IFRS and Small and Medium-Sized Entities

Summer 2010

By Timothy A. Carfang, CPA

Many privately held companies wonder where the accounting standards-setters will lead them. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are working toward eliminating differences between U.S. Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS), and many wonder if they should transition to IFRS, stay with U.S. GAAP, or if there are other alternatives.

On July 9, 2009, some clarity was brought to the issue. IASB released the long-awaited IFRS for Small and Medium-Sized Entities (IFRS for SMEs). IFRS for SMEs is the culmination of a five-year project designed to reduce the burden and complexities of implementing IFRS for private companies.

This new set of standards is an alternative to both U.S. GAAP and IFRS. The IFRS for SMEs document is about 230 pages, which is 99 percent shorter than U.S. GAAP. This reduction was possible through the elimination of certain topics – such as earnings per share and segment reporting – and through a reduction in reporting and disclosure requirements. In addition, IFRS for SMEs takes a principles-based approach compared with the rules-based approach of U.S. GAAP.

Eligibility
The name IFRS for SMEs can be misleading. Size is not the determining factor of eligibility. Companies may use the framework if they meet the following criteria:

• Publish general-purpose financial statements for external users
• Do not have public accountability

An entity is considered to have public accountability if its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments for trading in a public market, or it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. This is typically the case for banks, credit unions, insurance companies, securities brokers/dealers, mutual funds, and investment banks.

Advantages
The IASB believes that there are several advantages to adopting the new accounting standard. Some of these are as follows:

• Provides improved comparability for users of accounts
• Enhances the overall confidence in the accounts of SMEs
• Reduces the costs of maintaining standards on both a national and international basis.

Factors to Consider
The transition to IFRS for SMEs could have costly and far-reaching effects. Many factors need to be evaluated in advance, including the following:

• Implementation – How does a company implement IFRS for SMEs? Should it create a parallel accounting system within its accounting package or adjust its current general ledger?
• External Reporting – How will the results of the transition affect a company’s financial results? Do loan covenants and other financial agreements need to be modified?
• Internal Reporting – How will IFRS for SMEs affect a company’s internal measurements and benchmarks for bonuses and profit sharing?
• Training – How should a company train employees for the new standards? How much will this training cost?
• Internal Controls – Does the company need to modify the way it accounts for and records certain transactions? Does there need to be a change in the company’s internal control structure?

Significant challenges are ahead for those companies that transition to IFRS for SMEs. IFRS for SMEs is not well-known among financial statement users in the United States. Many business investors and financial institutions do not understand the differences between U.S. GAAP and full IFRS let alone the differences between U.S. GAAP and IFRS for SMEs. The differences may be significant, and many businesses will not be prepared to make important business decisions inherent in adopting a new basis of accounting.

 

Rules-based U.S. GAAP is prescriptive in accounting for certain transactions. As a result, there is a consistency among financial statements that use U.S. GAAP. Both full IFRS and IFRS for SMEs are principles-based; therefore, they require more interpretation and professional judgment. These differences in accounting treatment can lead to significant differences in the financial results of a company.

Although IFRS for SMEs is a welcome option that brings relief from full IFRS adoption and an alternative to U.S. GAAP, the decision to transition to IFRS for SMEs should not be taken lightly. Given the challenges of implementation and the effects that transitioning will have on a company’s operating results, all businesses should carefully consider whether transitioning to IFRS for SMEs is a prudent endeavor.

Timothy A. Carfang, CPA, is an audit supervisor for Malin, Bergquist and Company LLP in Pittsburgh. He can be reached at tcarfang@malinbergquist.com.