IFRS for Smes

Karlstad business school

Birgitta Kindgren

IFRS for SMEs

An overview of the new standard

IFRS for Small and Medium-sized Entities

International Financial Accounting

Date/Term: 09-10-22

Supervisor:Berndt Andersson

Examiner:Berndt Andersson

Contents

1Introduction...... 1

2International Accounting Standards Board (IASB)...... 2

3International Financial Reporting Standards (IFRS)...... 3

4IFRS for small and medium-sized Entities (SMEs)...... 4

5Background to the develop of IFRS for Small and

Medium-sized Entities (SMEs)...... 5

6The objective of the IFRS for Small and Medium-sized Entities...... 7

6.1 Determination of distributable income and determination

of taxable income are not specific objectives of the IFRS for

Small and Medium-sized Entities...... 7

7Financial statements...... 8

7.1 Complete set of financial statements...... 9

7.2 Notes...... 10

8Different users need dissimilar information...... 11

9Analysis...... 13

10Conclusions...... 14

12.1Reflections...... 14

11Bibliography...... 15

1Introduction

There’s not one country that has the same financial, legal or/and tax system as another country. Even in Europe, despite the European Union, there are huge differencesbetween neighbouring countries system. Therefore it is difficult to enforce understandable international accounting standards with high quality that every country can follow (International Accounting Standards Board (IASB) 1 2009).In Europe, for example, there are several types of law systems. The two most common, the traditional ones, are the Code-based legal system and the Common-law system (Arce & Mora 2002).

Code-based legal system (or the continental system) is primarily based on banking in the business financial structure.The main providers of finance are financial institutions. It has creditor-orientation legislation and is more conservative than the Common-law system.Accounting conservatism has preferably the highest value of liabilities and expenses and the lowest values of assets and revenues. Using the conservative measurement, the items receives a higher valuation multiples. With this system the book value is more relevant than earnings. Code-based legal system is characterized by the presence of governmental (not professional) regulatory bodies because the strong tax influence on accounting (Arce & Mora 2002).

Common-law system (or the Anglo-American system) is based on common law and the capital market is well-developed. It has market oriented, and therefore an investor-oriented legislation and is not as conservative as the code-law legal system. The system has issued, under the auspices of professional bodies, accounting rules independently from tax rules. Earnings, not the book value, have more relevance with this system (Arce & Mora 2002).

Market-orientated countries are more value relevant in their accounting information than creditor-oriented countries but in accounting valuation earnings and book value seem to play different roles.“… different accounting systems affects the relevance of the accounting information of the companies in the stock market.” Therefore it’s most important, to obtain a level of harmony and to increase the comparability, that regulatory bodies (such as European Commission, national regulatory bodies and the IASB) can reach an agreementon the strategy of harmonizing consolidated accounts (Arce & Mora 2002).IASB1 (2009) claims that “…high quality global financial reporting standards improve the efficiency of allocation and the pricing of capital.”In order to achieve global harmony and toprovide stakeholders with comparable information from the companies, the International Accounting Standards Board (IASB) has developed a framework called International Financial Reporting Standards (IFRS).

2International Accounting Standards Board (IASB)

To coordinate and to find high quality solutions to National Accounting Standards, International Accounting Standards and International Financial Reporting Standards, the IASB has developed International Financial Reporting Standards (IFRS) and pro-motes the use of those standards. IASB was established in 2001 and is the standard-setting body of the International Accounting Standards Committee (IASC) Founda-tion. There are 22 Trustees in the governance of the IASC Foundation and they are responsible for appointing the members of the IASB as well as securing financing for the organisation. It consists of 15 members, some of the part-time members. The main objectives of the IASB are, for example:

To develop an understandable global accounting standards, with high quality, to help stakeholder in the capital markets to make economic decisions.

To promote the use of those standards.

To achieve high quality solutions to national accounting standards(IASB 2 2009).

In order to achieve these objectives and to set standards, the IASB have constant contact with investors, regulators, business leaders and auditors around the world (IASB 3).Before the IASB began operations, the board of IASC established 1973, International Accounting Standards (IASs) and related Interpretations. IAS and related Interpre-tations are still applicable and have the same authority as IFRSs (IASB 2 2009).

Source: IASB 3 (2009page 2).

Some processes can also be implemented so that academics can help standards setters when certain issues arise. The fact that academics have analytical skills is appreciated by the standards setters, according to Brown and Howieson (1998). They suggest that academics should not be shy to volunteer to help the standards setters. Academics have various ways to communicate their views to assign draft but very few make their own submissions. To promote timely ex ante research there can be institute an ‘early warning system’ that helps academics and practitioners to predict the next item to surface (Brown & Howieson 1998).

3International Financial Reporting Standards (IFRS)

“International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) that is becoming the global standard for the preparation of public company financial statements”(The American Institute of Certified Public Accountants AICPA 12009).

Approximately 113 nations have adopted IFRS and it is estimated that IFRS could grow to 150 in a couple of years (AICPA 1 2009).

IFRSs are suitable to be applied to profit driven units' general financial reports. In order to supplyinformation to shareholders, employees, creditors and the public at large,a general financial reports is required. Information’sfrom general financial reports are an important part for users in making economic decisions (IASB 2 2009).

IASB 2 (2009) state that: “(IFRS) set out recognition, measurement, presentation and disclosure requirements dealing with transactions and other events and conditions that are important in general purpose financial statements. They may also set out such requirements for transactions, events and conditions that arise mainly in specific industries. IFRSs are based on the Framework, which addresses the concepts underlying the information presented in general purpose financial statements. The objective of the Framework is to facilitate the consistent and logical formulation of IFRSs. It also provides a basis for the use of judgement in resolving accounting issues”(IASB 2 2009).

The International Federation of Accountants conducted a survey in 2007 to accounting leaders from 92 countries around the world. The question was worded if they be-lieved a single set of international standards is importantfor economic growth. 90 percent (55 + 35 percent) reported that it was very important, nine percent said it was important and one percent found it not important(AICPA 2 2009).

Source: AICPA 2 (2009)page 2.

One reason why it is good to convergence is that some companies have subsidiaries in countries that must use IFRS and it will therefore be easier to use one accounting language company-wide instead of multiple. On the other hand, some companies not using IFRS, are afraid that the costs of adopting the standards will exceed the benefits and therefore opponents to IFRS (AICPA 1 2009).From 2005, the IASBs standards are mandatory for listed companies in the European Union (Sundgren et al. 2007).

4IFRS for small and medium-sized Entities (SMEs)

IASB has developed a standard for Small and Medium-sized Entities (SMEs). IFRS for SMEs refers to Small and Medium-sized Entities (SMEs), non-publicly account-table entities and private entities and the standards should be applied in their general purpose financial statements and other financial reporting. Due to that every juris-diction require different measurements in tax law and regulations and because these measurements not comply fully with SMEs, many countries have developed own definitions for Small and Medium-sized Entities (IASB 2 2009).

According to IASB 2 (2009) the description of Small and Medium-sized Entities is:

The entities don’t have public accountability.

The entities publish general purpose financial statements for external users (IASB 2 2009).

There are several reasons to have global financial reporting standards for Small and Medium-sized Entities. For example when credit rating agencies shall develop ratings uniformly across borders, financial institutions operates multinationally and make loans across borders, if vendors or suppliers, before they sell goods on credit, want to evaluate the financial health of the buyers. Even if these companies are small, private or non-publicly accountable entities, the stakeholders such as employees and creditors, is favoured of these standards in financial statements (IASB 2 2009).

Auditors will also be affected by the new standard. Docent Stefan Olsson[1] state that IFRS for Small and Medium-sized Entities will have a great significance on auditors. Large accounting firms have their own resources to interpret IFRS. It is important, according to Manager Dominic Rachez[2], that auditors know how to work with the standards. He also says that, despite the fact that it is unreasonable, the aim with IFRS for Small and Medium-sized Entities is that everyone should understand the standards.

5Background to the develop of IFRS for Small and Medium-sized Entities (SMEs)

In 2001 a Board of the IASB set up a working group of experts to provide advice on alternative and potential solutions to develop standards suitable for Small and Medium-sized Entities. A discussion paper “Preliminary Views on Accounting Standards for Small and Medium-sized Entities” was published by the Board in June 2004. Some of the issues in the discussion paper were:

If the IASB should develop the standards for Small and Medium-sized Entities?

What should the objectives of a set of financial reporting standards for Small and Medium-sized Entities be?

Which entities would be intended for the IASB standards for Small and Medium-sized Entities?

What should be the basis for modifying the concepts and principles and related mandatory guidance in full IFRSs for Small and Medium-sized Entities? (IASB 1 2009).

Due to the responses on the discussion paper many countries clearly demand and International Financial Reporting Standard for Small and Medium-sized Entities. They preferred international developed standards over locally or regionally deve-loped standards. Therefore, the Board decided that the next step was to publish an exposure draft of an IFRS for Small and Medium-sized Entities. Even if the respondents wanted to have a proposed treatment of the full IFRS, they did not suggest how they wished that the standards would be simplified. This meant that the IASB considered that more information was needed. To identify the problems they created a questionnaire which would be discussed with stakeholders in public round-table meetings. These meetings were created to locate what changes needed to be done (IASB 1 2009).

There were two questions in the questionnaire: First, if the Board should try to simplify the measurement principles of Small and Medium-sized Entities and what areas should be aimed at simplifying? Second, if the respondents, from own experience, felt that there were areas in IFRS that were not necessary for Small and Medium-sized Entities, as they rarely occurred, and therefore could be excluded from the IFRS for SMEs. Over a two-day period, the Board discussed theses issues with participants, a total of 43 groups. The Board received, after these discussions, 101 responses to the questionnaire. In June 2005 came a summary of what has emerged during these meetings. Recommendations on what should be included in the exposure draft of IFRS for Small and Medium-sized Entities were made by the board. The recommendations included regarding, for accounting, presentation, measurement and disclosure.Subsequently, a preliminary decision was made from the Board on what should be included in the exposure draft.The purpose of the exposure draft was to develop self-contained and simplified set of accounting principles for Small and Medium-sized Entities, based on full IFRSs. To encourage auditors, bankers and typical Small and Medium-sized Entities to participate in the process, a comprehensive outreach programme was conducted. An introduction was also provided in a non-technical language. The exposure draft has been translated into five languages and views on the proposal would be made before 30 November 2007. 162 letters of comments on the exposure draft received to the Board.The Boards very difficult task of redeliberations of the exposure draft took place between March 2008 and April 2009(IASB 1 2009).

When the Board developed the exposure draft of IFRS for Small and Medium-sized Entities, their intention was to make it a stand-alone document for many typical small entities.Another issue that therefore arose was how to publish IFRS for Small and Medium-sized Entities. Either the Board could make a separate edition ex-clusively for Small and Medium-sized Entities or fill out full IFRSs different parts with a section of Small and Medium-sized Entities.The advantages of astand-alone document would be that it is easier to use and more understandable, i.e. more user-friendly, and therefore will improve acceptance by jurisdictions considering adoption of the standard. Disadvantages with cross-references to full IFRSs would be more burdensome for Small and Medium-sized entities because they have to be familiar with both full IFRSs and IFRS for Small and Medium-sized Entities. One question is where the cross-references end. Some of the cross-referenced paragraphs refer to paragraphs within full IFRSs, either directly or indirectly, and this cause problem because updates are made to full IFRSs. In that case Small and Medium-sized Entities would need to monitor full IFRSs continuously in case of any changes. A separate volume was also generally favoured by the respondents to the discussion paper. The Board concluded that it was best to do a separate edition because it is more user-friendly for Small and Medium-sized Entities to have everything in one place(IASB 1 2009).

After a five-year development process, the 230 pages tailored IFRS for Small and Medium-sized Entities were issued by thirteen of the fourteen members of the InternationalAccounting Standards Board in July 2009 (IASB 4 2009).

6The objective of the IFRS for Small and Medium-sized Entities

“The objective of financial statements of a small or medium-sized entity is to provide information about the financial position, performance and cash flows of the entity that is useful for economic decision-making by a broad range of users who are not in a position to demand reports tailored to meet their particular information needs. Financial statements also show the results of the stewardship of management— the accountability of management for the resources entrusted to it” (IASB 2 2009)

6.1 Determination of distributable income and determination of taxable income are not specific objectives of the IFRS for Small and Medium-sized Entities

Because the information to the users, for example employees, creditors, shareholders and the public at large, should be available, there’s a need for general purpose financial statements. On these general purpose financial statements and other financial reports, the IFRSs are intended to apply (IASB 1 2009).

Special purpose financial statements are required to determining taxable income. The reason is that they should comply with the regulations and tax laws in a particular jurisdiction. Likewise, an entity is domiciled by the regulations and laws of the country where it resides and the entity’s distributable income is defined by these laws and regulations (IASB 1 2009).

One important external user of the general purpose financial statements is tax authorities. The tax authorities have the power to demand, in order to meet its statutory collection obligations and tax assessments, the information they need from a company.Tax service basis to determine taxable profits is often the financial statements. To determine the taxable profit or to minimize the adjustments to the accounting profit or loss, some tax authorities have specific tax polices. By means of a reconciliation that is easily developed at a national level, the starting point for determining taxable profit in a given jurisdiction can be determined in conformity with the IFRS for Small and Medium-sized Entities but the standards can not deal with tax reporting in individual jurisdictions (IASB 1 2009).

To adjust profit or loss a measured by the IFRS for Small and Medium-sized Entities to distributable income under national laws or regulations, a similar reconciliation can be developed (IASB 1 2009).

According to Prof. Dr. Hanno Kirsch[3], this only exists in IFRS for Small and Medium-sized Entities and not in the full IFRS.

7Financial statements

Financial statements should provide information to, both existing and potential stakeholders – for example creditors, suppliers, employees and customers – to help them in important financial decisions. It should supply stakeholders with, not only information about the company’s financial condition and results but also changes in the financial position, performance and cash flows. Different stakeholders have different needs and therefore need dissimilar information.Thepurpose of financial statements is to reduce the gap between companies and users(Sundgren et al. 2007).