Small entities: What are the characteristics that could make an entity “small” for financial reporting?

The need for different reporting frameworks for small entities

The Board researched the financial reporting environment of small entities to understand if they should have different reporting requirements (see article on “Small entities”: Should there be different reporting requirements for them? [3 November article]).

The research noted that the classification of certain entities as “small” would have been necessary if the Board decided to prescribe reporting requirements or provide guidance to small entities. However, the Board decided that separate guidance is not needed for small entities. Some of the actions proposed by the Board assist all entities and not only those that are “small”. For example, guidance on developing accounting policies that are appropriate for an entity’s size and complexity of transactions could be applied by any entity, irrespective of size.

When could entities be considered small?

In the event that a classification of certain entities as small would have been necessary, the Board needed to understand what makes an entity small, because no definition or description of “small entities” exists in Standards of GRAP.

Potential matters that could impact on entities’ classification are discussed below. These include:

• Considerations in classifying entities.
• Specific characteristics.

Considerations in classifying entities

Who should classify entities as small?

Entities could classify themselves as “small” based on their characteristics. A party external to the entity could also make this assessment. Stakeholders expressed concern about entities performing a self-assessment. This is because small entities find it difficult to apply judgement. They preferred that an oversight body should determine an entity’s classification.

When should entities be classified?

Ideally classifications should not change from one year to the next, unless there has been a significant change in the nature and/or size of an entity’s operations. This implies that an initial assessment should be done and only reconsidered when circumstances change.

Stakeholders raised concerns about once-off transactions or events and that this could distort the assessment. Their impact would need to be carefully considered.

What methods could be used to classify entities?

There are different potential methods to classify entities. For example, using the characteristics of entities; or what type of entity they are, e.g. categories of municipalities, or certain types of public entities.

Stakeholders were not in favour of blanketly classifying all entities of a certain type as small, because within each type, entities vary in size as well as the complexity of their operations. Reservations were also expressed about classifying certain types of entities as small, for example municipalities and entities under their control, given their importance in delivering services. The same level of information would be required from these entities, to hold them accountable and for users to make decisions.

Specific characteristics

If characteristics are used as a method to classify entities, then specific characteristics would need to be developed.

What did stakeholders think?

Stakeholders supported the use of a combination of characteristics, both qualitative and quantitative, because considering only one characteristic in isolation could lead to inappropriate classifications. They further supported an approach of considering existing, instead of identifying new, characteristics. Most notably, stakeholders were in favour of using the following characteristics:

• Value of revenue
• Number of employees
• Functions performed by the entity
• Value of the budget
• Value of expenditure

The detailed information on the characteristics supported by stakeholders is included in the Research Paper.

What else did the research find?

More information on the challenges and issues identified by small entities, as well as the Board’s considerations and conclusions on the project, will be shared in upcoming posts in November.

How can the Research Paper be accessed?

The Research Paper has been published on the ASB’s website and can be accessed here.

The views expressed in this article are those of Secretariat and not the ASB Board.