The Negative Effects of IFRS Upon SMEs of the World

The United States is said to be a land of freedom and opportunity. It is a country filled with individual dreams and ideas of success. These may be the reasons why there are over twenty million entities which are classified as being small and medium-sized entities (SME's), not even to mention those that have grown beyond their original ideas and have created publicly traded corporations. Some now cross borders and oceans to involve individuals from other countries, backgrounds, and ideals. With the growing world comes innovation without boundaries, which in the end needs to be able to be receipted by others in order for them to understand what it is that these dreamers have now created.

On a more realistic and factual level, these businesses are not businesses without organization and reporting. In order for a company to be multi-national it requires the company to not only operate in several countries but to also to report their operations consistently throughout those countries. Even within single companies this is necessary for continuity and success, but the scale is on a smaller level. When one local baker needs to understand why his competitor is becoming more successful or the means to which they are able to budget what others cannot, comparability in financial records is the answer. The capability to record and document where an entity stands financially also gives support to investors and lenders before they take risks in a given company.

Reporting on finances is not new to the United States (or the world), with the installation of Generally Accepted Accounting Principles (GAAP) through the combined actions of groups and committees since the end of the Great Depression in conjunction with the laws and regulations which became the Principles. This system of reporting, though not agreed upon and signed into legislation by all countries and entities, created a system that seemingly created organization and comparability. But with new ideas and networks on the rise, the world has begun to shift towards international consistency. Smaller, less globalized entities are seeing increasing amounts of pressure to report in the same manner that mainstream stockholding companies of the world report as a result of the bigger entities needs to interpret statements from one country to the next. These actions are under the supervision and modification of the International Accounting Standards Board (IASB) (Grosu and Bostan 323).

The ISAB's set of accounting and reporting stipulations, International Financial Standards (IFRS), is relatively new, but the set of reporting laws which were created for these smaller businesses is even newer. The IASB (International Accounting Standards Board) published the 230 page IFRS for Small and Medium-sized Entities (SME) on July 9, 2009 (PwC 2) and has continued to monitor and revise the laws and limits as more countries and companies test the waters of the reporting system which had been simplified from the lengthier, more globalized set which had been created for entities who have business in numerous countries. IFRS for SME is simpler and more targeted towards the needs and standards of smaller entities (Moss Adams). But there continues to be negative effects and burdens which are placed on these groups which may seem to be unnecessary when Generally Accepted Accounting Principles (GAAP) had been working well up until this point.

One of the main effects IFRS for SME's has had on businesses that have used it so far, and it is assumed to continue for other SME's in the future, is the cost. Naturally there will be costs to any change within a system of reporting. For a small business without the knowledge and software that IFRS requires, the possibility of significant increases in cost have the potential to wipe out an entity entirely (#6). Between the expenses for a new software system, training from an IFRS expert and the costs to either hire new personnel or properly train existing employees, certain companies will not be able to keep their heads above the high tides of IFRS conversion. The complete conversion can possibly run as much as one percent of revenue. To add to this, if a SME uses LIFO in their reporting of inventory, they will need to spend additional time in order to be in accordance with IFRS ruling principles and this, "Accounting change frequently results in negative tax consequences," (ERRC). On top of this, until IFRS is actually placed into effect or removed entirely, clients and other companies may still continue the use of GAAP reporting. This would cause entities that are in the mist of conversion to report twice, adding a large sum of hours to the sometimes monotonous labor load already.

Regardless of the modifications which were meant to create a simpler set of IFRS for smaller companies who do not trade publicly, IFRS for SME's continues to be unproductive and unsuccessful. This is evident in other countries where IFRS for SME has already been enacted and tested. Companies from countries such as those found within the European Union have tested the waters and used the new regulations to begin the process of international reporting. Looking back on businesses in these countries experience with this reporting method shows that IFRS for SME still, though it is a vast improvement from full IFRS, is not ideal for these sized entities. They have stated that, "The average age of tax accountants is going up because no one wants to enter the profession anymore," as a result of the high compliance cost and large amount of change within the skill set and knowledge base as IFRS takes its toll on SME's (Beer 2). As for the actual regulations' consideration and modifications to better suit SME's reporting (particularly within Europe), feedback has shown that the benefit to SME's are still not kept in mind. "The IFRS for SME's as well as the full IFRS are based on a top-down-approach. This is completely incompatible to the important "think small first"-principle of European legislation," (UEAPME 5). In order for IFRS to be effective globally, there needs to be feedback which portrays the advantages of this system in all strata of classification. For one, fairly large, portion of the required field to be inflicted with such burdens and risk, IFRS cannot be the proper step for the world.

Due to the large amount of SME's that exist and, "dominate the business world, almost in every developed country from the economic... point of view," and on the basis that a large portion of even these companies have under fifty employees (Grosu and Bostan 323), even the SME variation of IFRS is not worth forcing upon them. The high costs of both set up and maintenance of the new system could potentially force these smaller companies to either remove themselves from operations or cause them to spiral out into bankruptcy or be bought out by larger companies to grow and expand. To go with this, the amount of negative feedback and evaluations from entities in countries where IFRS for SME's has been previously implemented shows that even with the modifications of its original full intent, SME's continue to struggle finding value in the cost of converting to IFRS. Overall, these large costs which are incurred in the process are not counteracted with sufficient outcomes. In order for IFRS to be successful for SME's in the future, the board must constantly and consistently monitor the implementation of the specialized SME version and find proper changes which will become beneficial to these smaller entities whose business and operations remaining within a single country, which can be handled by the current reporting system (GAAP in the case of United States businesses).

Beer, Stan. "Small Firms, Bog Worry; ACCOUNTING." Sydney Morning Herald 13 Nov. 2004, First ed., My Career sec.: 2. Print.

Grosu, Veronica, and Ionel Bostan. "IAS/IFRS Standards for SMEs and the Impact on the Romanian Accounting System." International Journal of Academic Research 2.4 (2010): 323-28. Print.

Moss Adams, LLP. "IFRS for SMEs/Private Companies." 2 Sept. 2009. Lecture.

Pricewaterhouse Coopers, comp. IFRS for SMEs: A Less Taxing Standard? PricewaterhouseCoopers, LLP, 2009. Print.

UEAPME, comp. Consultation of the International Financial Reporting Standard for Small and Medium-sized Entities. Rep. Belgium: European Commission: Internal Market and Services DG, 2010. Print.

"What the Latest IFRS Developments Mean to Private Companies - Mid-Market Blog." Economic Recovery Resource Center (ERRC). 27 Aug. 2010. Web. 8 Nov. 2010. http://blogs.cbh.com/midmarket/?p=2273.

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Are IFRS and GAAP Converging?

Generally Accepted Accounting Principles (GAAP) is the current accounting standards that public companies in the United States are required to follow since the mid 20th century. GAAP was issued by The American Institute of Certified Public Accountants and is currently enforced by the Securities and Exchange Commission (SEC). These rules are enforced in order to ensure that all financial statements and reports are free from manipulation, are accurate, consistent, and relevant. GAAP assumes that business is separate from its owners. Revenues and expenses should be kept separate from personal expenses. It is assumed that a business will operate indefinitely and that stable currency (the US Dollar) is going to be the unit of record. GAAP also assumes economic activities of an enterprise can be divided into time periods. Generally Accepted Accounting Principles are accounting rules that are used to prepare, present, and report financial statements and follows the cash basis of accounting

International Financial Reporting Standards (IFRS) are principle based standards that were issued by the International Accounting Standards Board after 2001. IFRS uses the accrual basis of accounting. The accrual basis of accounting assumes that revenues are recognized as they occur as opposed to when cash is actually gained or paid. Also International Financial Reporting Standards assumes that an entity will continue in operation until a foreseeable future. Financial capital maintenance is in nominal monetary units or traditional historical cost accounting, but financial capital maintenance is in units of constant purchasing power during low inflation and deflation. International Financial Reporting Standards, like Generally Accepted Accounting Principles is followed to ensure reliability, relevance, and comparability of financial reports and statements.

IFRS and GAAP differ. GAAP is rule-based and IFRS is principle-based. "The IFRS must follow LIFO when recording inventory, where GAAP allows a choice between LIFO and FIFO" (Wall 1). IFRS does not segregate extraordinary items on the income statement like GAAP does, and the earnings per share do not average the individual interim period calculations under IFRS rules. Earnings per share do average the individual interim period calculations under GAAP (Wall 1). These differences affect the decisions the SEC are currently facing due to globalization in the market.

The market today is becoming globalized. Due to this globalization, the United States market has been expanding to an international level. "As the United States businesses move towards a global economy, there is a need to move towards global accounting standards" (Hansen 15). Over one hundred countries have already adopted IFRS rules, and many are in the process of adopting them (Hansen 16). Eventually, all countries will follow the same standards.

In my opinion, IFRS should and will eventually be adopted. IFRS was supposed to be put into place during late 2012, but it is has been pushed back to a later date. In my opinion, it will be adopted within the next two years. I believe that due to globalization, IFRS should be adopted because it is a universal standard. Accounting is like a "language" of business. This means that if every country eventually adopts IFRS, they will all be speaking the same "language."

The SEC has many concerns about becoming international and making changes to GAAP (Leone 22). Some concerns of the Securities and Exchange Commission include a fear of affecting revenues and customer loyalty programs, affecting effective tax rates, and affecting company's capital needs. GAAP and IFRS recognize revenues differently which is an issue. I also believe that the biggest concern and challenge will be accounting for revenue. IFRS will drastically change revenue recognition.

IFRS also lets companies take advantage of declining costs, allows profit-boosting reversals, and makes the cash flow statement harder to evaluate because interest expenses appear in different places than GAAP cash flow statements. Because of the many concerns, the movement from GAAP to IFRS or the convergence of the two is happening very slowly (Leone 26).

Many larger multinational companies in the United States are welcoming these changes because the IFRS standards are nearly in every other country that they operate in anyway. These larger companies believe that the United States would benefit from the convergence to international rules. I, again, also believe that IFRS will benefit the United States because of globalization and being able to do business with other countries much easier because most of them already have adopted and follow IFRS standards. "IFRS standards will improve comparability between United States and non-US reporting companies" (Hansen 15). Movements towards international accounting rules will only mostly negatively affect smaller United States companies. Small companies believe the switch will be costly and that they will get little or no benefit from it. I also believe one of the main problems may be small businesses going out of business.

The United States is currently moving towards IFRS standards. The SEC and FASB is currently thinking of ways to incorporate international rules into the currently used US Generally Accepted Accounting Principles. The Securities and Exchange Commission has been monitoring the slow convergence and they are trying to take key elements from the IFRS to incorporate them into GAAP. In my opinion, the United States should adjust the IFRS standards. Other countries have done the same. This way, the United States can make the standards work for the needs of the businesses within the country. IFRS can be adjusted to fit the culture and needs of a country. I believe that the SEC should also slowly converge. One standard at a time will allow businesses to make the adjustments with more ease.

"Generally Accepted Accounting Principles may not necessary be replaced, but IFRS rules will supplement GAAP rules" (Wall 1). GAAP and IFRS rules will hopefully harmonize into a single set of Global Accounting Standards. The SEC hopes for prosperous, stable economy that will follow the new set of converged rules. In my opinion, I believe that it is a matter of time before IFRS is adopted and that it is inevitable that the standards will be put into place.

Hansen, F. (2008). Kiss GAAP goodbye. Workforce Management, 87(15), 16-17. Retrieved from EBSCOhost

Leone, Marie.(2011). IFRS Still Not Ready for the US.

Wall, K. (2010). Implications of the Convergence of International Financial Reporting Standards and Generally Accepted Accounting Principles. Conference Papers -- Law & Society, 1.

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IFRS Versus GAAP

There are two sets of accounting rules accepted for international use: U.S. standards referred to as Generally Accepted Accounting Principles (GAAP), and international standards known as International Financial Reporting Standards (IFRS). The first is developed by the Financial Accounting Standards Board (FASB), whose power is derived form the United States Securities and Exchange Commission (SEC). The second is developed  by the International Accounting Standard Boards (IASB), an independent London-based accounting standard-setting body. Although GAAP and IFRS share some similarities in presenting their financial statements, they do not agree on every issue. Differences do exist in reporting and classifying elements of Income Statements and Balance Sheets between these two sets of rules.

Unlike the more detailed GAAP rule-based standard, IFRS principle-based tends to be simpler in its accounting and disclosure requirements. The Income Statement is a required statement under IFRS as it is under GAAP and is known as the " Statement of Comprehensive Income". IFRS' statement of comprehensive income is similar to the one used by GAAP; nevertheless, few differences exist when comparing these two income statements.

Presentation of the income statement under GAAP follows either a single-step or multiple-step format. However, IFRS does not mention a single-step or multiple-step approach. Under IFRS, entities are required to classify expenses by either their nature (such as cost of material used, direct labor incurred, advertising expense, depreciation expense, and employee benefits), or their function (such as cost of goods sold, selling expenses, and administrative expenses). Although GAAP does not have that requirement, the SEC requires a functional presentation. While GAAP defines income from operation, IFRS does not recognize this key measure. In addition, extraordinary items are prohibited under IFRS; whereas, under GAAP, entities must report extraordinary items if they are unusual in nature and infrequent in occurrence. The portion of profit or loss attributable to the non-controlling interest (or minority interest) is separately disclosed in IFRS' statement of comprehensive income. Furthermore, while IFRS identifies certain minimum items that should be presented on the statement of comprehensive income, GAAP has no minimum information requirements. However, the SEC imposes stricter presentation requirements.

The presentation of the balance sheet is a requirement under both GAAP and IFRS. The most visible difference is how IFRS refers to this statement as the " Statement of Financial Position" rather than the Balance Sheet. The statement of financial position's accounts are classified under IFRS, which means that similar items are grouped together to arrive at significant subtotals. Also, the IASB indicates that the parts and subsections of financial statements are more informative than the whole; as a result, the IASB does not encourage the reporting of summary accounts by themselves ( for example, total assets, total liabilities, etc.). Unlike GAAP, IFRS' current assets are usually listed in the reverse order of liquidity. For instance, under IFRS, cash is listed last. In addition, most companies under IFRS present current and non-current liabilities as separate classifications on the face of their statements of financial position, except in industries where liquidity presentation provides more useful information. It is crucial to point out some major differences in reporting items in the balance sheet between GAAP and IFRS.

Under the current asset section, inventory is valuated differently under IFRS. The use of (LIFO) last-in-first-out is prohibited under IFRS. In addition, unlike GAAP, if inventory is written down under lower-of-cost-or-market valuation, it may be reversed in a subsequent period up to the amount of the previous write down under IFRS. Furthermore, IFRS permits the revaluation of property, plant, and equipment, and intangible assets and reports them as other comprehensive income.

IFRS uses different terminology in the equity section in its statement of financial position. For instance, Share Capital is the par value of share issued. It includes ordinary shares ( referred to as common share) and preferences shares ( referred to as preferred shares). Share Premium under IFRS' equity section is the excess of amounts paid-in over the par value.

A major problem caused by the disparity that is related to financial statement's presentation of GAAP and IFRS is the lack of uniformity. This problem creates difficulty in comparing financial statements across GAAP and IFRS. As a result, it is rational for U.S companies that have foreign subsidiaries to convert to IFRS in order to make it easier for stakeholders to make comparisons and allow themselves to access global capital markets. However, switching to IFRS may not be beneficial to small U.S firms; the conversion will result in incremental costs that might outweigh the  benefits.

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