firm opinion that it is the needs
of financial information users that determine the contents of accounting
standards. To support this position, users and their requirements for small
business financial information are both identified and examined. Foreign
practices on this topic are reviewed and the enterprise size issue is discussed in
relation to the needs of users. The recent developments in small business
reporting in Canada and the CICA Differential Reporting Exposure Draft are
studied in light of how well they fulfill the objective of accounting information - to
meet the needs of users - as defined in the CICA Handbook.
My conclusion is that reporting with differential should be permitted within GAAP
for small business. It is based on the nature and requirements of the users of
SBEs statements with due consideration for professional judgment and tradeoffs.
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Introduction
Currently, Canadian General Accepted Accounting Principles (GAAP) generally
applies to all profit-oriented enterprises. As a result, such enterprises are
governed by nearly identical financial reporting requirements regardless of their
size or the public interest in them. In recent years, due to the globalization of
financial markets and the concerns of securities regulators, accounting standards
has evolved and developed as justified for public companies on the grounds of
public interest. These standards require tremendous disclosure development.
Thus, the need to apply the same financial reporting standards to all profitoriented enterprises, including non-public and small, medium size companies,
has become more and more an increasing source of debatable. More and more
people have questioned whether GAAP continues to be appropriate for nonpublic, small/medium size companies, whose users are limited to a few users.
“The imposition of uniform recognition, measurement, and disclosure standards
on all entities without adequate consideration of the unique needs of different
type of entities and financial-statement users, and the costs and related benefits
of alternative approaches to meeting those needs…”i (American Institute of Certified
Public Accountants, August 1996, p.1.) This has resulted in the so-called ‘Standards
Overload’. It was in this context that the notion of differential reporting or small
business accounting has merged.
In this paper, I will, first, discuss why there is a need for small business
enterprises (SBEs) financial reporting with differential under GAAP. I will present
the current opinions on this issue and point out my opinion that information needs
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of financial-statement users determine the content of accounting standards and
thus, reporting should be allowed to reflect appropriate differences. To support
this opinion, I will identify the users of the small business enterprises (SBEs) and
their needs for SBEs’ financial information from both the users’ point of view and
theoretical point of view. I will, second, review the ways in which foreign
standard-setters have responded to the challenges the small business
information needs pose to general-purpose reporting guidelines. Third, I will
discuss the recent developments on this topic in Canada, the CICA Exposure
Draft and its recommendations and formulate my opinion on the framework.
Fourth, I will support my opinion by discussing trade-offs and professional
judgment, both of which are often used by the profession in practice. Finally, I will
summarize the whole paper and draw the conclusion: financial reporting should
be allowed with differential for SBEs.
Opinions presented in this paper are also extracted from published articles and
papers as well as opinions from a chartered accountant, a banker who is a small
business loan officer and an owner who operates a small telecommunications
business enterprise.
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The Opinions on Small Business Reporting
Big GAAP vs. Little GAAP
The Big GAAP/Little GAAP debate has been ongoing for the last two decades. 1
Those who feel that complying with certain GAAP requirement is of limited value
to private enterprises advocated simplified or different standards for small or nonpublic companies. They have called for two separate sets of accounting
standards: one set for larger or public companies, i.e. Big GAAP, and another set
for small or non-public companies, i.e. Little GAAP. The Big GAAP is the GAAP
as it now exists. It prescribes extensive disclosure requirements for public
companies because their financial statements are widely circulated and the users
are at an unlimited number and variety. The Little GAAP is a simplified Big
GAAP. Advocates of Little GAAP believe that it should be tailored to the small or
non-public companies because the users of their financial statements are more
limited in number. By complying with a simplified GAAP, SBEs will save the time
and financial resources now consumed by the preparation of their financial
statements as well as reduce the amount of irrelevant information to the users.
GAAP is GAAP
Some accountants have argued that reporting standards are reporting standards
and they should be equally applied to all financial statements that purport to give
a fair presentation. Rules are rules and they should be everybody’s rules, i.e.
GAAP is GAAP. They believe that a strong body of GAAP cannot have
differential application and that uniformity in the application of GAAP is vital to the
CICA Special Committee on Standard-Setting – Report (1980), Financial Reporting by Small Business –
A report of the Accounting Standards Committee (May 1984).
1
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comparability of financial statements. “To serve the financially unsophisticated
reader, the financial report needs to use standards and methodologies that are
consistent and uniform over time and across companies. Sophisticated users will
analyze and manipulate the data for their own specific needs and interests. Both
cases require consistent, clear and detailed notes to the financial statements that
provide all of the relevant information so users can quickly and reasonably make
assessments. It is not up to the company or its auditors to assume what the
users want, or to assume that a reader understands the nuances of a reporting
methodology.”ii (Ted Anderson, April 1999)
I side the first argument and support the opinion that GAAP should be tailored to
meet the needs of small business financial statements users. In order to
establish a solid argument on this issue, I believe it is important to identify who
are the users of a small business and what are the users’ financial information
needs. Keeping these two questions in mind, I did some research and
interviewed 3 persons who deal with small business in Canada.
The Users
The Users and their Needs
According to the Study Group on Financial Reporting by Small Business
Enterprises, for financial reporting purposes, SBEs are “entities other than public
enterprises, cooperative organizations, pension plans and financial institutions.”iii
(Andree Lavigne, Oct. 1999) According to the same article, “users of SBE financial
statements are normally few in number, consisting mainly of bankers,
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owner/mangers, tax authorities and, in certain instances, venture capital
providers. SBEs prepare GAAP financial statements primarily to meet their
bankers’ needs.” (Andree Lavigne, ibd.)
To further understand the users and their needs, I interviewed Mr. Kam Manhas,
small business loans officer at CIBC, Mr. Jacques Demers, owner who operates
his own business and Ms. Winnie Szeto, CA at Deloitte & Touche.
I asked Mr. Demers, the owner of the small business, who the users of his
financial statements were. The answer was “myself, Revenue Canada and my
banker.” Mr. Demers operates the business himself. He makes every single
management decision and gets involved in every transaction that takes place
within the operations of the business. He has the greatest access to any
financial/non-financial information of his own firm. “We have to file tax reports. As
long as I can support my numbers, not a lot trouble. But the banks are pretty
picky. I have to get my financial statements audited, very costly for an 11-person
business. Besides the financial statements, they also ask me additional
information such as collaterals and how much money I can make to pay back
loan and interest. ” Jacques Demers, owner, Personal Interview, 20 February 2002.
According to Mr. Manhas, a loan officer for small business, the most important
information for a loan decision is the credit history of the business. Financial
statements play a major role in bankers’ decisions concerning loans as the
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entity’s asset/liability situation will provide collateral and cash flow will provide
repayment. Banks may require proof of the asset situation to make sure the
assets stated in the financial statements are accurate. “… not all the information
(in the financial statements provided by SBEs) is useful. Future cash availability
is the biggest concern.” Kam Manhas, Banker, Personal Interview. 18 February 2002.
Ms. Winnie Szeto, CA, shared her insight that “the key element is to understand
who are the users of a company’s financial statements. A user is somebody who
uses the information provided in the financial statements to make decision.
Depending on how heavily they rely on the information, users can be classified
as primary user or secondary. It is obvious that in Canada, owners are the
primary internal users for a small business. Lenders or trade creditors are the
primary external users of the financial statements of a private company. When
you think of the relationship between a lender and a firm, they are not only users
and preparers but also parties of a loan contract. So, if a bank can exercise its
power to gain access to the additional information, so can other lenders. The
specific information that a lender needs from a borrower is its ability to provide
future interest and principal payment. This kind of information must be timely and
relevant, …” Winnie Szeto, CA. Personal Interview. February 18, 2002.
“In Canada, in most circumstances, the primary external users of the financial
statements of privately held enterprises are lenders and trade creditors. The
most crucial financial information for creditors is how much cash will be available
for payment of the debt. The cash generating ability of the enterprise and short-
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term liquidity are of prime importance to short-term creditors. Long-term creditors
will pay more attention to the earnings-generating ability…”iv (CICA Exposure Draft,
Differential Reporting, September 2001)
It is now clear that the users of SBEs are limited to a narrower range. The
primary internal users for SBEs are the owners and the primary external users
are the creditors who provide financial support to the SBEs. The creditors are
seeking specific information, such as collateral and project cash flow, to make
their credit decisions. In order to make sure that SBEs provide relevant and
timely information to meet these specific information needs, the financial
information provided for these users should be focused on these specifics rather
than disclose a lot of other less relevant information. To further support this
opinion, I will look at Information Asymmetry Theory and apply it to the case of
the SBEs.
Information Asymmetry Theory
Information Asymmetry is a “unifying theme that formally recognizes that some
parties to business may have an information advantage over others.” (William R.
Scott, 2000) This theory provides a convenient context within which to consider
the major issues associated with relations between business entities and their
external financial statements users. Information asymmetry exists between those
within a business and those who provide external financial support to the
business, the creditors, because obtaining information is inevitably very difficult
and costly for external users without the access and resources at the disposal of
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insiders. To overcome difficulties associated with information asymmetry and to
improve the access to reliable facts and figures that would allow users to judge
the performance of the companies, it is paramount to have rules and guidelines –
GAAP, which imposes disclosure standards on financial statement preparation.
Public companies have unlimited users who are using financial information for
different purposes. To meet these all-purpose needs of users, it is appropriate to
require extensive disclosure so as to shorten the information gap between
preparers and users. In the case of SBEs, financial information is likely to be an
important source, sometimes, the only source, of firm specific information. In this
sense, the inherent risk associated with information asymmetry for SBEs is even
larger than that for a public company. “Small business financial reports must
provide specific information which can be used as a basis for enforcing contracts
that permits lenders and borrowers, in this case, users and preparers, to make
mutually acceptable agreements as to the actions each will take and the sharing
of outcomes from those actions. Therefore, it is logical that we have to tailor
current GAAP to meet this need and prepare the specific required information.”
Winnie Szeto, personal interview. February 18, 2002.
From both a user’s and theoretical point of view, I have showed that the needs
for small business financial information are different from those of public financial
information. The CICA Handbook, section 1000, states that the objective of
financial statements is to communicate information that is useful to financial
statements users in making their resource allocation decisions and/or assessing
management stewardship (paragraph .15) and that the benefits expected to arise
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from providing information in financial statements should exceed the cost of
doing so (paragraph. 16). It is, therefore, the information needs of users that
should determine the content of accounting standards. In order to better meet
this objective, SBEs should be allowed to report their financial statements with
differential under GAAP.
I will next illustrate how standard setters have responded to the challenges posed
by the all-purpose financial reporting requirements and the alternatives they have
developed to deal with this issue. International practices are examined first and
then the Canadian practice is discussed. The purpose of presenting these
international practices is to provide a broader background and knowledge on this
topic. This process will clarify the issues associated with the introduction of
differential reporting and hopefully alternatives that better fit Canada’s own
circumstances.
Foreign Practices
UK
In November 1997, the Financial Reporting Standard for Smaller Entities
(FRSSE) was first issued “…with the aim of producing a small company reporting
framework to influence the development of reporting for the next 10 to 20 years.” v
Institute of Chartered Accountants of Scotland, “Breaking the Code… A Better Reporting
Framework for Small Companies.” October 1998, pp.5. It defined small businesses
under Companies Act of 1985 and it distinguishes small businesses from the
body of companies as a whole in terms of the form and the nature of their
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statutory financial statements. The qualificationsviof a small business must satisfy
any two of the following conditions:
a. A turnover of not more than 2.8million British Pounds2;
b. A balance sheet total of not more than 1.4 million British Pounds; and
c. No more than 50 employees.
“It is designed to provide smaller entities with a single accounting standard
tailored to their particular circumstances. The FRSSE sets out a simplified
version of all current UK standards but excludes a number of disclosure and
presentation requirements and provides a few measurement simplifications (for
example, the asset and the liability related to a finance lease are stated at the fair
value of the asset, not at the present value of the minimum lease payments,
unless fair value is not a realistic estimate). The FRSSE is not compulsory, but
when a small company chooses to adopt the FRSSE, it adopts all of it, and the
financial statements state that they have been prepared in accordance with it.”
CICA Exposure Draft, Differential Reporting. September 2001. pp.18. “Research
commissioned by the Institutes of Chartered Accountants in England and Wales,
Scotland and Ireland on samples of eligible companies showed that over 40
percent had adopted the FRSSE as of 1999. A more recent survey by the
Association of Chartered Certified Accountants of UK members in practice
indicated that over 80 percent of those surveyed used the FRSSE when
preparing accounts on behalf of eligible clients. The UK Accounting Standards
Board (ASB) has established a committee on Accounting for Smaller Entities
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which, on a regular basis, recommends to the ASB how new standards or
revisions to existing standards should apply to smaller entities.”vii Ibid. pp.19.
Australia
“The Australian Accounting Research Foundation, in its first Statement of
Accounting Concepts, linked the obligation to prepare general purpose GAAP
financial statements to the existence of external users dependent on financial
statements to make decisions. The following factors may be considered to
determine whether an entity is a reporting entity:

Separation of management from economic interest;

Economic or political influence; and

Financial characteristics (the Statement of Accounting Concepts mentions
the following, with no quantification: value of sales or assets, number of
employees or customers or level of indebtedness of the entity).
In a more specific way, the Australian corporations law states that small
proprietary companies have to prepare a financial report only if shareholders with
at least 5 percent of the votes give the company the direction to do so, or if it is
controlled by a foreign company. In addition, the direction may specify that the
financial report does not have to comply with some or all of the accounting
standards. A company is classified as small for a financial year if it satisfies at
least two of the following tests:

Gross operating revenue of less than Aus$10,000,000 ($8,000,000) for
the year;
“The UK government has announced its intention to raise these size parameters. Revenue threshold, for
example, is expected to be increased to 4.8 million British Pounds.” CICA Exposure Draft, “Differential
2
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
Gross assets of less than Aus$5,000,000 ($4,000,000) at the end of the
year; and

Fewer than 50 employees at the end of the year.”viii
CICA Exposure Draft, “Differential Reporting”, September 2001. pp.20.
New Zealand
“The Financial Reporting Standards Board of New Zealand implemented a
Framework for Differential Reporting in 1997. An entity qualifies for differential
reporting options when it does not have public accountability and:

At the balance sheet date, all if its owners are members of the entity’s
governing body; or

The entity satisfies at least two of the following size tests:
-
total revenue not exceeding NZ$5,000,000 ($3,200,000);
-
total assets not exceeding NZ$2,500,000 ($1,600,000); and
-
average number of employees not exceeding 20.
Qualifying entities are granted a number of disclosure exemptions but also a few
different measurement treatments (for example, the taxes payable basis is
allowed, and long-term contracts may be accounted for using the completed
contract method). The Framework for Differential Reporting allows selective
application of the options provided. An entity that opts for differential reporting
must disclose how it qualified and what exemptions it has applied.”ix CICA
Exposure Draft, Differential Reporting, September 2001. pp.21.
Reporting”, p.5.
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US
“In the United States, compliance with US GAAP is required for public companies
subject to regulation by the US Securities and Exchange Commission. Other
companies may choose to comply with it voluntarily or for contractual reasons.
Essentially, non-listed companies are permitted to prepare their financial
statements on other comprehensive bases of accounting (OCBOA). Those bases
include the US tax basis, the cash basis of accounting or a modified cash basis
of accounting. Financial statements prepared on another comprehensive basis of
accounting should include in the notes all appropriate disclosures under the basis
of accounting applied, as well as disclosure of the differences from GAAP
(however, the effect of the differences need not be quantified). A number of
issues have been raised by American auditors as to how to assess the adequacy
of these disclosures.”x CICA Exposure Draft, Differential Reporting, September 2001.
pp.17.
International
“At the international level, the Statement published by the Board of the
International Accounting Standards Committee in December 2000 recognized
that demand exists for a special version of International Accounting Standards for
small enterprises. The UN’s intergovernmental group on International Standards
of Accounting and Reporting (ISAR) has recently set up a working group with the
objective of preparing proposals for a differential reporting model linked to
International Accounting Standards. The expected outcome is an ISAR guideline
intended to be a non-mandatory aid for regulators in developing countries.”xi
CICA Exposure Draft, Differential Reporting, September 2001. pp.23.
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Size Issue
Identifying which entities qualify for the different bases of reporting is a key
consideration in all above foreign alternatives. Having presented the above
international experiences, I would like to address this key issue, as it is the
premise for introducing the model of differential reporting. Where should be the
cut-off? Should it simply be the size using revenue, asset or employee as a
measurement or measurements? As discussed above, the UK FRSSE applies to
small companies as defined in company legislation. The criteria are based on
revenue (2.8 million British Pounds), total assets (11.4 million British Pounds)
and average number of employees (50 people). The New Zealand standardsetting body includes as a further criterion the involvement of all owners of an
enterprise in its governing body. People who favor a size test believe quantitative
measurements are a good surrogate for assessing the cost-benefit trade off.
However, “This is very arbitrary and very rigid. It simply undermines the
underlying reasoning for introducing small business accounting – to meet users’
needs.” Winnie Szeto, CA. Personal Interview, February 18, 2002. I hold the same
opinion as that of Winnie Szeto: the users should be the criteria to determine if a
company can comply with differential reporting guidelines. How Canadian deals
with this size issue will be presented later in this paper.
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Recent Developments in Canada
Background
People have advocated simplified or different standards for small or non-public
companies for the last two decades3. In 1995, when CICA issued Section 3860,
FINANCIAL INSTRUMENTS – DISCLOSURE AND PRESENTATION, strong
arguments were brought into the spotlight that it was unnecessarily demanding
for private enterprises. “Subsequently, application of INTERIM FINANCIAL
STATEMENTS, Section 1751, and INCOME TAXES, Section 3465, has been
deferred for enterprises other than public enterprises, co-operative organizations,
deposit-taking institutions and life insurance enterprises, pending the completion
of the project on differential reporting.”xii CICA, Exposure Draft, Differential Reporting,
September 2001. Footnote, p.2.
In Canada, several indicators underline the need for differential reportingxiii:

Public accountants are reporting increasing concerns of their clients
regarding the work and related costs necessary to comply with certain
GAAP requirements that are perceived as primarily aimed at public
companies and of limited value of private enterprises.

To limit the costs of the engagements, some private enterprises have
chosen to depart from GAAP on certain issues, with the result that the
audit or review reports have contained a reservation noting the departure.

Other private enterprises no longer have their financial statements audited
or reviewed by their public accountants, preferring instead a compilation.
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In a compilation engagement, the financial statements commonly depart
from GAAP in some respects and the public accountant provides no
assurance concerning those financial statements.
CICA, Exposure Draft, Differential Reporting, September 2001. pp.7.
In 1998, a Research Report was commissioned by AcSB “to examine how the
financial information needs of providers of capital to small business enterprises
might be met more effectively, and the degree to which reporting accordance
with GAAP could be modified to meet those needs.” CICA , Exposure Draft,
Differential Reporting, September 2001. pp.10.
To explore this area, the Study Group on financial reporting by small business
enterprises held consultative meetings throughout the country, met with
representatives of major Canadian banks and posted a survey on the CICA
website. The purpose of the survey was to find adequate solutions for the
improvement of financial reporting by SBEs and for better meeting the needs of
users of SBE financial reports. Based on the research and survey results, the
Study Group completed the Research Paper, “Financial Reporting by Small
Business Enterprises” in May 1995. According to this report, small businesses
and their stakeholders do have unique reporting needs: SBEs prepare GAAP
financial statements primarily to meet their bankers’ needs. According to the
Study Group, some of the information required under GAAP is clearly of little
relevance to SBEs. The Research Paper also proposed that differential reporting
be established within Canadian GAAP. “… accounting rules governing SBEs
CICA Special Committee on Standard-Setting – Report (1980), Financial Reporting by Small Busienss –
A report of the Accounting Standards Committee (May 1984). CICA Exposure Draft, “Differential
3
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would be permitted to differ from accounting rules applicable to public enterprises
when such rules do not meet the financial reporting needs of SBEs or when the
cost of applying the rules would outweigh their potential benefits for these
enterprises.”xiv Peter Mart, CA Magazine. August 2000.
Following the publication of this Research Report, AcSB established the
Differential Reporting Advisory Committee as a standing committee to provide
input to the standard-setting process concerning financial reporting by SBEs.
The Exposure Draft
In 2001, CICA published DIFFERENTIAL REPORTING Exposure Draft:
“ACCOUNTING STANDARDS BOARD PROPOSED ACCOUNTING
RECOMMENDATIONS – DIFFERENTIAL REPORTING EXPOSURE DRAFT”
was published in July 2001 and “BACKGROUND INFORMATION AND BASIS
FOR CONCLUSION – DIFFERENTIAL REPORTING EXPOSURE DRAFT” was
published separately in September 2001.
In the Exposure Draft, the Board again defined the users of SBEs’ financial
information and their needs. Based on the users and users’ needs information,
the AcSB concluded that uniform application of all accounting standards to all
types of enterprises is no longer appropriate. It also supports partial
differentiation on the basis of the objective of decision usefulness of financial
information and cost/benefit considerations.4
Reporting”, footnote, p2.
4
CICA, Exposure Draft, “BACKGROUND INFORMATION AND BASIS FOR CONCLUSION –
DIFFERENTIAL REPORTING EXPOSURE DRAFT”. September, 2001. pp. 26.
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CICA, Exposure Draft, “DIFFERENTIAL REPORTING”. July 2001.
The Differential Reporting Framework
Eligible Entities and Size Issues
The framework tackled the size issue by examining the characteristics of users
and adopted a qualitative approach. The board recognized that “Regardless of
their size, all private enterprises share a common feature that distinguishes them
from publicly accountable entities: they have a much narrower range of users of
their financial statements. Differential reporting is justified by the users’
characteristics rather than by the enterprise’s own characteristics. While medium
and large private enterprises have more financial resources and therefore may
be able to bear higher reporting costs than small ones, cost per user may still be
excessive for those enterprises relative to the benefits to be derived by a small
group of users.” Under this principle, the AcSB concluded that an entity should
meet the following two conditions in order to comply with differential reporting:

No public accountability; and

The owners’ unanimous consent in writing.
“The requirement of owners’ unanimous consent may act as an implicit size
test, as it may be harder to obtain this consent in larger private enterprises with a
relatively large number of shareholders. In practice also, lending institutions will
have a strong say in determining when differential reporting is acceptable.
Lenders’ acceptance of differential reporting may vary, depending on an
enterprise’s characteristics, circumstances and the type and size of loan. As a
result, under differential reporting the basis on which an enterprise’s financial
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statements are prepared will be determined more explicitly by the needs of the
users of the individual enterprise’s financial statements.”xv CICA, Exposure Draft,
Differential Reporting, pp. 46.
I, personally, strongly believe that this approach is a great alternative for the size
issue because it was based on the needs of financial-statement users’ needs and
is a good reflection of the financial statement objective as indicated in CICA
Handbook, section 1000. It also strongly supports my contention in this paper
that it is the information needs of financial-statements users that determine the
content of accounting.
Options
The following sections were approved by the AcSB (subject to written ballot):

Section 1590, Subsidiaries and Section 3055, Interests in Joint Ventures:
use of the equity method and the cost method.

Section 3050, Long-term Investments: use of the cost method.

Section 1751, Interim Financial Statements: presentation of annual
comparatives when year-to-date comparatives have not been previously
prepared.

Section 3240, Share Capital: limitation of the disclosure to issued classes
of shares.

Section 3465, Income Taxes: use of the taxes payable basis.
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
Section 3860, Financial Instruments – Disclosure and presentation:
preferred shares issued in specific tax planning arrangements may be
presented as equity.
Amendments were also made to Financial Statement Concept, Section 1000, to
emphasize cost/benefit trade-offs for individual entities.
The concept of differential reporting may still be controversial, but the framework
presented by the Exposure Draft was assessed highly in relation to users’ needs.
If the profession agrees that the financial statements should communicate
information that is useful to financial statements users in making their decisions, I
do not see why it is not a better idea to better fit these needs by allowing
reporting with differential for SBEs.
Trade-off and Professional Judgment
I stated previously in this paper that some accountants argue that rules are rules.
They believe that a strong body of GAAP cannot have differential application and
that uniformity in the application of GAAP is vital to the comparability of financial
statements. However, I believe that comparability should not be used as an
argument because it is fundamentally inconsistent with providing accounting
alternatives. When a conflict arises between the characteristics of relevance,
reliability, comparability and understandability, a trade-off needs to be found that
enables the objective of financial statements, i.e., the decision usefulness, to be
met. This trade-off decision requires professional judgment. Professional
judgment is often mentioned in an accounting environment. To decide which
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inventory valuation method better suits the company requires professional
judgment. To decide what would be a good estimate of bad debt allowance
requires professional judgment. These are only two of the many examples of
using professional judgment for accountants. CICA Handbook section 1500.06
states: “No rules of general application can be phrased to suit all circumstances
or combination of circumstances that may arise and the determination of what
constitutes fair presentation or good practice in a particular case requires the
exercise of professional judgment.”xvi CICA Handbook – Volume 1, section 1500.06.
This indicates that GAAP cannot cover every accounting situation and therefore
requires accountants to use their professional judgment to deal with different
situations. For SBEs, it is clearly a situation where the group of users and their
specific needs can be identified and where the needs are different from those of
public companies. Given this fact, shall we apply the same guidelines and leave
the rest to the professional to make their own individual judgment or would we be
better off to tailor our rules to better fit the circumstances? I firmly believe that if
we recognize the great needs differences and leave it all to professional
judgment, the latitude for information interpretation and manipulation is so large
that it will lead to confusing, ambiguous and misleading information. I am also
convinced that allowing reporting with differential for SBEs will reduce accounting
policy ambiguities and loopholes and provide a more consistent accounting basis
for small business financial information. Therefore, we should allow differential
reporting for small business enterprises.
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ADMS 4510 Winter 2002: 202724318, Yu Jia.
Summary and Conclusion
After introducing the two arguments regarding the issue of differential reporting, I
presented my opinion that the needs of financial-statement users determine the
content of accounting standards and if the needs of the users are significantly
different and identifiable, reporting should be allowed with a difference. To
support my opinion, I did a lot research and interviewed a banker, a small
business owner and a CA who deals with small business to identify who are the
users of small business financial information and what their needs are for the
financial information. My interview results concurred with other research papers
on the fact that the users of small business enterprises are different from those of
public companies and their needs are more specific. These results indicated the
need for a tailored GAAP for SBEs. I then reviewed how foreign standard-setters
responded to this situation and expressed my opinion on how the size-issue
should be handled: it should satisfy the needs of users. The discussion was then
moved to the Canadian context by introducing the background information of the
Differential Reporting concept and the framework of the differential reporting
model published by the CICA in September 2001. My conclusion was that given
the fact that the users and the users needs are different from those of public
companies, financial reporting should be allowed with a difference within GAAP
for SBEs. For this reason, I named my paper “Reporting with Differential for
Small Business Enterprises”. Although this concept may be controversial, it
allows financial information to be communicated to the users and better fit their
needs. The introduction of the differential reporting concept will set a precedent
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ADMS 4510 Winter 2002: 202724318, Yu Jia.
for more discussion in the accounting profession. Other topics such as
government accounting may soon follow this path and argue that it is necessary
to have a different set of GAAP or a differential reporting for government
reporting, given the uniqueness of government entities and its financial
information users. I believe that the concept of differential reporting is one of the
milestones for accounting theory development and that it will evolve with time
and the advances of the global economy and business practices.
Endnotes:
i
American Institute of Certified Public Accountants, Report of the Private Companies Practice
Section on Standards Overload, August 1996, p.1.
ii Ted Anderson, “Tailor-made, or one-size-fits-all?” AK/ADMS 4510, Course Kit, p.137.
iii Andree Lavigne, Standards with a differential, CA Magazine, Toronto, Oct. 1999.
iv CICA Exposure Draft, Differential Reporting Background Information and Basis for
Conclusions, September 2001. pp.28.
v Institute of Chartered Accountants of Scotland, “Breaking the Code… A Better Reporting
Framework for Small Companies.” October 1998, pp.5.
vi Ibid, pp.7.
vii Ibid. pp.19
viii Ibid. pp.20
ix Ibid. pp.21
x
Ibid. pp. 17.
Ibid. pp.23
xii Ibid. p.2. Footnote.
xiii Ibid. pp.7.
xiv Peter Martin, CA Magazine. All creatures great and small. August 2000, pp.47-48.
xi
xv
xvi
CICA, Exposure Draft, “Differential Reporting”. Pp.46.
CICA Handbook, Volume 1, section 1500.06.
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ADMS 4510 Winter 2002: 202724318, Yu Jia.
Bibliography
1. Accounting Standards Board (UK) Exposure Draft, “Financial Reporting
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ADMS 4510 Winter 2002: 202724318, Yu Jia.
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27