Graham Holt looks at the impact of IFRS for SMEs on the development of UK GAAP and considers the implications and choices for businesses
This article was first published in the October 2010 edition of Accounting and Business magazine.
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The UK Accounting Standards Board (ASB) recently set out its strategy for the future of UK/Irish Generally Accepted Accounting Practice (UK GAAP) and its convergence with International Financial Reporting Standards (IFRS). The ASB's intention is to work under the framework of the International Accounting Standards Board (IASB) and to converge, to the fullest extent possible, consistently with IFRS, taking into account the needs of UK entities. As a result, under the ASB's proposed approach, UK GAAP will cease to exist.
However, the ASB is not relinquishing the right to set UK GAAP, but it will be superseded by IFRS. The ASB's intention is to issue an exposure draft (ED), withdrawing existing UK GAAP, and it will be through this means that modifications of the underlying IFRS literature will be proposed.
The ASB is proposing that UK accounting should take the form of a three-tier reporting structure (below):
Swipe to view table
|TIER||Nature of company||Standards to follow|
|Tier 1||Listed companies and other publicly accountable entities||EU-adopted IFRS|
|Tier 2||All other entities||IFRS for SMEs|
|Tier 3||Small companies
(as defined by company law)
IFRS for SMEs is a standard published in July 2009 by the IASB for non-publicly accountable companies. Public companies will need to apply EU-adopted IFRS.
The standard is a simplified version of EU-adopted IFRS, developed with the intention of better meeting the needs of private and smaller companies. IFRS for SMEs is a simplified IFRS, but it has some different measurement requirements. For example:
- Goodwill and intangible assets are amortised over 10 years where an entity is unable to make a reliable estimate of the useful life.
- There is an option to carry investments in associates and joint ventures at cost.
The disclosure requirements are less onerous than under full IFRS.
Under the proposed framework:
- All consolidated accounts of publicly traded companies continue to comply with EU-adopted IFRS.
- A company reporting under the UK Companies Act may elect to prepare its accounts in accordance with EU-adopted IFRS.
For entities that do not fall into either of the two categories above:
- An entity that has public accountability should prepare its accounts in accordance with EU-adopted IFRS.
- An entity currently able to use the Financial Reporting Standard for Smaller Entities (FRSSE) is able to continue to prepare its accounts using FRSSE.
- An entity that is not publicly accountable and is not able to use FRSSE could prepare its accounts using IFRS for SMEs.
Under these proposals all entities will have the option to voluntarily adopt a higher tier. As an example, entities using FRSSE could opt to apply IFRS for SMEs or EU-adopted IFRS. An entity may elect to do so because, where it is part of a group that reports under IFRS or because of the nature of its business, IFRS provides better information for access to capital markets.
The ASB has worked with the UK Department for Business Innovation and Skills (BIS) in considering the interaction between accounting standards and the law, including the key definition of public accountability to be used.
The ASB believes these proposals will improve financial reporting as:
- Reporting arrangements will be simplified by having more targeted and proportionate reporting requirements based on the nature of an entity's accountability obligations and its size.
- UK GAAP will be based on IFRS and thus provides a consistent basis for preparing financial reporting, and it reduces the burden associated with understanding and complying with differences in reporting requirements and interpretations of accounting principles.
- It improves comparability and understandability of financial reports and will also assist in accessing capital markets in building investor and creditor confidence, and in strengthening transparency.
- It enables the UK and the Republic of Ireland to devote their standard-setting resources to influencing the IASB and ensures that IFRS satisfies the needs of constituents in the region.
The proposals are intended to apply to all entities, other than those in the public sector, in the UK and the Republic of Ireland that are required to prepare financial statements that give a true and fair view.
It encompasses all the entities that are currently required to apply UK GAAP, including those that presently apply the industry-specific guidance contained in the Statements of Recommended Practice (SORPs).
Based on current proposals, companies reporting under UK GAAP would need to adopt either full IFRS or IFRS for SMEs from 1 January 2010. This means that a company with a December year-end will need an opening balance sheet under IFRS at 1 January 2011. However, it seems there will be slippage in the proposals and the requirement will probably run from 1 January 2013, with an ED expected in autumn 2010.
UK GAAP has become a mix of IFRS and UK standards, and is very complex for use by a typical UK entity. UK GAAP is not in the curriculum of most accounting bodies per se and is becoming out of date as the IASB moves its agenda forward. The IFRS for SMEs is shorter and more manageable for entities than UK GAAP.
The definition of 'publicly accountable' requires more guidance. Under IFRS for SMEs, the definition is left to each jurisdiction. The ASB needs to explain what the definition means so as to enable users to apply any standard in a consistent manner. Many of the terms used in the definition are capable of different interpretations and clear application guidance will be needed to ensure consistency of interpretation.
There may be issues under the proposals for non-publicly accountable subsidiaries of listed companies. These subsidiaries currently prepare financial information based on full IFRS for the purposes of the listed group's consolidated financial statements. Such subsidiaries will also have to prepare information suitable for the compilation of group disclosures. In addition, however, these wholly owned subsidiaries have to prepare their own statutory accounts.
This would mean that under the proposals they would have to either:
- Prepare accounts under full IFRS, which would be beneficial as they would have to follow the same recognition and measurement rules as their parent, but the disadvantage would be the cost of preparing full IFRS accounts. Preparing accounts of subsidiaries under full IFRS is a considerable burden, largely because of the extensive disclosures.
- Prepare accounts under IFRS for SMEs, which would be good as they could take advantage of the reduced disclosures of IFRS for SMEs.
However, it would be disadvantageous as they would be following recognition and measurement rules that are not exactly the same as their parent. As the IASB's agenda currently covers a number of areas such as leasing, revenue recognition, provisions and pension accounting, the differences between full IFRS and IFRS for SMEs look likely to widen rather than narrow in the short to medium term.
Although the IFRS for SMEs provides relief from the more complex areas of full IFRS, for those that already operate in the full IFRS arena, being able to align accounting within the group and subsidiary financial statements is of great advantage at the individual entity level.
The nature of the disclosure requirements for such subsidiaries needs to be considered. The disclosures in many IFRS are both extensive and disproportionate in the context of non-publicly accountable subsidiaries of publicly accountable entities.
At present, certain subsidiaries reporting under UK GAAP benefit from not needing to prepare consolidated accounts or a cashflow statement and may claim exemptions concerning related party disclosures, such as publication of the profit and loss account and financial instruments disclosures. These benefits would be lost or diluted if IFRS for SMEs was adopted without amendment.
There is a temptation to amend IFRS for SMEs to change the parts that are not well supported in the UK, such as its rules on deferred tax. However, adjusting IFRS for SMEs would in itself create further complexity and another level of reporting.
The ASB is reluctant to be seen to interpret IFRS by issuing an equivalent document to a SORP. However, users will require application guidance for specific sectors and this should be considered in the ASB's deliberations. The ASB needs to liaise with the relevant SORP-making bodies to ensure that SORPs continue to provide robust guidance for dealing with sector-specific issues.
There are clearly some legal and regulatory issues that need dealing with before UK GAAP can be changed, including whether IFRS for SMEs is compatible with the EU directives. Additionally, guidance is needed as to whether entities can move between the proposed tiers. Entities can presently move from UK GAAP to IFRS, but not the other way round.
The ASB needs to decide whether entities can move between tiers as circumstances change. There will also be taxation implications of movement between tiers as the accounting principles are different and will produce differing results.
The impact of a move from UK GAAP to full IFRS or IFRS for SMEs will depend on a number of factors, such as the size and complexity of an entity. There are several areas to consider. Measurement differences will arise, which could impact on taxation, distributable reserves and banking covenants. The measurement differences and potential changes in the balance sheet presentation may lead to a breach of bank covenants and the need to renegotiate existing arrangements.
Entities will need to understand the implications of a choice of GAAP. There are advantages and disadvantages for different companies in using IFRS for SMEs, as opposed to full IFRS, and these need to be considered properly.
For entities adopting IFRS for the first time, there will be a substantial amount of work to convert the accounting records and supporting systems, as well as to prepare the financial statements. Thus the movement from UK GAAP to full IFRS or IFRS for SMEs has many implications.
Graham Holt, ACCA examiner and principal lecturer in accounting and finance, Manchester Metropolitan University Business School.