• Friday, May 24, 2024
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Why FRCN must revisit wrong definition of SMEs

Financial Reporting Council (FRC)

In its document on the roadmap for the adoption of IFRS in Nigeria, the Financial Reporting Council (FRC) of Nigeria defined SMEs as entities that may not have public accountability and:

their debt or equity instruments are not traded in a public market;

they are not in the process of issuing such instruments for trading in a public market;

they do not hold assets in a fiduciary capacity for a broad group of outsiders as one of their primary businesses.

the amount of its annual turnover is not more than N500 million or such amount as may be fixed by the CAC,

its total asset value is not more than N200 million or such amount as may be fixed by the CAC,

no Board members are an alien,

no members are a government or a government corporation or agency or its nominee, and

the directors among them hold not less than 51 percent of its equity share capital.

FRC then mandatorily requires such SMEs to prepare and present their financial statements based on International Financial Reporting Standard (IFRS), effective 2014. Hence the above definition determines whether an entity adopts IFRS for SMEs or not.

It has been six years since SMEs are required to prepare IFRS based financial statements. But there are issues associated with the above definition and its mandatory IFRS requirement especially in this period of COVID-19 pandemic.

The first problem is that the FRC definition of SMEs is tied to a fixed amount of turnover or total assets not independently determined by it but tied to CAC fixation. Apart from this, the CAC definition places other conditions that work to compound our understanding of what constitutes an SME; for example, no foreigner as a board member, no government corporation or agency as member.

The interpretation of the latter is that once a foreigner invests in an entity who’s turnover and assets meet the CAC fixed amount, it will no longer be a SME. One question that arises is whether a ₦100,000 investment in a Nigerian company by a Ghanaian or Korean is enough ground for that company not to qualify as a SME even though its turnover is ₦500 million or total assets, ₦200 million.

It should be noted that the CAC definition of SMEs, which FRC adopted, accords with that of IASB as both stresses not having public accountability, but IASB does not impose further restriction as FRC has done. I do recognise that IASB allows local jurisdiction to take into consideration local exigencies in defining SMEs, it cannot be said that the chosen exigencies of fixed turnover, asset, foreign ownership and ownership by government corporations are the best for our environment.

This is problematic for IFRS adoption because a company that qualifies as an SME today and is mandatorily required to adopt IFRS may tomorrow, as a result of say COVID-19 or CAC’s dictates, not meet the turnover and asset threshold. The implication is that the investment made to implement IFRS by these SMEs may be wasted.

For example, section 394 (3) of the recent 2020 CAMA has specified a turnover of ₦120 million and total assets of not more than ₦60 million for qualification as SMEs. This supports the reason why FRC must revisit its wrong definition of SMEs that is tied to CAC fluctuating definition. Without this, many entities will continue to bear unnecessary cost and burden of mandatory IFRS adoption as opposed to voluntary adoption.

The way out for FRC is to adopt a universal definition of SMEs that is not constrained by local exigencies. To this end FRC should simply define SME as “an entity that has no public accountability”. Public accountability should then be restricted to considerations as to whether their debt or equity instruments are being traded in a public market; whether they are in the process of issuing such instruments for trading in a public market and whether they hold assets in a fiduciary capacity for a broad group of outsiders as one of their primary businesses. So, on the strength of the last consideration, finance companies will always not qualify as SMEs on account of holding assets in a fiduciary capacity.

The IASB is currently requesting information for the amendment of IFRS for SMEs and this therefore presents another opportunity for FRC to revisit its definition of SMEs in order to correctly mandate IFRS adoption among entities who will derive maximum benefits from its adoption.


Innocent Okwuosa, PhD

Dr Okwuosa PhD, CPFA, FCIB, FCA Chairman, IFRS Expert Forum (IFRSEF), Nigeria