Financial Reporting

Out with the old in with the new

On 9th July 2009, the International Accounting Standards Board (IASB) issued the international standard for the remainder of the United Kingdom – those in the Small-Medium Entity (SME) sector.  Titled ‘International Financial Reporting Standard for Small and Medium-sized Entities’ (IFRSSME) the standard comes in at 230 pages and will affect approximately 90% of businesses in the United Kingdom.

So why have the IASB issued this standard?

At the moment in the UK, PLC’s and Aim-listed companies must report under IFRS.  Clearly, therefore it was always going to be the case that those companies that fall within the scope of SME would follow suit.  There is also a proposal by the EU to bring in a ‘micro-entity’.  Under these proposals a micro-entity would be able to follow a simplified accounting framework and would also be excluded from following accounting directives as well as receiving exemption from statutory audit.  The proposed micro entity will have:

• less than 10 employees;
• a balance sheet total of below 500,000 Euros; and
• turnover of below 1,000,000 Euros.

Whether this is adopted in the UK remains to be seen.  However whilst all these exemptions from accounting standards and disclosures might seem appealing, it has to be kept in mind that HMRC require financial statements to be prepared using GAAP so IFRSSME may still have to be adopted by default for those falling under the realms of a micro-entity in the United Kingdom.

General Purpose Financial Statements

The IFRS regime adopts the term ‘General Purpose Financial Statements’ and sets out clearly that these financial statements are directed to those users who are not in a position to demand reports tailored to their requirements e.g. financiers, creditors and such like.  But who exactly fits within the parameters of an SME for the purposes of IFRSSME?

Under the current regime, the UK has size limits to determine whether a company is small or medium and these limits determine the disclosures that are to be made in the financial statements.  Clearly, a smaller company adopting FRSSE has to make lesser disclosure than that of a company who applies full FRS.  The IFRS regime does not have such limits.  Instead those companies that fall within the scope of small and medium-sized for the purposes of IFRSSME are those companies that:

• are not publicly accountable i.e. do not trade on a recognised stock market; and
• who prepare general purpose financial statements for external users.

At present medium-sized companies cannot adopt the current FRSSE, but once the IFRS regime is adopted, the new standard will apply to both small and medium-sized entities thus allowing medium-sized entities to apply the same disclosure requirements as small companies.

What does a set of ‘general purpose financial statements’ comprise?

Under IFRS a complete set of general purpose financial statements must comprise the following:

• a statement of financial position as at the reporting date (the year/period end) (UK GAAP currently terms the statement of financial position the balance sheet);
• either a single statement of comprehensive income for the reporting period or a separate income statement and separate statement of comprehensive income (UK GAAP currently terms such a statement as the profit and loss account);
• a statement of changes in equity for the reporting period;
• a statement of cash flows for the reporting period; and
• notes to the financial statements

Differences between UK GAAP and IFRSSME

For some years, the UK Accounting Standard setters have always tried, where possible, to converge UK GAAP with IFRS because it has always been the intention that the UK will eventually fully adopt IFRS.  The good news in this respect is that there are very little differences between UK GAAP (FRS/UITF/SSAP) and IFRS.  There are a few notable differences which I will summarise as follows (note the list is not exhaustive – it only contains some key differences between UK GAAP and IFRSSME):

Terminology
As briefly mentioned above, the profit and loss account becomes the ‘income statement’ and ‘statement of comprehensive income’.  The balance sheet is referred to as the ‘statement of financial position’ and the cash flow statement is known as the ‘statement of cash flows’.

In addition, debtors and creditors become ‘receivables’ and ‘payables’, fixed assets are known as ‘non-current assets’ and stock becomes ‘inventory’. 

Inventory
Under UK GAAP the ‘last-in first-out’ method of stock valuation is a permitted valuation technique under SSAP 9.  Paragraph 13.18 of IFRSSME states that the ‘last-in first-out’ method is not permitted under the International regime therefore only leaving the ‘first-in first-out’ and ‘weighted average’ methods of valuation permissible.

Cash Flow Statement (Statement of Cash Flows)
Under FRSSE and FRS 1 ‘Cash Flow Statements’ a company that meets the definitions of small does not have to prepare a cash flow statement.  The bad news is that under the IFRS regime, the statement of cash flows becomes a mandatory statement and therefore will have to be prepared.  This may cause particular problems for those practitioners who do not use reliable accounts production software as it may be a case of back to the text books and brushing up on cash flow statements!

Under IFRSSME, the statement of cash flows is prepared using three headings: Operating Activities, Investing Activities and Financing Activities.  FRS 1 prepares a cash flow statement using eight headings.

Fall Back to Full IFRS
In UK GAAP, if FRSSE does not cover a transaction or event, then we are to refer to the full FRS for the relevant treatment.  Under IFRSSME, if IFRSSME does not deal with a particular transaction or event, then management is to use its judgement in developing and applying an accounting policy to deal with such a circumstance.  In developing such an accounting policy, management must ensure that the accounting policy they develop results in the financial statement achieving both relevance and reliability (these are terms contained within the IASB’s ‘Framework Document’).  Paragraph 10.4 of IFRSSME details the requirements which management should follow in developing and applying an accounting policy not covered by IFRSSME.

Accounting Policies
Under FRS 18 ‘Accounting Policies’ and the FRSSE, an entity must review its accounting policies to ensure they remain the most appropriate to its particular circumstances for the purposes of giving a true and fair view.  IFRSSME, at paragraph 10.8, states that an entity will change an accounting policy only if the change results in the financial statements providing reliable and more relevant information about the effects of transactions or other events.  Note the differences between UK GAAP ‘true and fair’ and IFRS ‘relevant and reliable’.

Deferred Tax
Under FRS 19 ‘Deferred Taxation’ and FRSSE, an entity can choose to discount its deferred tax to present day values (though admittedly this is rarely done in practice).  Paragraph 29.23 of IFRSSME prohibits an entity discounting its deferred tax assets or liabilities.

Related Parties
In FRS 8 ‘Related Party Disclosures’ there is an exemption where disclosure of a related party transaction would conflict with the entity’s duties of confidentiality arising by operation of law.  IFRSSME does not contain such an exemption.

Investment Properties
SSAP 19 ‘Investment Properties’ does not allow an entity to use the depreciated historic cost model for investment properties.  IFRSSME, at paragraph 16.7, allows an entity to use the depreciated historic cost method where the fair value of the investment property can only be ascertained with a degree of undue effort or cost.

Employee Benefits
FRS 17 and its FRSSE equivalent only deal with ‘Retirement Benefits’.  Under IFRSSME at section 28 this covers all forms of employee benefits such as wages and salaries, holiday pay, sick pay, medical care, housing, cars etc.

Property, Plant and Equipment Held for Sale
In UK GAAP currently, there is no specific standard which deals with fixed asset that are held for sale.  They are currently dealt with in FRS 3 ‘Reporting Financial Performance’.  IFRSSME deals with such non-current assets at paragraphs 17.27 to 17.30.

Specialised Activities
Under FRS 15, biological assets and exploration and evaluation assets are included within this FRS and FRSSE equivalent.  IFRSSME deals with such assets in section 34 ‘Specialised Activities’ and are therefore excluded from Section 17 ‘Property Plant and Equipment’.

When Will it Happen?

Currently there is no effective date for the SME sector to adopt the new standard and it will be up to the Government to announce such a transfer date. 

Conclusion

The IASB have said in the standard that they will undertake a review of the experiences of SME’s in applying the standard when two years’ of financial statements using the IFRSSME have been published by a broad range of entities.  The IASB have also said that they will propose amendments to the standard after the implementation programme by issuing exposure drafts once every three years, though this is a tentative plan rather than a firm commitment. 

The switch over from UK GAAP to IFRS should be a painless process for practitioners, if sufficient preparation has been undertaken.  Practitioners and their staff need to have a basic awareness of IFRS in order to deal with the change.  It should also be noted that a change from UK GAAP to IFRS is NOT a change in accounting policy – it is a whole new reporting framework.  I will cover how a firm should deal with the transition in a later article.  Illustrative financial statements and a disclosure checklist is contained in a separate booklet which is available from the IASB’s website at http://www.iasb.org.uk

Steve Collings FMAAT ACCA DipIFRS is the Audit and Technical Manager at Leavitt Walmsley Associates Ltd and a partner in AccountancyStudents.co.uk He is also the author of ‘The Core Aspects of IFRS’ which is due to be published in August 2009.