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The national Generally accepted accounting principles (here after GAAP) to international financial reporting standards (here after IFRS) is one of the most major transitions in the international accounting world.
This may prove to be a vital step towards adoption of single global accounting standard. It is even more crucial for small and medium enterprises (here after SMES) which have or are planning to expand internationally. With expansion of the EU and similar economic zones around the world, more and more SMES are trading internationally. IFRS for SMES provides an ideal opportunity for such SMES to develop their financial reports according to universal standards. In conducting business with private companies in different countries, lenders, venture capitalists and other users would just need to understand and work with one financial accounting and reporting standard (IASB, 2009a). But adoption of IFRS will have some strategic implications for the SMES (for e.g. issues such as taxation, debt servicing etc will be affected) and this need to be taken care of while transforming from local GAAP to IFRS.
This report analyses the implications of adoption of IFRS for SMES.
Small and Medium Enterprises:
According to IASB (2009b) (IFRS section 1), an entity can be categorised as SMEs if it:
(a) does not have public accountability, and
(b) publishes general purpose financial statements for external users (such as non managing shareholders, existing and potential creditors, and credit rating agencies). General purpose financial statements are those that present fairly financial position, operating results, and cash flows for external capital providers and others.
The standard does not contain a limit on the size of an entity that may use the IFRS for SMES provided that it does not have public accountability (IASB, 2009a). Public sector entities, not-for-profit entity or a subsidiary whose parent or group uses full IFRS may use the IFRS for SMES if the entity itself does not have public accountability. On other hand, listed companies, no matter how small, may not use the IFRS for SMES. In general, this accounting framework is intended for private small scale firms which do not have the size or resources to use full version of IFRS (Grant Thornton, 2009).
The Department for Business, Enterprise and Regulatory Reform (BERR) defines a small to medium sized enterprise as one that has less than 250 employees. The sector can be further dissected into sub categories, as shown below in table 1.
IFRS for SMES:
On 9th July 2009, IASB released a modified version of IFRS to be implemented for SMES. These are the first global set of accounting standards released for SMES. These standards provide simplifications which reflect the needs of users of SMES's financial statements and cost-benefit considerations. It contains element only specific to SMES and has simplified methods of recognising and measuring assets, liabilities, income and expenses (PWC, 2009) (Please refer to appendix 1 for key definitions and attributes of IFRS for SMES). In order to make the process easy for SMES, revisions to IFRS will be limited to once in 3 years.
All national regulators are not pressing hard for adoption of IFRS for SMES and SMES advised to use the accounting framework which best suits their objectives; for example, in the US, SMES can use either US GAAP, full IFRS, IFRS for SMES or an other comprehensive basis of accounting ("OCBOA"), such as cash- or tax-basis to prepare their accounts. But most countries now recognize IFRS as GAAP and hence firms have the flexibility of adopting IFRS for SMES as their accounting standard. The only resistance in this case could come from the users of the financial reports.
Difference between IFRS and GAAP:
While IFRS and GAAP, both identify all elements of business accounting but the definitions may vary. For example, UK GAAP identifies assets or liabilities only when there is concrete evidence of flow of economic benefits to/from the entity. IFRS on the other hand uses the term "probable". Also, certain intangible assets will be identified under IFRS but not under GAAP.
There are marked differences between IFRS and GAAP. For example, unlike in US GAAP, in IFRS (KPMG, 2009):
â€¢ Disclosures are simplified in a number of areas including pensions, leases and financial instruments.
â€¢ LIFO is prohibited.
â€¢ Goodwill and indefinite life intangible assets are amortized over a period not exceeding ten years.
â€¢ Depreciation is based on a components approach.
â€¢ A simplified temporary difference approach to income tax accounting.
â€¢ Reversal of impairment charges, if certain criteria are met, is allowed.
â€¢ Accounting for financial assets and liabilities makes greater use of cost.
GAAP and IFRS differ in their treatment of deffered payments. Firms pay a premium for credit and this premium depends on the amount of credit, the time lapse and firm's risk of default. Most GAAP (e.g. UK GAAP- SSAP 9) did not deal with the difference in deferred payment and actual. But IFRS (section 11) identifies the difference between the two; if a company is making deferred payments, IFRS requires the difference between the credit money and actual money i.e. the credit premium, to be considered as interest payment. Thus the IFRS better addresses the issue of cost of credit. This is significant because such accounting practice identifies the possibility of improving cash flow by making immediate payments in order to reduce interest payments (AICPA, 2006).
There is difference in how current tax is shown in GAAP and IFRS. For example, under IFRS, current tax is to be charged directly on equity if it relates to credits or charges that directly relate to the equity while under UK GAAP (FRS16) all current tax is included in the profit and loss account statement. IFRS does not allow discounting of deferred taxes while UK GAAP (FRS 19) permits discounting of deferred taxes. Also, IFRS requires reconciliation of total tax charges including both current and deferred tax charges while FRS 19 requires reconciliation of current tax charges only.
IFRS and GAAP also differ in their application of the principle of prudence. For example, German GAAP and UK GAAP allow the firm the right not to disclose information which can harm the interests of the firm, as long as the firm can prove this. IFRS does not allow any such exemption. Disclosure requirements under IFRS are more stringent as compared to under GAAP (ASCG, 2009).
IFRS and GAAP differ in their valuation of assets. IFRS (section 17) do not consider property, plant and equipment listed as for sale and it also excludes the recognition and measurement of exploration and evaluation assets. Most local GAAP (e.g. UK GAAP (FRS 15), South African GAAP) does not exclude these (SAICA, 2009).
IFRS (section 18) recommends that intangible assets (other than goodwill) should be expensed i.e. it does not allow any capitalization of development expenditure. These can be quite significant where the firms invest a lot in research and where the firm's main assets are derived from exploration and evaluation only such as in case of mining industries. IFRS adds subsequent expenditure on the assets similar to the initial spend on the same. Most GAAP recognizes such expenditures only when the subsequent expenditure brings in a measurable change to the asset (Deloitte, 2009a).
IFRS (section 11, 16) also includes the fair value option for asset trading. IFRS states that if the fixed assets of the firm are exchanged for a non monetary asset than the cost of the acquired asset should be measured at the fair value unless it is impossible to do so. There is no such clause in the most GAAP frameworks. The methods of calculating fair value also differ a lot between IFRS and GAAP. For example, IFRS recognizes prevailing (open) market value as the fair value of the asset while UK GAAP (FRS 15) uses the 'value to the business' as the fair value. FRS 15 requires revaluation to 'current value' which is defined as being the lower of replacement cost and recoverable amount. As a result FRS 15 is considered more prescriptive in requiring non specialized properties to be valued at existing use value and specialized properties to be valued at depreciated replacement cost and properties surplus to requirements at open market value )Deloitte, 2009b).
There are marked differences in the valuation of assets and liabilities. IFRS requires consistent treatment of all items of the inventory. Most local GAAP (e.g. UK and German GAAP) had a 'principle of consistency' which implied the same thing but firms were still able to use different calculations to value different items in the inventory. This would mean that different firms may use different sort of calculations thereby arriving at different values for similar assets. This irregularity is removed in IFRS which requires the firms to confirm to the established and enforced set of rules (ASCG, 2009).
IFRS (section 5) allows a one statement or a 2 statement approach for reporting income- either a single statement of comprehensive income, or two statements: an income statement and a statement of comprehensive income. It does not allow any item termed as 'extraordinary'. Under IFRS (section 18, 19), all goodwill must be amortised. If the entity is unable to estimate useful life, then amortization should be done over 10 years. In case of 'negative goodwill', first original accounting should be reassessed and if that is ok, then should perform immediate credit to profit or loss. For reporting impairment of assets IFRS recommends write down, in profit or loss, to recoverable amount, if below carrying amount. When the circumstances that led to the impairment no longer exist, the impairment is reversed through profit or loss (Deloitte, 2009a, 2009b).
IFRS (section 9) also recommends that a parent company (adopting IFRS) should presented consolidated statements in which it consolidates its investment in all its subsidiaries in accordance with IFRS. This means that for group companies, it becomes essential to prepare at least one complete set of accounts in compliance with IFRS is any member of the group decides to adopt IFRS.
IFRS for SMES is a short modified version of the full IFRS system and is intended to provide a consistent and universal accounting framework for SMES. There are several key differences between the IFRS for SMES and local GAAP. This report discussed the differences between IFRS and several local GAAP (US, UK, Germany, South Africa) and finds that IFRS is more prescriptive and standardized as compared to GAAP. On one hand, it is beneficial because it provides unambiguous guidelines but on the other hand, it could prove harmful to firms with unique business environment which requires flexibility in accounting; for example, the firms investing in exploration, research or intangible information gaining activities.