Examining accounting standards for small and medium sized enterprises

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There has been a long wait for the accounting standards which was issued in the International financial reporting standards (IFRS) for small and medium sized enterprises also known as SMEs which was published by IASB in July 2009.

There are several definitions of an SME, according to IASB the definition of an SME has no 'public accountability' which means securities that are not traded in the public market i.e. not a financial institution and does not holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. However under IFRS there is no definition of what constitutes 'small and medium', but states in the exposure draft "The IASB will not develop detailed guidelines on which entities should or should not be eligible to use the IFRS for SMEs." (IASB, 2009) and further states that each jurisdiction should develop guidelines on which entities will use the IFRS for SMEs. Therefore 'SME' can be misleading given that private companies with multi-billion pound balance sheets that are not publicly accountable would fall into the scope of this standard. Moreover a definition of SME according to EU is it must be less than 250 employees, has an annual turnover not exceeding €50 million and/or balance sheet not exceeding €84 million. In the US it depends on the type of industry and in the UK it is stated in the Companies Act 2006 (turnover test, balance sheet total test and number of employees test). However there is no one definition that is universally applied.

The objective of this standard is designed to meet the financial reporting needs of non public accountability entities and financial statements for external users i.e. banks, credit rating agencies, potential creditors etc. Full IFRSs is designed to meet the needs of equity investors in companies in public capital markets, but does not meet the requirements for users of the financial statement of small companies, but, rather are more focused on assessing shorter-term cash flows, solvency and liquidity.

Introducing the Exposure Draft, Sir David Tweedie, IASB Chairman, said:

"Our goal has been to produce a standard for use by smaller and unlisted companies that offers the comparability of full IFRSs... SME standard will make the accounting requirements more accessible to smaller preparers in both developed and emerging markets." This will improve comparability and understandability of financial statements and consequently boost the investors' confidence and improve the quality of reporting as compared to existing GAAP. (IASB, 2009)

Introducing this system will enable countries around the world 'speaks the same language' and achieve consistency of accounting standards. Furthermore ASB stated financial reporting in the UK will improve and will reduce the burden of interpreting and complying with accounting principles.

Brian Shearer, National Director of Financial Reporting at Grant Thornton and Chair of the ICAEW group monitoring the development of the new IFRS said: "The new standards mark a sea change in how private companies will prepare their accounts. They will greatly enhance the comparability of financial statements for private entities making them more valuable for those working internationally." (Grant Thornton, 2009)

There are 3 tiers for this regime tier 1 is Full IFRS which are publically accountable i.e. listed and AIM companies including subsidiaries, tier 2 is IFRS for SMEs which is non-publically accountable entities and tier 3 is FRSSE which is small entities.

Under these proposals all entities will have the choice to adopt a higher tier e.g. Companies that reports under FRSSE can adopt the IFRS for SMES. Companies that use IFRS for SMEs will not able to say that they comply with full IFRS as IFRS for SMEs is a standalone standard which incorporates the principles laid down in the existing IFRS but which has been simplified. Disclosure beyond that required by the standard may then be needed to present a true and fair view.

"US companies with subsidiaries in the UK that do not qualify with small companies will need to prepare their subsidiaries' statutory accounts using either full IFRS or IFRS for SMEs." (PWC,209) the problems that companies may come across is that will the financial reporting system will be capable of multi GAAP reporting transferring from GAAP to full IFRS as IFRS for SMEs. Another problem that arises is what if the owner of a company is also managing it, will it have to comply with IFRS or will there be reduced disclosure?

In various jurisdictions there has been disagreement saying that a two-tier system of financial reporting subjects different entities to different accounting rules. Conversely practitioners have also expressed concerns about the undue cost in actually implementing the new standard.

The advantages of using IFRS for SMEs are the accounting rules is easier to read and understand, because of the simplified format and plain English used. There is low on going costs.

There will be one set of standards to follow enabling harmonisation of principles with overseas entities applying IFRS especially for foreign owned companies.

This will also facilitate investors and lenders to better compare financial performance of private entities and meet users' needs. It will allow more access to capital.

It will also enable "One-stop shop" of accounting requirements which is only updated every 3 years

As it is smaller it will be quicker and cheaper to implement and the audit fees will be cheaper. Uniform education and training and auditing efficiencies.

The disadvantages of using IFRS for SMEs is there will be an initial conversion cost in applying the standards. It also may provide more information than private entities provide currently in comparison with UK GAAP. There can be as possibility that users might not consider or accept the standards and may in the short term request UK GAAP financial statements.

There may be tax, legal and financial implications differences that will influence the users' decisions. In the short term users might need training and/or technical support on IFRS. Simplification does not necessary mean better. Not one size fits all. There will be a loss of sovereignty.

There are five simplifications to the full IFRS stated in the IFS of SMEs

• Topics omitted

• simpler option only included

• simplifications of recognition and measurement

• reductions in disclosures

• Redrafting in 'plain English'

Examples of simpler options included are:

• Revaluation of PP&E and intangible assets (IAS 16 & 38).

• Borrowing costs (IAS 23).

• Various options for government grants (IAS 20).

• Financial instrument options e.g. available for sale and held to maturity.

Examples of simplified recognition and measurement are:

• Goodwill impairment: always amortise over useful economic life or 10 years, whichever is longest.

• Expense all research and development costs.

• Expense all borrowing costs.

• Only review PP&E if there is a change.

After so many consultations between IASB and ASB the question is whether the standard adopted in the UK will effectively replace the current UK GAAP for unlisted companies?

According to Ian Mackintosh "For a number of years, the board has stated that, in the medium term, there is no case for the use of two different accounting frameworks in the UK" (Christodoulou, M, 2009)

In contrast to this statement "Current proposals from the UK-based Accounting Standards Board (ASB) would see Irish and UK GAAP as we currently know it cease to exist by 2012 to be replaced by either full IFRS or IFRS for SMEs" (Irene O'Keeffe and Fiona Hackett, 2009)

Moreover Sobel Sharp, audit partner at Deloitte, she favours the new standard away from the "profusion and confusion" of UK GAAP, but believes the implementation date of 1 January, 2012 set by ASB is ambitious. (Sharp, I, 2009)

The ASB's previous uncertain decision on UK convergence was to support a two-tier approach, where the lower level being based on IFRS for SMEs project.

Consequently, the decision to postpone any finalised decisions on convergence until feedback from the ITC has been analysed and discussed by the ASB and to see if a judgement can be made as to whether or not it is suitable for the needs of the UK and Republic of Ireland.

In conclusion the new standard is regarded as suitable for large private companies and perhaps medium-sized ones too. This transition would inevitably involve some cost and disruption, but the current stop: start process of convergence does not seem sustainable.

Our tentative view is that for the very smallest entities there are costs: benefit grounds for preserving the generally well-regarded FRSSE, albeit over time its provisions would no doubt become more closely aligned with the principles of IFRS

Whether this IFRS for SMEs will ultimately provide the solution to the accounting and financial reporting needs of the SMEs remains to be seen. But for now, the IFRS for SMEs is considered as a welcome development that will minimize the difficulties encountered by SMEs in complying with IFRS-based standards.

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