Excerpt
Table of contents
1. Introduction
2. Scope
2.1. Scope of the Standard.
2.2. Definitions of SMEs
2.3. Implications
3. IFRS for SMEs
3.1. Objective.
3.2. Examples of accounting simplifications compared to Full IFRS
3.2.1. Goodwill
3.2.2. Intangible Assets
3.2.3. Financial Instruments
3.3. Implications
4. IFRS for SMEs in the EU
4.1. Reasons for implementation
4.2. Compatibility with the EU Accounting Directive
4.2.1. Goodwill
4.2.2. Extraordinary items
4.2.3. Financial instruments
4.2.4. Implications
4.3. Further Obstacles
4.4. Prospects of implementation
5. Conclusion
Bibliography
Appendix
1. Introduction
The harmonization of financial reporting standards in Europe is taking up pace. After the International Financial Reporting Standards (IFRS) were made a requirement for the consolidated statements of all listed companies in the EU in 2005,[1]the attention now shifts towards the harmonization of reporting standards of non-listed companies.
The discussion intensified after the International Accounting Standard Board (IASB) published the International financial Reporting Standard for Small and Medium-sized Enterprises (IFRS for SMEs, also referred to as: 'the standard', or 'the new standard') after a five-year development process in 2009 as a response to many small and mediumsized entities (SMEs) arguing that adopting full IFRS imposes a burden on these entities in terms of cost effectiveness and user friendliness.[2]Compared to full IFRS, the IFRS for SMEs represents an autonomous and less complex framework designed for the financial reporting requirements of small to medium-sized companies with the idea that the benefits of a global and hence comparable IFRS-based accounting standard may also apply to SMEs that seek capital. Among other things, the implementation of the new standard could result in the reduction of compliance costs as well as in the removal of uncertainties affecting the cost of capital of SMEs in the European Union (EU). It would seem as if the implementation of the standard in the EU would prove to be very important for the harmonization of markets and thus to facilitate the fulfillment of the EU's 'four freedoms'[3]- "the cornerstones of the single market".[4]Nonetheless, the issue of the IFRS for SMEs was recorded globally with very different resonance. While it was perceived with great interest and quickly transferred into national law in some countries,[5]in others, i.e. Germany, France and Italy, the critical and dismissive voices predominate.[6]Especially within the EU no uniform view can be identified, as there are both opponents and advocates of the new standard.[7]
In this paper I am going to analyze the reasoning for a potential implementation of the standard. I will start off by outlining the scope and the objectives of the IFRS for SMEs and compare it to the scope of SMEs currently set in the EU Accounting Directives. Furthermore I will identify the major differences of the new standard to full IFRS. In the main part of the paper I am going to examine if the IFRS for SMEs actually seems as an appropriate standard for SMEs in Europe and whether it can contribute to the harmonization of European accounting standards. Subsequently I will analyze the compatibility of the standard to the EU Accounting Directives and identify further obstacles to the implementation. The paper will be round off by a conclusion.
2. Scope
2.1. Scope of the Standard
The use of the IFRS for SMEs is restricted only to entities that meet the definition of a SME,[8] which will be described below. The standard clearly states that entities which do not fulfill the requirements laid out in the framework cannot claim compliance with the IFRS for SMEs, even if they are permitted or required to do so in their jurisdiction.[9] Furthermore, subsidiaries within a group may apply the standard irrespective of whether the parent or the group report under full IFRS.[10] As this would potentially require a dual reporting system for statutory and group purposes, it may not be favored by such entities.
2.2. Definitions of SMEs
According to the standard (IFRS for SMEs) an SME is defined as an entity that does not have public accountability, yet still publishes general-purpose financial statements for external users (i.e. non-managing partners of the business, existing and potential creditors and rating agencies).[11] This rather broad definition by the IASB is further narrowed in the standard. Correspondingly an entity has a public accountability, if it trades debt or equity instruments in a public market (or it is in the process of issuing such instruments) or holds assets in managed accounts for a broad group of outsiders as one of its primary businesses.[12] The second criterion of public accountability applies mostly to financial institutions, such as banks, insurance companies, securities brokers or dealers, mutual funds or investment banks, which are thus restricted to adopt IFRS for SMEs as their primary standard for financial reporting.
In contrast to the IASB, the European Parliament implemented a different set of definition for SMEs in its Fourth Accounting Directive 78/660/EC as well as in a recommendation by the European Commission (EC) in 2003 which puts greater emphasis on the actual size of a company. According to the amended Directive 78/660/EC[13] companies in the EU are categorized into micro, small and medium-sized enterprises, which have different thresholds in terms of average staff headcount (full time equivalents = FTE) during the financial year, turnover and balance sheet total. Companies are thus defined as SMEs if they do not exceed the following limits for two of those three factors: 250 FTE over the financial year, € 35 million in annual turnover, or € 17.5 million annual balance sheet total.[14] The lower bound for SMEs is characterized by the definition of micro-entities which according to the newest proposal by the European Parliament employ on average no more than 10 people over a fiscal year and have a net turnover not exceeding € 1 million as well as a balance sheet total not exceeding € 0.5 million.[15] In the EC recommendation the thresholds for SMEs are slightly higher and the annual FTE count was made a requirement. However the EC recommendation does not relate to accountancy issues.[16]
2.3. Implications
Compared to the definition of the IASB, the characterization of SMEs by the EC is rather narrow. Whereas the IASB regards the lack of public accountability as the most important criterion for the definition of a SME, in the EU SMEs are defined by a specific set of threshold values. In the development of the new standard the Board anticipated international differences and therefore left it to the individual governments to decide upon a quantifiable limitation of the scope.[17] Thus some criteria are left vague. Especially the transition to public accountability is rather imprecise and leaves an area of discretion.[18]
Currently, the IFRS for SMEs does not represent a legally binding framework within the EU. If the EC were to implement the new standard in its Accounting Directives,[19] there would be a necessity to adjust the scope according to the standard, so that the quantifiable thresholds which already exist in the EU do not conflict with the scope of the standard yet still be very precise. The implementation of the standard in the EU could hereby be pursued using two possible ways. Firstly it could be done by implementing the standard into European Law using the endorsement process which facilitated the implementation of full IFRS in accordance with the Regulation (EC) No 1606/2002.[20] The scope of IFRS endorsement process was initially limited to the consolidated statements of listed companies,[21] though it can be extended to non-listed companies and statutory accounts using a Member State Option. Secondly the IFRS for SMEs could be implemented into national law of respective Member States in accordance to the EU Accounting Directives. Hereby the standard must be compatible with the requirements of the Directives. Before analyzing the compatibility of the new standard with the EU Accounting Directives, the major differences to full IFRS will be identified.
3. IFRS for SMEs
3.1. Objective
With the issue of IFRS for SMEs the IASB was following its objective to develop a financial reporting standard which provides a simplified, self-contained and internationally applicable set of accounting principles to meet the financial reporting needs of non-listed companies.[22] This follows the intention of the full IFRS to bring businesses worldwide to follow globally acceptable common set of financial accounting reporting standards which does not only enable cross national business offerings but also impart much needed transparency in financial data disclosure,[23] however with the focus on small to medium-sized entities.
The objective of an IFRS for SMEs-statement 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.[24] The new standard is intended to lower guidance and disclosure requirements and simplify the accounting rules in comparison to full IFRS. Simplifications are achieved in various ways. Some topics are omitted in the new standard because they are not relevant to the average SME.[25] Many of the recognition and measurement principles were simplified in the IFRS for SMEs and substantially fewer disclosures required. Moreover certain accounting policy options are not being granted because a less complex and time-consuming method applies better to SMEs. Simplified redrafting was further used to reduce complex disclosure requirements.
It is to be noted that the IASB was open for dialogue during the issue of the new standard and considered significant objections in its final draft.[26]Overall the new IFRS for SMEs with its 232 pages makes up only about one tenth in terms of framework pages compared to full IFRS, which consists of about 2,500 pages.[27]To illustrate some of the major differences of IFRS for SMEs to Full IFRS the sections concerning intangible assets, financial instruments and goodwill accounting will subsequently be analyzed.
3.2. Examples of accounting simplifications compared to Full IFRS 3.2.1. Goodwill
Supposedly some of the most significant accounting differences between the two standards are to be found in the area of intangibles assets, i.e. goodwill. While under both IFRS for SMEs and full IFRS, goodwill is measured as a residual, the computations differ due to the focus in IFRS on measuring the components of the business combination at their acquisition date fair values, while IFRS for SMEs adopts a cost- based approach according to IFRS for SMEs 19.22.[28] Moreover IFRS for SMEs differs from full IFRS by requiring that goodwill be amortized over its useful life or if the useful life cannot be reliably measured, over 10 years,[29] thus eliminating the option to have an indefinite useful life for goodwill. Under IAS 36 Impairments of Assets in contrast, amortization of goodwill is prohibited, but impairment tests are required at least annually or when indicators request an impairment test.
The new standard is very likely to reduce the work required for preparers of financial statements significantly as there are considerable disclosure reliefs for SMEs compared to the disclosure required under IFRS 3 Business Combinations and also because impairment tests will only be required if there are indicators of impairment.[30]Based on these differing requirements, however, significantly differing carrying amounts for goodwill might be expected to arise under IFRS for SMEs and full IFRS in postcombination periods.[31]
3.2.2. Intangible Assets
IFRS for SMEs further differs from full IFRS with respect to the amortization of intangible assets. While under IAS 38 Intangible Assets, the useful life of an intangible asset is either finite or indefinite, according to IFRS for SMEs 18.19-18.20 all intangible assets have finite useful lives analogical to goodwill and must be amortized accordingly.[32]
If the useful life cannot be measured reliably it is again presumed to be 10 years.[33]Also in contrast to IAS 38 Intangible Assets, internally generated intangibles, including research and development costs as well as costs for internally generated goodwill, are prohibited to be capitalized to the balance sheet and must hence be expensed on occurrence.[34]This could particularly affect companies that operate in sectors where numerous intangible assets are generated, i.e. the pharmaceutical industry.[35]Furthermore the application of the revaluation is not permitted under the new standard.[36]
3.2.3. Financial Instruments
For the recognition and measurement of financial instruments IFRS for SMEs gives entities the choice of applying either the requirements of Section 11 and 12 of the standard or applying IAS 39 Financial Instruments: Recognition and Measurement and the disclosure requirements of IFRS for SMEs (Section 11 and 12).[37] The disclosures requirements according to IFRS 7 Financial Instruments: Disclosures are omitted for both options. In some cases there are significantly different treatments concerning the financial instruments which entities will need to consider before deciding to adopt IFRS for SMEs.[38]
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[1]Commission Regulation (EC) No 1725/2003
[2]Cf. KPMG (2010)
[3]The free movement of people, goods, services and capital, cf. European Commission (2012)
[4]Cf. European Commission (2012)
[5]Over 80 countries (in Europe: Bosnia, Estonia, Macedonia and Switzerland since 1.1.2013; planned adoption in the UK and Ireland) have adopted the standard or announced plans to do so, cf. IFRS Foundation (2012)
[6]Cf. Fülbier/ Gassen (2010) and Janssen/ Gronewald (2010)
[7]According to a consultation of the European Commission 19 EU Member States favor a Member State Option while 6 EU Member States (Austria, Belgium, Germany, France, Italy and Slovakia) oppose, cf. IFRS Foundation (2012) and European Commission (2010)
[8]IFRS for SMEs 1.1 IFRS for SMEs 1.5 IFRS for SMEs 1.6 IFRS for SMEs 1.2 IFRS for SMEs 1.3
[9]Amended by the Directive 2006/46/EC for thresholds on small and medium-sized enterprises and the Directive 2012/6/EU for threshold on micro enterprises 14 Cf. Directive 2006/46/EC and Directive 2012/6/EU
[10]Cf. IASB (2007), pp. 4
[11]Cf. FASB (2012)
[12]IFRS for SMEs 2.2.
[13]IFRS for SMEs does not address earnings per share, segment information, interim reporting, insurance contracts and the classification of non-current assets, cf. KPMG (2010) pp. 4
[14]Cf. Beiersdorf/Eierle/Haller 2009, S. 1557.
[15]Cf. European Commission (2009)
[16]Commission Recommendation (2003/361/EC), Art.2, see also Appendix 1 for a comparison on tresholds
[17]IFRS for SMEs Basis for Conclusion (BC) 69, et seq
[18]Cf. Kajüter/Saucke (2012) Rn. 18
[19]4th Directive: 78/660/EC and 7th Directive: 83/349/EEC
[20]Cf. Winkeljohann/ Morich (2009), pp. 1633
[21]Cf. Regulation (EC) No 1606/2002
[22]Cf. IASB (2007), pp. 4
[23]Cf. FASB (2012)
[24]IFRS for SMEs 2.2.
[25]IFRS for SMEs does not address earnings per share, segment information, interim reporting, insurance contracts and the classification of non-current assets, cf. KPMG (2010) pp. 4
[26]Cf. Beiersdorf/Eierle/Haller 2009, S. 1557.
[27]Cf. Hennrichs (2011), pp. 1067
[28]Cf. Ernst & Young (2010), pp. 33
[29]IFRS for SMEs 19.23 (a)
[30]Cf. KPMG (2010), pp. 16 and Ernst & Young (2010), pp. 27
[31]Cf. Ernst & Young (2010), pp. 33
[33]Cf. Ernst & Young (2010), pp. 60
[32]Cf. PWC (2009), pp. 50
[34]IFRS for SMEs 18.20
[35]Cf. Ernst & Young (2010), pp. 59
[36]Cf. PWC (2009), pp. 51 and Ernst & Young (2010), pp. 60
[37]IFRS for SMEs 11.2 and cf. PWC (2009), pp. 37
[38]Cf. Ernst & Young (2010), pp. 55
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