“Small entities”:  Should there be different GRAP requirements for them?

Stakeholders shared concerns with the Board about the ability of “small entities” to prepare financial statements in accordance with Standards of GRAP. The main reason for their concerns was that small entities have constrained human and financial resources.

What was the Board’s response?

To determine possible actions, it was necessary for the Board to obtain a clear understanding of the problem. The Board responded by researching the financial reporting environment of these entities in 2018/19 to determine what could be done. The research focussed on:

1. Identifying the characteristics that could be used to classify entities as “small”.
   Because no definition or description of “small entities” exists in Standards of GRAP, the Board needed to understand what makes an entity small.
2. The challenges and issues faced by “small entities” to prepare GRAP financial statements.

While the Board decided not to introduce separate reporting requirements for “small” entities, they were of the view that the results of the research would be helpful to stakeholders. The results were published in a Research Paper, which is available on the ASB’s website.

What could a “small” entity be in the public sector?

As there is no definition of a “small” entity in the public sector in the Standards of GRAP the Board consulted stakeholders on what a “small” entity could be.

Stakeholders considered whether “small” entities should be identified based on specific characteristics or whether specific types of entities, e.g. certain types of municipalities or certain public entities could be considered “small”. Stakeholders were not in favour of classifying certain types of entities as “small”, because within each type, entities vary in size and the complexity of their operations differ.

On balance, stakeholders supported the use of a combination of characteristics, both qualitative and quantitative. 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, along with additional issues raised, such as who should perform the assessment, and whether this could change over time.

What issues do small entities face in preparing financial statements?

As part of the research it was necessary for the Board to obtain a clear understanding of the issues that small entities face in preparing their financial statements using Standards of GRAP. The following challenges were identified.

Accounting challenges

These challenges often relate to areas where judgement is required. Small entities do not have the necessary skills to apply judgement, nor do they have the resources to acquire those skills. Areas were also identified where the requirements of the Standards of GRAP may be misunderstood and misapplied. The most prevalent areas are:

1. Accounting for non-current assets. The challenges include:
   • Determining fair value, which was raised as an on-going challenge and not only once-off.
   • Applying judgement to separate assets into components.
   • Applying judgement to determine useful lives and residual values of assets and adjusting for fully depreciated assets still in use.
2. Applying materiality.
3. Keeping up-to-date with changes in the reporting framework.
4. Standards of GRAP are complex and may be difficult to interpret, particularly for less skilled finance staff.
5. Accounting for, and disclosure of, financial instruments.

Broader small entity environment

A number of issues impact on entities’ ability to prepare GRAP financial statements when they are small. These are not directly related to specific accounting issues. The key issues are set out below:

1. Human resource capacity and skills.
2. Budget constraints.
3. Lack of daily and monthly controls, including record keeping.
4. Overreliance on consultants.
5. Difficulty complying with legislation.

What did the Board decide? 

The Board considered a number of factors in deciding whether there should be different requirements for small entities. These factors included:

• The legislative environment, including the need for consistent financial norms and standards across the sector.
• The need for consistent reporting to prepare consolidated financial statements at various levels, including eventually for “RSA Inc”, i.e. the whole public sector. .
• The need for consistent reporting to meet other reporting requirements, e.g. statistical reporting.
• The effectiveness of solutions to address the problem.
• Stakeholder views. Most stakeholders did not support a different reporting framework for small entities, for the following reasons:
  • Concerns were expressed by users about the information they need for small entities no longer being available in financial statements. This is particularly the case where there is a drive for consistent reporting across the sector. The information produced by entities is used by a number of users, and it is important that it is reported consistently and comprehensively.
  • Entities cannot get the basics right and adding another framework would not resolve the issues.

Based on these factors, the Board decided not to introduce reporting requirements or guidance for small entities. The Board instead identified other actions that would be more appropriate for the environment, including:

• A number of the Board’s projects and related guidance would assist entities with their accounting challenges. These are identified in the Research Paper. Most notably, the Guideline on The Application of Materiality to Financial Statements contains guidance that would be useful to address some of these challenges.
• Publishing the results of the research and the resources available in the Research Paper.

A number of issues were identified that are outside the Board’s mandate to address (inherent to small entities and their environment). These have been communicated to stakeholders that may be able to assist small entities.