• Small entities - Accounting Alert March 2018

Small entities

For profit entities – are you sure you’re using the correct accounting standards?

What is the issue?

A vast majority of New Zealand’s for-profit entities legislatively do not have a general purpose financial reporting requirement.

More often than not, this is due to these entities not being ‘large’ as defined under New Zealand law. Determination of whether an entity is deemed to be ‘large’ (or not) is driven by metrics surrounding that entity’s (i) asset base, and/or (ii) how much revenue it generates (and in the case of for-profit public sector entities, expenses).

However, what some ‘non-large’ for-profit entities sometimes fail to remember is that New Zealand law also prescribes the basis by which these metrics are calculated i.e. the metrics must be calculated in accordance with the accounting framework required by ‘large’ for-profit entities (i.e. New Zealand equivalents to International Financial Reporting Standards (NZ IFRS)).

What this effectively means is that even non-large entities that currently do not apply NZ IFRS and instead report under a special purpose accounting framework still need to keep up to date with impending changes in NZ IFRSs, to ensure that their asset base and revenue is being calculated correctly in terms of legislative requirements. (The amounts for assets and or revenue calculated under NZ IFRS could be very different to the amounts calculated under an entity’s special purpose accounting framework.)

For entities that are governed by pieces of statute that mandate general purpose reporting (for example companies, limited partnerships and partnerships – not an exhaustive list) any ‘large’ entity that fails to comply with its relevant Act may incur fines, penalties, and/or sanctions for the entity, as well as the entity’s directors (or equivalent officers), accountants, and/or professional advisors.

For this reason, the risks associated with a failure to comply with New Zealand law in determining if an entity is large should not be lost to any of the aforementioned parties.

So what is on the NZ IFRS horizon that I need to be aware of?

In the world of NZ IFRS there are three new significant changes in accounting standards that are beginning to come into effect from the 1st of January this year, relating to the accounting treatment of:

  • Revenue (NZ IFRS 15)
  • Financial instruments (NZ IFRS 9), and
  • Leases (NZ IFRS 16)*.

* effective from 1st January 2019

These impacts were highlighted and addressed in the November issue of Accounting Alert, and we would strongly recommend that readers revisit this article.

At a high-level where are the risk areas for me?

Entities that currently do not report under NZ IFRS, but may inadvertently be required to as a result of the accounting impact of the above NZ IFRS standards, are those most at risk.

Accordingly any for-profit entity that is currently applying ‘simplified’ accounting standards under a special purpose financial reporting framework should take note.

The risk occurs when changes in accounting treatments under these new accounting standards result in an entity’s asset base and/or revenue is pushed above the ‘large’ thresholds.

While there is no ‘silver bullet’ that will quickly identify whether an entity is at risk, entities and their professional advisors should be asking themselves (at a minimum):

  • Does the entity currently recognise any of its revenue streams over time?
    If so, would the new requirements of NZ IFRS 15 require recognition of these revenue streams to be accelerated (i.e. more upfront), pushing the entity’s revenue for the period above the ‘large’ threshold?
  • Does the entity currently have any agent-principal relationships in terms of its revenue streams?
    If so, would the new requirements of NZ IFRS 15 require these revenue streams to be recognised as a principal (gross) rather than as an agent (net), and would this then push the entity’s revenue for the period above ‘large’ threshold?
  • Does the entity currently have operating leases, in particular potentially long term building leases?
    If so, would bringing these on-balance sheet based on their expected lease term (i.e. considering any renewal clauses), as required by NZ IFRS 16, push the entity’s asset base at year end above the ‘large’ threshold?
  • Does the entity currently have trade and other receivables (including advances and loans to third parties) that have non-standard (complex) terms and clauses in regarding how interest is calculated and/or when repayments are due?
    If so, would the new requirements of NZ IFRS 9 require these financial assets to be measured at fair value instead of amortised cost, and would this then push the entity’s asset base at year end above the ‘large’ threshold?
  • Does the entity currently measure any of its passive investments in shares at cost?
    If so, would the new requirements of NZ IFRS 9 to instead measure these at fair value push the business’ asset base at year end above the ‘large’ threshold?

The complexities of the new NZ IFRS standards should not be underestimated. The accounting requirements of these new NZ IFRS standards could result in significantly different accounting balances compared to those calculated under a special purpose accounting framework.

Need help?

If you need help in starting the process of assessing the impacts of these new standards or whether they will impact your reporting status as small or large, please contact your local BDO representative.