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Remi Forgeas
Remi Forgeas
 

Transition to IFRS for Smaller Entities

Five questions companies should pose before taking the leap.

August 24, 2009
by Remi Forgeas, CPA

For years, debates on the transition to Internal Financial Reporting Standards (IFRS) were focused on public companies. But the process has now lost part of its momentum. Currently, U.S. public companies are not allowed to file using IFRS. However, U.S. private companies can issue their financial statements in accordance with IFRS.

Since most of discussions on the complexity of the transition have been focused on public companies, impacts for private companies, especially smaller ones, were overlooked.

In practice, smaller companies should follow a project management approach to complete the transition just like large ones, but they will realize that impacts are generally not as extensive as usually presented and therefore the process will be less complex and not as expensive.

IFRS Already Accepted in the U.S. and Companies Must Be Ready

The U.S. Securities and Exchange Commission (SEC) initiatives in 2007 and 2008 regarding the acceptance and future adoption of IFRS in the U.S. were seen as signs that the U.S. would adopt IFRS without delay. The financial crisis along with the changes at the SEC slowed down the process. While the SEC has not given any official guidance, comments from Mary Schapiro — chairperson of the SEC — saying that she will not be bound by the roadmap and the passage of time with no guidance, can be seen as indication that the timetable will not be met.

  • May 2008. The AICPA recognized the International Accounting Standards Board (IASB) as a standard setter. This decision gave AICPA members the option to use IFRS as an alternative to U.S. Generally Accepted Accounting Principles (GAAP).
  • July 2009. The IASB issued IFRS for Small and Medium-Sized Entities. This comprehensive set of rules tailored for private entities may provide an incentive for some private companies to switch to IFRS.

In an apparent paradox considering the debates in recent years, private companies have now the choice between GAAP and IFRS, whereas public filers are still not authorized to do so.

Transition Will Be Unsuccessful Without Sound Project Management

Management of the transition is critical for smaller companies because of limited resources that are dedicated to this project compared to large companies.

While a transition may not be as complex for a smaller company, changing a company’s basis of accounting is likely to have material effect on its financial position and results of operation.

The key to a successful transition to IFRS is the implementation of a strong project management which covers all aspects of the entity.

Readers should note that not all work-streams are included in this chart such as tax compliance, planning and internal control. Financial statements and reporting usually go together.

The project would be divided in three phases and would cover the entire operations as shown in the chart below: 

Transition Will Be Less Complex for Smaller Entities

As a result of the convergence process in the U.S., which started in 2002 (Norwalk Agreement), IFRS are similar, but obviously not identical, to GAAP on a significant number of topics. Using the required (until 2007) reconciliation from IFRS to GAAP for foreign private issuers in their 20-F as a benchmark, differences with significant impact on financial statements relate usually to complex accounting standards and/or specific complex transactions.

For smaller and less complex companies, one can anticipate that differences between GAAP and IFRS will have fewer effects on the financial statements and the organization of these entities.

For example, IFRS requires the segregation of fixed assets into components. Under GAAP, component depreciation is allowed, but not required. For many companies — small or large — this area may be one of the difficult areas for many companies to implement. Having one location may make it easier to implement than a multi-location enterprise, but the affect can be just as material to the financial statements regardless of the number of locations.

Another point for consideration is the option between the IFRS for small and medium-sized entities (IFRS for SMEs) and the full IFRS, assuming the company meets the criteria for adoption of IFRS for SMEs.

The reduced complexity derived from the fact that IFRS for SMEs are made of only one standard, which covers — in 35 sections — all accounting topics. Many options that exist in the regular IFRS are removed and disclosures are less extensive. However, this standard does not reduce the requirements in term of quality of the information presented.

Implying that IFRS for SMES are not as robust as “full IFRS” would be misleading. IFRS for SMEs are tailored for less complex companies, with probably less resources to address technical accounting questions. However, the standard provides guidance on what to do when a transaction is not addressed by it.

A smaller entity deciding to opt for IFRS for SMEs would face an even less complex transition process.

Questions Smaller Companies Should Pose Before Making the Switch

Prior to making a final decision on the transition to IFRS, a company should at least address the following questions:

  • Are there any legal constraints, such as bank covenants, earn-out clause, that would forbid the transition to IFRS?
  • What is the purpose of the financial statements? Are the expected users familiar with IFRS?
  • What are the high level impacts expected on the financial statements? Are operations potentially impacted by the transition?
  • Full IFRS or IFRS for SMEs?
  • Do the resources to perform the transition exist internally? What is the type of external assistance needed (consulting vs. IFRS expertise only)?

Conclusion

After years of discussions focused on public entities, IFRS are available for private entities in the US today.

Most of comments on the complexity and the cost of the transition were made for public companies and may not be as relevant for smaller entities. Consequently, these companies should not presume that the transition will be a very complex and lengthy process. Instead they should review the potential transition to IFRS with regards to their needs and opportunities this could represent.

Once the decision is made, management has to develop a project management plan. Its implementation will vary depending upon the size and the complexity of the entities, affecting the timeframe and, ultimately, the cost to be incurred.

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Remi Forgeas, CPA, is an audit and assurance partner for Mazars in the U.S. For European IFRS contact, you can reach Steven Brice, who is a technical partner in the financial reporting advisory group for Mazars in the U.K.