Print this article | Return to Article | Return to CFO.com
In spite of their interest in the proposed "little GAAP," small businesses are not ready to move on "IFRS light."
Marie Leone, CFO.com | US
October 6, 2009
Following the release of a private-company version of international accounting standards this summer, most smaller U.S. companies are not signing on to the idea of switching from U.S. rules — at least not yet. Accounting firms that focus on smaller businesses say their clients are in no rush to adopt International Financial Reporting Standards for small and medium-sized entities (SMEs), or "IFRS light."
"There will have to be a cultural shift" before companies begin adopting IFRS light on a voluntary basis, posits Sal Collemi, a senior manager at accounting and audit firm Rothstein Kass. That cultural change is related to the biggest disparity between IFRS and U.S. generally accepted accounting principles: that IFRS allows for more professional judgment on the part of company management and accountants, while U.S. GAAP shields both groups with more rules and implementation guidance.
The culture of using extensive professional judgment when applying accounting rules varies from country to country but is rare in the United States, contends Collemi. He calls that kind of judgment a "soft skill" that requires training in how to "think differently" about transactions.
There's also a more practical reason why private companies in the United State aren't moving quickly to adopt IFRS light, despite its lure of attracting global investors, partners, and customers. That is, American banks, creditors, and investors — which still hold enormous sway in the global economy, especially over smaller U.S. companies — are not yet "up to speed" on IFRS, notes Collemi, who works on IFRS training programs for his firm, as well as for clients.
The new SME standards are based on full IFRS but have been whittled down from 2,500 pages to a mere 230 pages. The pruning took five years of discussion, debate, and editing, but now that the trimmed-down standards have been issued, the International Accounting Standards Board has promised that IFRS light will only be revised every three years, so smaller companies that use the standards won't have to worry about the time and expense of implementing new rules every year, which is usually the case with full IFRS.
The pared-down version of the standards is available for use by SMEs, which the IASB defines as nonpublic entities that publish general-purpose financial statements for external users (i.e., owners who are not involved in managing the business, existing and potential creditors, and credit-rating agencies). In practice, that means IFRS light was written for private companies, which according to the IASB make up 95% of the world's businesses.
"The IFRS for SMEs will provide businesses with a passport to raise capital on a national or international basis," noted Paul Pacter, director of the project, in a statement when the standards were released.
In theory, smaller private companies that want to raise capital from foreign investors, or borrow from foreign lending institutions, should find it easier to report results in a format that is accepted by the 100 or more countries that now recognize IFRS. Further, companies that deal with foreign suppliers and customers, or are owned by a foreign parent, may find that using IFRS light, instead of country-specific versions of GAAP, saves a lot of time and money with respect to reconciling financial statements within their own companies, says Collemi.
When the diminutive standards were released this summer, Big Four accounting firm Deloitte surveyed 220 private-company financial professionals, 77% of them from companies with less than $1 billion in annual revenues. More than half (51%) of the smaller-business finance executives claimed they favored the idea of having separate accounting standards for public and private companies.
Deloitte experts say the support for IFRS light is likely to swell as more company executives become familiar with the standards and their potential benefits with respect to capital raising. "Some private companies are still not aware of the IASB's efforts in addressing the needs of private companies," noted Deloitte partner D.J. Gannon after the survey results were released. In fact, when the rules were issued, 43% of the SME respondents were unaware of the IFRS light project.
The IASB launched the project because it concluded that full IFRS were heavily weighted to meet the rigorous disclosure needs of equity investors in publicly traded companies. Illustrating the burden public-company rules placed on private companies, consider that IFRS light contains 300 to 400 disclosure requirements, while full IFRS mandates 4,000.
Full IFRS also covers a wide range of issues specifically geared toward public-company investors, such as rules dealing with earnings per share, interim financial reporting, and segment reporting, and it contains a significant amount of implementation guidance surrounding those provisions. By contrast, SMEs and their investors and lenders focus their attention on assessing shorter-term cash flows, liquidity, and solvency.
In addition, IFRS light removes some of the options that full IFRS allows public companies to use, such as those related to the revaluation at fair value of intangibles and property, plant and equipment. Recognition and measurement issues are also simplified under IFRS light. For instance, when goodwill is amortized, SMEs can stop testing after 10 years, instead of being required to test for impairment over its useful life, as is the case with full IFRS.
The release of IFRS for SMEs gives the international standard-setter a leg up on its American counterpart, the Financial Accounting Standards Board, which has been toying with the idea of issuing "little GAAP" since 2004. Like IFRS for SMEs, little GAAP would be a truncated version of the 25,000 pages that make up full U.S. GAAP, the rules that are considered the "gold standard" by many companies and investors around the world.
Many U.S. critics turn their thumbs down at the little GAAP concept. "The accounting profession in the United States has consistently rejected Big GAAP/Little GAAP over the years," the New York State Society of Certified Public Accountants noted in a March comment letter to the Securities and Exchange Commission. In the letter, the accountants expressed concern about, among other things, the quality of IFRS compared with U.S. GAAP in response to an SEC plan to require U.S. public companies to file financial results using IFRS. Their objection to little GAAP is rooted in a belief that the American rules, which are more prescriptive than IFRS, should not be tinkered with, and that introducing exceptions to full U.S. GAAP is not an appropriate way to deal with private-company issues.
Nevertheless, it is impossible to deny that companies, both public and private, increasingly operate in a global marketplace, where a single set of high-quality global accounting standards would prove useful. Last month the U.S. Treasury reported that by the end of 2008, foreign investors held more than $10.3 trillion worth of long- and short-term U.S. securities, both equity and debt — a $600 billion increase from the year before. At the same time, American investors held $4.3 trillion worth of foreign securities, down from the $7.2 trillion they held in 2007.
That kind of market pressure may eventually push U.S. companies to adopt IFRS. To be sure, the IASB and FASB are already seven years into their joint project to converge IFRS and U.S. GAAP, and the SEC continues to study the idea of potentially weaning American companies off of GAAP and requiring financial statements to be prepared in IFRS. "Given today's economic and financial environment, we're seeing a fundamental shift in accounting and financial reporting toward global standards," says Gannon. "This shift is not limited to public companies. Private companies, in particular midsize ones, may want to reevaluate their approach to financial reporting and carefully weigh their financial-reporting alternatives."
While proponents of IFRS for SMEs claim that the long-term benefit of having access to the global markets outweighs the initial conversion costs — which have not yet been estimated — there are some implementation challenges ahead, says Collemi. For instance, companies will have to conduct a line-by-line analysis of accounts to weed out GAAP vs. IFRS differences, make changes to information technology systems to accommodate IFRS, and rewrite revenue agreements with customers, as well as third-party lending agreements, that include covenants based on GAAP or full IFRS measures.
In March consultancy Accenture estimated that public and private companies with annual revenue between $1 billion and $4.9 billion would spend 0.731% of that revenue to convert to IFRS. Companies with revenue over $50 billion would only spend 0.103% of their top line. Still, once the changes are implemented, IFRS light is supposed to result in a "streamlined" accounting process that saves smaller companies money by eliminating the reconciliation of multiple GAAPs, says Collemi. Adopting IFRS light means "companies will be speaking one accounting language."