Exempting small business from financial reporting

The European Commission is well on its way to legislate proposals that would exempt micro-business from the preparation of financial statements. What is micro-business for Europe may well be a substantial part of our business in Malta. In Malta a substantial part of micro business is carried out by means of limited liability companies. As such they are subject to an annual statutory audit and without financial statements such audits cannot be carried out. Once we start removing financial reporting requirements a host of issues will spring out of the box.

Financial reporting for small business is not really that burdensome and it is certainly not the biggest burden that small businesses have. The absence of financial reporting may favour or disadvantage those businesses that opt for it thus creating undesirable discrimination which can even be abused. Small businesses which opt out of financial reporting will find it more difficult to face their banks and creditors. If a small business were to be constrained to prepare financial statements after a break of several years it might even be costlier than the money saved not producing them.

Shareholders of small businesses will not be able to control each other and secure transparency and accountability without financial reporting. The exemption might give the false impression that accounting records of business transactions need not be kept. It would be difficult then to tell how opting businesses would prepare their VAT returns and what their taxation would be based on.

These and several other questions and issues would need to be addressed before the Commission's new directive comes into being in Malta. In a country of several micro businesses, the removal of financial reporting can wreak havoc if mishandled.

I recently read that the burden of financial reporting may contribute to the closure of business and their ability to keep workers in employment. Nothing can be farther from the truth. Financial reporting is the basis of all good business decisions, accountability and financial order. While benefits of easing the preparation of financial reporting cannot be disregarded we need to avoid applying it in Malta without due consideration to our business environment.

Accordingly we need to look at what we have already done in Malta to ease the burden of small businesses preparing financial statements in accordance with International Financial Reporting Standards. Malta was one of the first countries in Europe to adopt IFRS (then IAS). That was one very important step in positioning Malta as an advanced country when it came to financial reporting.

We have taken it so seriously that we made it law and that was one of the major attractions for investing in Malta. Shareholders of companies with set ups in Malta feel comfortable with the decision partly because of secure international financial reporting. This characteristic had to come under the lens in Malta because IFRS have become so complex that legitimate application to our small private business has indeed become an impossible task, futile and to a certain extent inaccurate.

The accounting profession in Malta responded impressively to this situation. Last January the Minister of Finance crowned a four year exercise by launching General Accounting Principles for Smaller Entities (GAPSE) purposely and professionally catering for the financial reporting of small business. GAPSE is a scaled down pragmatic version of IFRS. In my opinion the Maltese profession surpassed International Federation of Accountants (IFAC) in producing a document which caters for the financial reporting needs of small businesses. GAPSE is a document that has received widespread approval in Malta compared to the sceptical reaction by world markets to IFAC's IFRS for non-publicly accountable entities. We found a formula which eases the burden of small business without compromising the quality of financial reporting let alone its very existence.

In addition firms such as Ernst & Yong lost no time to take the facility a step further. It provided yet more ease in the production of financial statements by providing a tool to its clients and others, which takes them step by step through the process of drafting their financial statements. There is no need to flick through reference manuals or falling back on IFRS themselves. Simply follow through the line items of the financial statements and the preparer will be taken directly to the relevant section of the GAPSE directive.

GAPSE removes difficulties in preparing financial statements but not the financial statements. It achieves simplification without compromising quality of financial reporting in Malta and avoids the constraints that the exemption from financial reporting is bound to produce in Malta. GAPSE, I am sure, will serve as a model to other countries which want to adopt local GAAP.

GAPSE is Malta's breakthrough in drawing up its first national financial reporting standards with Maltese business in mind. It contributes to the attractiveness of Malta by upholding its financial reporting credentials. Yet GAPSE necessitates the professional accountant's involvement in the same way as the simplest medical certificate necessitates the involvement of a medical doctor.

We need to receive the forthcoming European Commission's directive on financial reporting with maturity. Small business owners should only resort to such an option after proper consultation with their professional accountant.

The author is managing partner at Ernst & Young.