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Applying IFRS to Small Companies - Update

The International Accounting Standards Board (IASB) has been busy developing a financial reporting framework for companies in the UK that fall under the umbrella of ‘small and medium’. This will typically affect approximately 90% of companies within the UK. The IASB published a document in February 2007 – ‘International Financial Reporting Standard for Small-Medium Entities’ which was commonly referred to as ‘IFRSSME’. The IASB then took the decision to rename the document ‘International Financial Reporting Standard for Private Entities’ in view of the target audience.

Overview of IFRS Adoption in the UK
Companies that are listed on a regulated market already have to apply International Accounting Standards and have been doing so since 1 January 2005. This was rolled out further in January 2007 for those companies listed on the Alternative Investment Market (AIM). Small-medium entities can choose to adopt IFRS if they wish but once they have adopted IFRS they cannot switch back to UK GAAP if things do not go according to plan.

In the UK we have the much-loved ‘FRSSE’ which applies to only small entities. However, unlike the FRSSE the scope of the IFRS for Private Entities will be for all private entities who are not listed on a recognised market. It will cover a much wider range of companies than the current FRSSE from the smallest of limited companies through to the large private concerns.

It is also worth mentioning at this point that if guidance is not included in the FRSSE on the accounting treatment of a specific item, then the preparer of the financial statements should refer back to full UK GAAP in order to determine the true and fair treatment. Under IFRS this is not required i.e. you are not required to fall back to full IFRS to determine the treatment. Instead, preparers of financial statements should consider the IFRS Framework Document and the requirements of IAS 8 ‘Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies’.

Adoption of IFRS by the SME Sector
The IASB has issued an Exposure Draft on their proposed standard and is expected to issue a final standard in the second quarter of 2009. So how will this impact on companies in the UK? Are there many differences between UK GAAP and IFRS? Will it be a major headache for practitioners/preparer’s of financial statements?

The answer to these commonly asked questions is “no” but preparer’s of financial statements in the UK need to be aware of IFRS and should now start thinking about training staff in the basic requirements of IFRS.

The UK has always anticipated this convergence to IFRS and has always aimed to keep the accounting standards (FRS, SSAP and UITF abstracts) in line with the IFRS regime.

Financial Statements Composition
The first thing we need to consider is what a set of financial statements will actually comprise under the IFRS regime. An IFRS set of financial statements must comprise:

(a) a statement of financial position as at the reporting date (balance sheet);
(b) a statement of comprehensive income for the period (profit and loss account);
(c) a statement of changes in equity for the period (statement of total recognised gains and losses); and
(d) a statement of cash flows (cash flow statement) for the period.

It is worth noting at this point that the statement of cash flows IS mandatory under IFRS and thus it follows that every company in the UK will have to prepare a cash flow statement under the proposed standard. Under UK GAAP there is an exemption for small companies which does not require a cash flow statement to be prepared. Under IFRS this exemption is not allowed. The preparation of cash flow statements for small companies is going to cause a headache for those practitioners who do not use reliable accounting software.

Under IFRS a reporting entity can choose to present a single statement of comprehensive income or it can present two separate statements. One will contain the elements that make up profit and loss, the other statement will contain the other comprehensive income such as recognised gains and losses. It is to be noted, however, that if two separate statements are provided then they should be presented immediately after the other.

The Application of IFRS for the First Time
The application of IFRS is NOT a change in accounting policy, therefore companies adopting IFRS for the first time simply cannot go ahead and do a restatement of prior years financial statements as if it were a change in accounting policy. The application of IFRS for the first time is the start of a whole new basis of financial reporting.

Because the application of IFRS for the first time is a whole new basis of financial reporting, then in the first year of adopting IFRS, the prior year’s financial statements (the comparatives) should also be converted to IFRS.

Let us consider this example:

Illustration
Shepland Laboratories Limited has a balance sheet date of 31 December 2008. The Board of Shepland Laboratories Limited has decided that it wants to report under IFRS for the first time in 2008. How should Shepland Laboratories Limited deal with the first-time adoption of IFRS in terms of restating its prior year’s financial statements?

Solution
The reporting date is 31 December 2008, therefore the 2007 comparatives also need to be restated to comply with IFRS. However, under IFRS 1 ‘First-Time Adoption of IFRS’ Shepland Laboratories Ltd must prepare an IFRS balance sheet at the start of the earliest period for which comparative information is required (this is known as the ‘transition date’).

Therefore, Shepland Laboratories Limited will have to restate the opening balances as at 1 January 2007 (i.e. the 2006 closing trial balance).

Once we have restated the comparative year then we need to look at the transitional balance sheet and undertake the following requirements to comply with IFRS 1:

(a) recognise all IFRS assets and liabilities;
(b) not recognise assets and liabilities not permitted under IFRS;
(c) classify assets and liabilities in accordance with IFRS; and
(d) measure assets and liabilities in accordance with IFRS.

It should be noted that IFRS 1 does contain exemptions where it considers that the costs of compliance will not be of benefit to users.

Recognise all IFRS Assets and Liabilities
An example of this requirement is in respect of IAS 19 ‘Employee Benefits’. Where a company has a defined benefit pension scheme then IAS 19 requires the employer to recognise its liabilities under the defined benefit pension scheme. This is the same under UK GAAP FRS 17 ‘Retirement Benefits’. However, IAS 19 goes on further to say that the employer should also recognise its obligations for medical and life insurance, holiday pay, termination benefits and deferred compensation.

Not Recognise Assets and Liabilities
An example of this requirement is where a company recognises ‘reimbursements’ and ‘contingent assets’ that are not virtually certain. In this respect, such items should be eliminated in the opening IFRS balance sheet.

Classify Assets and Liabilities by IFRS
Largely in UK GAAP the classification of assets and liabilities has been consistent with IFRS. However, under some GAAPS it is permissible to recognise mandatorily redeemable preference shares as equity. Under IFRS these should be recognised as a liability.

Measure Assets and Liabilities in Accordance with IFRS
Where an entity adopts IFRS for the first time then it must comply with the principles of IFRS in measuring assets and liabilities at the date of transition.

Other Requirements with First-Time Adoption
Companies must disclose that their financial statements comply with IFRS but only if they comply with all the relevant standards. Therefore if the financial statements do not comply with full IFRS then a company must not disclose that their financial statements comply with IFRS.

A reporting entity adopting IFRS for the first time should also disclose the impact that adoption has had on the reported financial performance, financial position and cash flows. This includes:

(a) a reconciliation of equity reported under UK GAAP to equity under IFRS at both the date of the opening IFRS balance sheet and at the end of the last annual period reported under UK GAAP. In our example above, the reconciliations for Shepland Laboratories would be as at 1 January 2007 and 31 December 2007;
(b) a reconciliation of profit or loss for the last annual period reported under UK GAAP to profit or loss reported under IFRS for the same period;
(c) an explanation of any material adjustments that were made in adopting IFRS for the first time to the statement of financial position, income statement or statement of cash flows;
(d) an explanation of any errors discovered in the course of transition to IFRS and separate disclosure of those errors;
(e) any recognised or reversed impairment losses in preparing the opening IFRS balance sheet being disclosed; and
(f) an explanation if the entity has taken advantage of any of the exemptions permitted under IFRS 1.

Notable Differences Between UK GAAP and IFRS
There are some differences which were discussed in my article titled ‘UK GAAP vs. IFRS’ which summarises the notable differences between UK GAAP and FRS.

Conclusion
The switchover from UK GAAP to IFRS need not be a complete nightmare for accountants but it is something which is gathering lots of pace now as the consultation period draws to a close and the IASB become increasingly closer to issuing a final standard for us. Accountants do not need to be IFRS experts but do need to consider staff-training in this area and have an awareness of the notable differences that exist between UK GAAP and IFRS in order to ensure their clients are not caught out!

Steve Collings FMAAT ACCA DipIFRS is Audit Manager at Leavitt Walmsley Associates Ltd and a partner in AccountancyStudents