AAT Articles

IFRS for SMEs

Steven Collings look at how IFRS are applicable to SMEs.

On 1 January 2005 International Financial Reporting Standards became mandatory for large companies, typically those Companies who were listed on the stock exchange.

Over the last couple of years debates have been ongoing as to how those companies in the United Kingdom that prepare accounts under UK GAAP will report under International Standards in order for complete global harmonisation to be achieved.

Understandably there have been concerns in the Small, Medium Enterprises (SME) sector as to how relevant International Standards are in relation to SMEs. If you look at the International Accounting Standards for those larger companies that now have to report under them you will see that the Standards are simply too extreme to be applied to a typical SME.

The Accounting Standard setters have arrived at an exposure draft for International Financial Reporting Standards for Smaller and Medium Entities. The exposure draft was issued on 15 February 2007 and is open for comment until 1 October 2007.

In the United Kingdom, companies either report under UK GAAP or International Financial Reporting Standards. Most companies listed on the stock exchange have been required, by law, to produce their consolidated financial statements under IFRS from 1 January 2005. For those companies listed on the Alternative Investment Market (AIM) they are adopting IFRS in their consolidated accounts for accounting periods starting on or after 1 January 2007.

The IFRS for SMEs is a stand-alone document with a number of cross-references to the full standards. The full standards are very detailed and the IASB had this in mind when debating the IFRS for SMEs. It would be inappropriate for an owner-managed Limited Company to prepare its financial statements and associated notes to the same level a blue-chip company listed on the stock-exchange has to do. As a consequence the Board reduced the volume of accounting guidance by 85% when you compare it to the full standards. However, as is always the case in these matters, the IFRS for SMEs is not condensed to the point that makes it an “easy read”. It is still 250 pages long with a further 80 pages of guidance notes.

So how do you determine if you are a SME and therefore eligible for adoption of the simpler accounting standards?

The exposure draft states that a SME are those that:

Are not publicly accountable (i.e. not on a listed stock exchange)
Published general purpose financial statements for external users.

The IFRS goes on to say that an entity has public accountability if it files, or is in the process of filing its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class or instruments in a public market; or

It holds assets in a fiduciary capacity for a broad group of outsiders, such as a bank, insurance entity, securities broker/dealer, pension fund, mutual fund or investment banking entity.

The IFRS states that “general purpose financial statements” are produced for external users. Examples of such external users are “owners who are not involved in managing the business, existing and potential creditors and credit-rating agencies.

Under the current legislation, there are size limits to determine whether a company is small or medium. Typically a company is small and can report under the (current) Financial Reporting Standards for Smaller Entities (FRSSE), if:

It has a turnover level of £5.6million or less
It has a balance sheet total of £2.4 million or less; and
It has less than 50 employees

The International Accounting Standards Board has not set limits in this format – instead they have assumed a SME to have 50 employees or less and an annual turnover of approximately 10 million Euros.

When Will IFRS be made Mandatory?
At present there is no timetable for the implementation of IFRS for SMEs. The exposure draft has been made available for comments which will close on 1 October 2007. Whilst the IASB has not issued a date for implementation, from the dates set for comments closure it would not be a surprise if IFRS happen possibly for accounting periods commencing on or after 1 January 2009. In any event if the date for adoption of IFRS were to be 1 January 2009, then the comparatives for the prior year will also need to be re-stated under IFRS so a “dry run” would take place in 2008.

The Objective of Financial Statements for SMEs
In the exposure draft, the IFRS has stated that the objective of financial statements for SMEs 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 tailored reports to meet their particular information needs. In meeting that objective, financial statements also show the results of the management’s stewardship of the resources entrusted to it.

It goes on that the financial statements have to have 10 characteristics present in them – namely:

Understandability
Relevance
Materiality
Reliability
Substance over form
Prudence
Completeness
Comparability
Timeliness
Balance between benefit and cost

The Contents of the Financial Statements under IFRS
Under the FRSSE financial statements typically comprise the trading and profit and loss account, balance sheet, statement of recognised gains and losses and the related notes.

Under the IFRS the exposure draft states that the financial statements will comprise:

A balance sheet
An income statement
A statement of changes in equity, showing either:

(all changes in equity, or
changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders

A cash flow statement, and
Notes, comprising a summary of significant accounting policies and other explanatory information

If the only changes to the equity of an entity arise from profits or losses, payments of dividends or correction of prior period errors and changes in accounting policies then the entity may present a statement of income and retained earnings in place of the income statement and statement of changes in equity.

The Main Differences between FRSSE and IFRS for SMEs
There are a couple of fundamental differences between the current FRSSE (Financial Reporting Standards for Smaller Entities) and IFRS for SMEs.

Notably the main difference is the status of the document. The IFRS for SMEs is a stand-alone document which has cross references to the main standards and guidance notes. The FRSSE is not a stand-alone document – it runs in conjunction with the current Financial Reporting Standards.

The FRSSE was revised for accounting periods commencing on or after 1 January 2007 in light of various changes to FRS 20 – Share Based Payments and in view of the changes in the Companies Acts.

The FRSSE 2007 allows changes in the fair values of liabilities under the Cash-Settled Share Based Payment Method to be disclosed by way of notes to the financial statements. This was particularly good news for those SMEs who have share-based payments because the FRSSE 2005 required changes in the fair value of the liabilities to be written off to the profit and loss account. The good news was further accentuated by the fact that FRSSE 2007 can be adopted early, whilst FRSSE 2005 could not be.

The exposure draft of IFRS states that any changes in the fair values of the liabilities must be written off to the income statement – so the good news appears to be very short-lived.

Under FRSSE a SME does not have to produce a cash flow statement if it does not wish. Under the IFRS a cash flow statement will have to be produced.

Model Financial Statements
The exposure draft does contain a set of model financial statements which it expects entities within the SME sector to follow. These can be found at the back of the IFRS exposure draft.

Conclusion
Undeniably, the majority of accountancy professionals will have been hoping that the adoption of IFRS will happen later rather than sooner. However, it has always been in the pipeline that an International Framework will be adopted for those entities in the SME sector – though at the moment there is no timetable as to when the International Standards will be effective.

Steven Collings FMAAT ACCA is Audit/Accounts Senior at Leavitt Walmsley Associates Ltd