IFRS for Private Entities A Practical Guide
Author:
Irene O'Keeffe
As the International Accounting Standards Board (IASB) is expected to vote to approve a final International Financial Reporting Standard (IFRS) for Private Entities in the fourth quarter of 2008, private company management teams should now consider exploring the business case for moving to this proposed IFRS-based standard. Irene O’Keeffe, Assurance Partner, PricewaterhouseCoopers, outlines the status and scope of the proposed standard and explores the business case for private companies considering conversion.
Background
The International Accounting Standards Board (IASB) has recognised that for private companies without a capital market focus, the potential benefits of full IFRS can be outweighed by the difficulty or cost ofpreparing fully compliant IFRS information. The full series of IFRS standards were designed to meet the needs of equity investors in public companies and they therefore cover a wide range of issues and require disclosures appropriate for public companies and relevant to the readers of the financial statements of public companies. Users of financial statements of private entities have a different focus to those investing in public companies on capital markets and do not necessarily have the same information needs or requirements. The IASB recognised and acknowledged the need to provide useful and beneficial financial statement information to users of private entity financial statements while not imposing an excessive cost burden on the preparer.
To address this, the IASB took on a project with the twin goals of meeting user needs while balancing costs and benefits from a preparer perspective. The end product of this project would be an IFRS expressly designed to meet the financial reporting needs of private entities.
In February 2007 an Exposure Draft of the proposed IFRS for Small and Medium-sized Entities was issued with a deadline for comments of 30 November 2007. The IASB received 162 comment letters. Some of these have resulted in the IASB reconsidering the title of this proposed standard which they are currently finalising and referring to as the IFRS for Private Entities. The standard will be derived from full IFRSs with appropriate modifications based on the needs of users of private entity financial statements and cost benefit considerations. For example, some of the options on accounting treatments
that are included in full IFRS are not included with only one accounting basis included. Some topics that are generally not relevant to private entities have been eliminated and the disclosure requirements of full IFRSs will not form part of the final standard. It is expected that the new standard will stand on its own and not require the preparers of private entity financial statements to cross refer to full IFRSs. The Board of the IASB plans to vote to approve a final IFRS for Private Entities in the fourth quarter of 2008. It is expected that a final standard will be issued in the first half of 2009.
Scope and Application
Adoption of IFRS for Private Entities (as well as the effective date) will be at the discretion of each individual country and jurisdiction. Once the standard is issued, it will be available for individual jurisdictions to adopt. Paul Pacter, Director of Standards for Private Entities at IASB, commented that jurisdictions should not rush to make the standard mandatory in 2009 but rather give time for companies and auditors to familiarise themselves with the contents of the standard and to plan the transition to the standard. In light of this he indicated that 2010 would probably be the earliest realistic date for adoption for most jurisdictions. However, if a jurisdiction currently requires full IFRS for private entities, a transition in 2009 may be feasible.
The IASB has suggested that the standard will be usable by all private companies with the guidance based on the nature of the entity rather than the size. The guidance in the proposed standard suggests that the standard would be suitable for any entity that
- does not have public accountability and
- publishes general purpose financial statements for external users.
An entity has public accountability if it files its financial statements with a securities commission or other regulatory organisation for the purposes of issuing any class of instruments in a public market or it holds assets in a fiduciary capacity for a broad group of outsiders, e.g. bank, insurance entity, pension fund, securities broker/dealer. While not specifically addressed in the proposed standard, Paul Pacter noted that Not-for-Profit organisations are not automatically precluded from using the proposed standard by virtue of their nature and that unlisted subsidiaries of listed companies are also eligible to use the proposed standard. However, if a jurisdiction wants subsidiaries of listed companies to use full IFRS rather than the proposed standard, the jurisdiction could impose such a requirement.
Embedding IFRS for Private Entities across a private group with extensive global operations, currently using a variety of GAAPs, would significantly ease the monitoring of financial information, reduce the complexity of statutory reconciliations (thereby reducing the risk of error), make the consolidation process more efficient and streamline accounting procedures across group entities.
The Future of UK and Irish GAAP
In 2005 there was a general expectation that Irish and UK GAAP (i.e. accounting standards issued by the Accounting Standards Board in the UK (ASB)) would converge at some future date with IFRS. However, this programme of convergence has stalled in recent years and UK GAAP currently consists of some standards that have been converged in their entirety with IFRS, some standards that have converged in parts with their IFRS equivalents and standards where no convergence has been made.
Current indications are that the ASB may publish a Discussion Paper over the coming months setting forward a proposed three-tier reporting structure that would replace what we now know as UK GAAP. Any final document that is developed by the ASB is contingent on the final standard that is issued by their International equivalent, the IASB. The three tiers would be:
1. Full IFRS for entities that are deemed to have public accountability;
2. IFRS for Private Entities for the middle tier;
3. The ASB’s Financial Reporting Standard for Smaller Entities (FRSSE) for the smallest tier.
The thresholds and ‘bright lines’ for determining which entities will fall into which tier have not been finalised and are likely to be open to public comment.
Global Domination?
Since 2005 the number of countries adopting or permitting adoption of IFRS or IFRS-based standards has grown significantly as the perception of IFRS as a robust global accounting language has increased. 2011 will be a significant date in solidifying the global acceptability of IFRS-based standards and the attainment of a single set of high quality, transparent global accounting standards, as this is when the SEC anticipates finalising a decision as to whether a mandatory IFRS implementation date of 2014 for current US GAAP reporters will apply.
The Business Case
IFRS for Private Entities has clear benefits for investors, lenders and those seeking to raise finance through the transparency afforded by a consistently applied, global set of financial reporting standards. One aim of the proposed IFRS for Private Entities is to provide a standard for entities in countries that have no national GAAP or for entities that are not of the size nor have the resources to adopt full IFRS. With approximately 55 different SME
GAAPs currently being used in Europe, a second aim of the standard is to provide countries that already have an established national GAAP with an alternative, IFRS-based standard that will be recognised an understood across different territories. Adoption of the IFRS for Private Entities by growing private entities would also ease transition to full IFRS if they become publicly accountable.
In the event that the ASB allows certain companies to use IFRS for Private Entities there are some very distinct advantages associated with using IFRS for the middle tier of companies all over the world, including: Comparability of companies’ financial information The application of IFRS for Private Entities will significantly improve the comparability of entities within an industry and across different industries, regardless of where the reporting entity is domiciled. Under the IFRS for Private Entities, similar transactions and economic circumstances are accounted for and presented more consistently than under varying national requirements.
Internationally, financial indicators are not comparable because different recognition and valuation principles are applied in each country. This makes it difficult for users of financial statements to make informed decisions on a private entity’s performance and cash flows. Privatecompanies that move to widespread use of IFRS for Private Entities should find that it improves both the comparability of information and the quality of communications to stakeholders.
Acquisitions, partnerships and cooperation agreements
The adoption of IFRS for Private Entities will often make it easier to implement planned cross-border acquisitions and to initiate proposed partnerships or cooperation agreements with foreign entities. Furthermore, maintenance of financial information under this IFRSbased standard may simplify the sale of the reporting entity itself, either as a whole or on a piecemeal basis. This is because financial statements are key documents for evaluating an acquisition and negotiating a purchase price, as well as for assessing potential partnership or cooperation agreements. Interpreting the performance of the other party’s business becomes significantly easier, and agreement is more likely, when both sides already have financial statements prepared using a similar accounting framework. If financial information is based only on national requirements, additional time and expense must be invested in order to understand the different basis of accounting and reach a clear assessment of the other party’s performance. Post acquisition, th costs of integrating the financial reporting systems are lower where both the acquirer and the acquiree use the same accounting framework.
Building relationships with overseas customers
The use of IFRS-based information should help private entities involved in buying / selling goods or services across national borders to initiate new relationships with customers and suppliers. As the spread and acceptance of IFRS-based standards grows internationally, so should the importance of IFRS-based financial statements as a tool to cultivate a positive image. It is not only large foreign groups that now demand financial statements from companies as part of the process of supplier selection and evaluation. Suppliers that only prepare financial statements under their national GAAP may well find themselves at a disadvantage compared to competitors with IFRSbased financial statements. To eliminate disadvantages in the global competition for new contracts and allow businesses to compete on their merits, an entity must be able to provide high-quality information that, at the very least, is as convincing and as relevant for decision-making as the information its competitors provide. This is particularly important when entering into long-term trading relationships: in these circumstances, potential customers or suppliers usually want reassurance about the entity’s solvency before committing to a relationship. This information can be better conveyed using an internationally-accepted accounting framework, such as the proposed IFRS for Private Entities, rather than a national framework that needs to be explained.
Dealing with finance providers
Demonstrating compliance with an IFRS-based accounting framework should strengthen a company’s position in negotiations with credit institutions and reduce the costs of borrowing because of the positive effect it can have on credit ratings. IFRS can also result in more accurate risk evaluations by lenders and, in many cases, a lower risk premium. This is because financial information prepared using an IFRS-based standard emphasises the economic substance of transactions and tends to provide higher-quality information, with better disclosures and transparency than many national accounting frameworks.
Compliance with an IFRS-based accounting framework may also help private companies to take advantage of alternative forms of finance. Equity financiers, just like credit institutions, want top-quality information to help them assess the risks and rewards of the entity or project to be financed. IFRS-compliant information should facilitate clearer comparison of investment opportunities in various countries to be made, and help investors to identify the specific advantages of each. The better the information for investors, the easier it should be to attract them and the lower the risk premium for the company.
Next steps
With the new standard expected to issue in the first half of 2009, now is the time for private company management to consider their current position and the impact that the proposed standard may have on their business and reporting requirements.
Irene O’Keeffe, FCA, is a Partner in PwC’s Assurance Practice.