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Does Transparency Matter for SMEs?

Tuesday, 07 July 2015

This article originally appeared on the IFAC Global Knowledge Gateway. Visit the Gateway to find additional content on a variety of topics related to the accountancy profession.by Ricardo Julio Rodil, International Liaison Partner, Baker Tilly Brazil

Introduction

There are a variety of reasons the owner-manager of a small- or medium-sized entity (SME) might pursue a policy of financial transparency. For example, it seems reasonable to expect investors to be more inclined to risk their venture capital in entities that have sound and relevant information on their operations and financial health. In many jurisdictions, there are also legal reasons to keep accounting records and report periodically. Though many businessmen may not be aware of these requirements, they have the potential to severely complicate their lives and personal finances. This article takes a closer look at the reasons, legal and otherwise, transparency matters for SMEs.

Legal aspects

Let me summarise the relevant laws and regulations in Brazil as they relate to the provision of financial information to external users. Many other jurisdictions have similar or even stronger rules in this area. The Brazilian Civil Code sets forth that all enterprises, no matter their legal structure, must keep accounting records according to the prevailing framework and must prepare periodic financial statements in accordance with that framework.

Specifically, Brazil has adopted International Financial Reporting Standards (IFRS). Law 11.638/2007 specifies that non-regulated companies or groups of companies, under common control and above a certain size threshold, must adopt the full set of IFRS, an obligation that was restricted to regulated companies before that law was passed. Meanwhile, business entities below that threshold must apply the IFRS for SMEs. The authoritative accounting body (CFC – Conselho Federal de Contabilidade) issued a set of standards—Brazilian Accounting Rules or Normas Brasileiras de Contabilidade (NBCs)—based on a translation of IFRS, both full and for SMEs. As a result of that legal framework, every business entity in Brazil is required by law to adopt IFRS.

The laws in real life

Most SME owner-managers likely do not feel, in their day-to-day activities, the need to apply best practices of corporate governance for acting in a transparent manner (within the entity and to the public in general), or to prepare and publish financial information according to the legal rules summarised above. The practical consequences of this attitude for entities that do not depend on any kind of external financing for their activities was, in the short run at least, of little or no consequence for the entities and/or their owner-managers. This situation changed slightly in April 2015, when the Registrar of Commerce decided to require companies above the threshold to publish their financial statements before filing them at the Registrar. Failing to comply with this requirement may prevent companies to contract with the Government, to obtain financing at certain banks, and the like.

But entities in Brazil, or jurisdictions with similar or stronger regulations, that are not in compliance with these requirements expose themselves to significant risk. As the best practices described above are also legal requirements, non-compliance may lead a judge, for example, in regard to entities seeking protection or going bankrupt, to decide that the bankruptcy was fraudulent, leaving the owner-managers in breach of the penal code.

Business reason behind transparency

But, beyond the threat of jail, there is a compelling business reason for being transparent that owner-managers ought to be alert to: the usefulness that observing good practices of corporate governance and transparency may bring to attaining growth. As entities grow, so too does their need for finance. Finance may come from various sources: loans from banks; capital contributions from present or new shareholders; joint-ventures with suppliers; clients or competitors, either domestic or foreign; proceeds from selling part of the enterprise; and so on.

In any scenario that demands finance, the potential provider of capital will need access to relevant and reliable financial information. The potential investor also needs to be able to understand and interpret such information. For this to be possible, there are certain prerequisites for the entity’s management. Management must: adopt sound principles of corporate governance; emphasize transparency internally and externally; and prepare and publish reliable financial information in a consistent and understandable form for any potential interested party, domestic or otherwise, preferably, in the form of audited financial statements.

Conclusion

In light of the above, I am of the opinion that owner-managers ought to promote transparency in general. In respect to financial information, in particular, they need to promote transparency to ensure the long-term sustainable success of their businesses. Transparency extends to sound financial information and, specifically for Brazil and many other jurisdictions, this means financial statements prepared based on full IFRS or the IFRS for SMEs.

Learn more

See business reporting resources from around the world, including those on the IFRS for SMEs.
Ricardo Julio Rodil is the International Liaison Partner for Baker Tilly Brazil. He is a former member of the IFAC SMP Committee (2007-2012) and the IASB’s SME Implementation Group (SMEIG).

Copyright April 2015 by the International Federation of Accountants (IFAC). All rights reserved. Used with permission of IFAC. Contact permissions@ifac.org for permission to reproduce, store, or transmit this document.

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