Private U.S. companies have a new option in accounting standards following Wednesday’s release of a simplified, vastly slimmed-down version of International Financial Reporting Standards.
Private firms in the United States could already choose IFRS. Yet relatively few have done so, even though the full version of IFRS, at about 2,500 pages, is roughly a tenth the size of U.S. generally accepted accounting principles. It remains to be seen how many companies will find it harder to resist the new “IFRS for SMEs,” which weighs in at just 230 pages.
SME is an acronym, used widely outside the United States, for small and medium-sized entities. However, the International Accounting Standards Board, the promulgator of IFRS, does not include a size test in its definition of SME; rather, the smaller version of the standards is reserved for entities that have no “public accountability.” In other words, it is not available to companies that publicly trade equity or debt, or those that hold assets as a fiduciary for a broad group of outsiders as one of their primary businesses, as is typical for banks, insurance companies, securities broker/dealers, and mutual funds.
Adoption has the potential to be truly widespread: more than 95% of the companies in the world are SMEs, according to the IASB. But while private U.S. companies can start using the abbreviated standards right away, other jurisdictions may choose not to allow it. At the same time, some may choose to allow it even if they’ve previously spurned the international standards. “IFRS for SMEs is separate from full IFRS and is therefore available for any jurisdiction to adopt whether or not it has adopted the full IFRS,” the IASB said in a press release.
Even in the United States, though, a broad rush to broad adoption is hardly a given. “I will consider adopting the new standard when the primary users of financial statements are fully educated in it and can intelligently evaluate it,” says Ron Box, CFO at Joe Money Machinery, a Birmingham, Alabama-based regional dealer of heavy construction equipment.
Box is concerned that, for example, a bank analyst who doesn’t understand the new accounting concepts might deny a credit request from an early adopter. “Credit markets for small businesses are already volatile and very perplexing to most CFOs,” says Box. “Prematurely adding a new set of accounting rules to this mix could be very counterproductive.”
But Paul Pacter, the IASB’s director of standards for SMEs, is not so sure the pace of adoption will be all that slow in the United States. “It may be a little slower [than in Europe], but I think there’s going to be a lot of interest,” he says.
To be sure, there aren’t any rules that would prevent a private company from switching to the new standard. Last year the American Institute of Certified Public Accountants recognized the IASB as an official accounting standard setter. With that decree, “any professional barrier to using IFRS and therefore IFRS for SMEs [was] removed,” the AICPA said on its Website in response to the issuance of the shortened standards. It also said: “Private companies may find IFRS for SMEs to be a more relevant and less costly financial and accounting standard than U.S. GAAP.”
Other major accounting organizations, including the Institute of Management Accountants and Financial Executives International, have also suggested that companies should at least consider switching to the simplified standard.
It’s in Europe, though, where high adoption levels would have the most profound early impact. In the 27 European Union countries, there are at least 55 local accounting standards in use by SMEs, Pacter notes. A consistent, simplified standard would make it easier and less costly to do business in multiple countries, which is common in Europe even for tiny companies. “This will be a godsend for the millions of little companies that trade across borders,” he says.
Lenders and private investors may also benefit from widespread adoption. “Today there is no comparability of small-company financial statements,” says Pacter.
One potential thorn could apply to the relative handful of companies that will switch to the simpler standard and later be acquired by a company that uses full IFRS. In that case, some items in the historical financials would have to be reconciled. For example, while full IFRS requires borrowing and research and development costs to be capitalized, in the slimmed-down version they are recorded simply as expenses. But Pacter says that in most cases there would be only one or two such items to worry about.
Less Is More
There are several types of simplifications of the full version of IFRS in the streamlined standards. One type simply reduces clutter: some topics addressed in IFRS are omitted because they are not typically relevant to SMEs. These include earnings per share, interim financial reporting, segment reporting, and special accounting for assets held for sale.
Other simplifications have a more direct effect on financial-statement preparers. Notably, various accounting-policy options in full IFRS are replaced by simpler methods. For example, several options for financial instruments — including available-for-sale, held-to-maturity, and certain fair-value options — aren’t included in the pared-down standard. Neither is the revaluation model for property, plant, and equipment and for intangible assets. For investment property, the accounting is driven by circumstances rather than choosing between the cost and fair-value methods.
In effect, the IASB has said that “all of those choices are a complication and impose a burden in valuating the accounting each year, so we’re going to take them away and just say here, this is a good policy to use,” says H. David Sherman, an accounting professor at Northeastern University who has studied IFRS extensively.
The number of disclosures to be made in the footnotes to financial statements has also been substantially reduced.
In addition, there are many simplifications to the way asset values are measured and recognized. For example, goodwill and other intangible assets do not have to be measured anew each year to account for impairments; rather, an asset’s value is measured just once and then amortized over its “estimated useful life.” If that lifespan cannot be estimated reliably, it is simply amortized over 10 years.
Simplifications also were made to the measurement or recognition of financial instruments, investments in joint ventures, defined-benefit plans, and biological assets, among others.
What’s in a Name?
Asked why the new standard is called “IFRS for SMEs” even though there’s no test for company size in determining what entities are eligible to use it, Pacter notes that the IASB changed its working name several times during its five-year development process. SME was in the name at first, then it was changed to NPAE — “non-publicly-accountable entities.” “But that didn’t roll off the tongue easily, nobody had ever heard of it, and it wasn’t easily translatable,” says Pacter. “Besides, even a hot-dog stand has some public accountability — it’s got to follow the health laws.”
Then for a while the standard was called “IFRS for Private Entities.” But that too was judged unsuitable because in many countries — including China, France, Sweden, and several in Latin America — it is common for the government to be a part owner of companies and to consider such companies to be public. The IASB finally decided that no name was better than IFRS for SMEs.