A new report from the Institute of Chartered Accountants in England and Wales (ICAEW), SME Accounting Requirements: Basing Policy on Evidence, looks at the arguments for and against having differential accounting requirements for small- and medium-sized entities (SMEs). It also reviews the relatively small amount of research evidence available. It concludes that there is not a good understanding of why different countries have the particular SME accounting regimes that they do. It may be that each country has arrived at the right answer for its own particular circumstances. But it is equally possible, given the lack of relevant evidence for policy makers, that the differences are to a greater or lesser extent arbitrary. Nobody really knows.
SME accounting requirements—and I include in this audit requirements where they exist—are an interesting and problematic topic for policy makers. On the one hand, there is a strong desire to lighten regulatory burdens on SMEs. On the other hand, there is an equally strong feeling in many countries that it is important that all incorporated businesses should meet certain minimum standards of competence and integrity in their accounting—that accounting, even by SMEs, should not be a complete free-for-all.
In practice, while accounting requirements for listed companies around the world are increasingly moving toward a common approach based on International Financial Reporting Standards, requirements for private companies—and particularly for SMEs—still vary widely internationally.
Arguably this is quite right. It is the growth of international capital markets and, to a lesser extent, international product markets that are driving international harmonization for listed companies. These forces are less relevant for private companies, which are more likely to rely on domestic sources of finance and to operate mainly in domestic markets. Again, this is particularly so for SMEs.
But it is worth asking why accounting requirements for SMEs around the world are so diverse. In the US, SMEs—like other private companies—typically face much lighter statutory requirements. In general, they are not required by company law to file accounts publicly or to have them audited or to comply with US generally accepted accounting principles (GAAP), although many private companies do so. This does not mean, of course, that private company accounting in the US has been uncontroversial. After years of debate, in 2012 the US Financial Accounting Standards Board (FASB) set up the Private Company Council to advise it on improving the standard-setting process for private companies.
In the EU, there are statutory accounting requirements for SMEs, but they have been progressively lightened in recent decades. This contrasts sharply with the position in the UK just a few decades ago when companies complied with much the same statutory requirements regardless of size or ownership.
As the EU both lightens and complicates the SME accounting regime—in the EU we now have different rules for each of medium-sized, small and micro entities—it would be nice to think that all these changes are based on a thorough examination of the costs and benefits. Nothing could be further from the truth. There have been extensive consultations and some research, but it has been very limited and far from a careful review of the costs and benefits either of the current regime or of potential changes to it. At a political level, the deregulation has usually been justified on the grounds of reducing the burdens on SMEs. But if that’s all that matters, we will indeed end up with no regulation.
This is an unhelpful situation to be in. Unhelpful not only for the developed economies, whose accounting requirements for SMEs—as for other entities—have been evolving for the best part of 200 years, but also for less developed economies, which may well look to the developed world for a model to follow.
The ICAEW report calls for a substantial program of research into the costs and benefits of regulating and deregulating SME accounting. As we learn more about these costs and benefits, policy makers can increasingly base policy on evidence—which would be a welcome change.