Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

The great IFRS debate

by
3rd Aug 2010
Save content
Have you found this content useful? Use the button above to save it to your profile.

Steve Collings responds to recent calls for IFRS to be scrapped for UK financial statements and looks at how the ASB could retain the FRSSE.

IFRS is, once again, causing quite a stir within the profession, with certain critics urging the UK government to repeal the requirement to apply IFRS to UK financial statements –although I am not sure how entirely successful this would be.

This article will look at why IFRS was brought in to the UK, where current developments are up to in relation to the proposed IFRS for SMEs and how the ASB could possibly save the much-loved FRSSE.

Currently in the UK, quoted companies (and those on AIM) are required to adopt IFRS as their financial reporting framework. Companies not obliged to report under IFRS can choose to do so (although in reality very few companies voluntarily adopt IFRS.) If a company chooses to voluntarily adopt IFRS, it’s a ‘one-way’ switch only – they cannot switch back to current UK GAAP if things do not go according to plan.

Current developments
In July 2009, the International Accounting Standards Board (IASB) issued IFRS for SMEs, after a five year development process. The IASB estimates that companies that fall under the scope of a SME account for 95% of all companies, and an extensive consultation took place with companies in the SME sector worldwide.

The UK Accounting Standards Board issued a policy proposal ‘The Future of UK GAAP’ in August 2009 and comments on this proposal closed on 1 February 2010. The ASB received in excess of 150 comments and is currently in the process of sifting through the responses. An exposure draft is due to be issued containing the ASB’s proposals for the future of UK GAAP.

IFRS criticisms
The primary objective of the IASB is to produce a set of accounting standards which are intended to be adopted on a worldwide level. IFRS was introduced in 2005 by the European Union and has been criticised quite heavily, particularly with regards to the use of the fair value model of accounting as opposed to depreciated historic cost. Critics have blamed the fair value model for disproportionately overstating banks profitability and in turn overstating profit enabling excessive dividends to be paid. The upshot of all this led to the financial crisis, resulting in banks having to be bailed out by the taxpayer. Well known financial institutions such as Lehman Brothers collapsed and the accounting profession was in the spotlight, once again, for all the wrong reasons. Indeed, the adoption of full IFRS by larger listed companies has caused problems with its implementation.

One of the objectives of the coalition government is to reduce burdensome regulation. Some high profile critics have written a letter to The Times suggesting that a good place to start would be to repeal the legal requirements of IFRS reporting in the UK. The critics believe that the IFRS regime is ‘flawed’ and makes financial statements difficult to understand because of the concepts in some of the IFRS. Most notably, the critics believe that auditors of institutions who report under IFRS have been required to audit the financial statements in compliance with ‘a flawed accounting model’.

True and fair
Under the UK Companies Act, financial statements must give a ‘true and fair’ view of the state of an entity’s affairs at its balance sheet date (reporting date). Critics believe that IFRS conflicts with the UK’s true and fair principle.

In developing and revising accounting standards, the IASB refer to the ‘Framework for the Preparation and Presentation of Financial Statements’ (otherwise known as the Framework Document). The IASB’s Framework does not address the ‘true and fair’ principle. Indeed, the Framework Document itself does not have the force of an accounting standard and as a consequence its contents are not mandatory (except in relation to IAS 8 ‘Accounting Policies, Changes in Accounting Estimate and Error’). The Framework Document instead states that where accounting standards (IFRS) are followed and the qualitative characteristics are applied within the financial statements, this will result in the financial statements giving a true and fair view (or presenting fairly such information).

IFRS for SMEs
IFRS for SMEs is based on the principles in full IFRS. Full IFRS spans some 3,500 pages and is clearly inappropriate for use by a SME. IFRS for SMEs has been heavily condensed and is designed as a ‘standalone’ standard. In contrast to IFRS for SMEs, the Financial Reporting Standard for Smaller Entities (FRSSE) is not a standalone standard – FRSSE runs in conjunction with the mainstream standards.

The IASB has commented that IFRS were primarily designed to meet the needs of equity investors in companies in public capital markets.  It is for this reason the IFRS are so vast; they cover a wide variety of issues, contain a lot of implementation information and the disclosure requirements are appropriate for listed companies. In developing the IFRS for SMEs, the IASB recognised that the users of financial statements prepared for SMEs do not have the same needs as those of listed companies and are more focussed on shorter term cash flows, liquidity and solvency. In addition, the IASB acknowledged that many SMEs say that full IFRS would place an unnecessary burden on them so in their attempts to ‘kill two birds with one stone’ the IASBs objectives in developing IFRS for SMEs were to meet user needs whilst balancing costs and benefits from the perspective of the preparer.

The IASB wants global convergence – in other words it wants all financial statements to essentially ‘sing from the same hymn sheet’. In this respect, if we are to assume that the UK will fully report under the IFRS regime then clearly the proposed IFRS for SMEs is much more appropriate than full IFRS.

Complexities in IFRS for SMEs versus FRSSE
The ASB stated in its consultation paper that current UK GAAP has become ‘overly complicated’ and that it did ‘not make sense to maintain UK GAAP in its existing form’. However, IFRS for SMEs is quite complex in certain areas – and I am of the opinion that some areas of the proposed standard may be over-complicated for preparers of SME financial statements.

For example, deferred tax under current UK GAAP is recognised on ‘timing differences’ which recognise the mismatch between the accounting periods in which gains or losses are reported in the financial statements compared to when the tax effects arise. Deferred tax under the IFRS (SME) regime is recognised on ‘temporary’ differences which recognise deferred tax on the differences between assets and liabilities in the financial statements compared to the effect on taxable profit if the associated assets or liabilities had been sold or settled at the balance sheet date. This is far more complicated than current FRS 19 and FRSSE requirements and would result in more deferred tax provisions being recognised than under current UK GAAP.  In addition, other areas that are likely to be over-complicated for clients in the SME sector are in relation to pensions and leases.

UK GAAP has become established by preparers of financial statements and in the main is generally well understood. There are some particular areas which cause difficulties, such as financial instruments and IFRS derived standards (such as FRS 20: ‘Share-Based Payments’). In deciding the way forward for UK GAAP, the ASB is likely to take account of the complexities in the proposed standard in comparison to FRSSE.

FRSSE
Without a doubt, FRSSE is a much-loved standard and one proposal by the ASB is to retain FRSSE for ‘very small’ companies or to align FRSSE with IFRS for SMEs. A large number of practitioners who work with FRSSE are praying the ASB will keep the standard.

There are problems inherent with FRSSE the standard is considered in context with the proposed IFRS for SMEs (in its current form). The main problem with FRSSE is that it is a cut-down version of full FRS/SSAP. If FRSSE is retained and IFRS for SMEs (in its current form) is adopted in the UK, FRSSE will be based on a financial reporting framework which no longer exists. There are also various accounting treatments which FRSSE allows that are not permitted under IFRS for SMEs, for example revaluation of fixed assets, valuation of stock under last in, first out (LIFO) and the discounting of deferred tax.

Additionally, because of the fact that FRSSE is not a standalone standard, and where particular issues are not covered in FRSSE, fall back to the full standards is required to decipher an appropriate accounting treatment. As IFRS for SMEs is a standalone standard no fall back to full IFRS is required – management must develop a policy having regard to the IASB ‘Framework’.

In terms of FRSSE (in its current form) compared to IFRS for SMEs (in its current form) there are many inconsistencies which clearly the ASB will have to address; the main issue being the lack of comparability between the financial statements of an entity adopted FRSSE and those of a large company. If the idea of bringing IFRS for SMEs in is to enable consistency in financial reporting, my view is that if FRSSE is going to be retained, then it should be aligned with IFRS for SMEs – particularly with regards to the differing accounting treatments.

In light of the fact that FRSSE would (in its current form) be based on a financial reporting framework which would essentially be redundant, it would seem plausible for the ASB to dispense with FRSSE (in its current form) and produce an alternative FRSSE based on IFRS for SMEs. Those wanting to adopt the alternative FRSSE would be subject to eligibility criteria. In producing the revised FRSSE, certain aspects of IFRS for SMEs could be dispensed with – particularly the requirement to produce a cashflow statement and enable a disclosure-only approach to dealing with share-based payments. Users of FRSSE (in its current form) like it so much because of the reduced disclosure requirements and therefore it would make sense to have a FRSSE based on IFRS for SMEs also to allow reduced disclosure requirements.

The way forward
The UK ASB is still deliberating on the proposals for UK GAAP and indeed there are some genuine concerns about IFRS in terms of its appropriateness in certain areas – particularly in the controversial area of fair value accounting.

Most professional bodies are now examining students on IFRS, with many UK based papers having already been withdrawn from syllabuses or plans to withdrawn UK based corporate reporting papers which is resulting in the newly qualified accountants having undertaken their training under IFRS.

An exposure draft is due out shortly from the ASB outlining its plans for UK GAAP.  FRSSE is a bit of a ‘problem child’ in that if the ASB keeps the FRSSE then a company that is currently on the borderline of being considered ‘small’ would be required to report under IFRS for SMEs and would not be eligible to apply FRSSE. If the same company in the succeeding year were to suffer a bad year and the numbers meant the company was subsequently classified as small, the ASB would need to consider how such companies would deal with this – particularly in terms of comparability within the financial statements.

Interesting times lie ahead in the area of financial reporting, although I suspect the complete withdrawal of IFRS in the UK might be a little over-optimistic given that it has always been the intention of adopting an IFRS based reporting framework in the UK. If readers feel strongly about the whole issue, fill in the questionnaire on the ASB’s website and help develop their proposals.

Steve Collings FMAAT FCCA DipIFRS is the audit and technical director at Leavitt Walmsley Associates Ltd and a partner in AccountancyStudents.co.uk. He is also the author of ‘The Core Aspects of IFRS and IAS’ and lectures on financial reporting and auditing issues.
 

Replies (2)

Please login or register to join the discussion.

avatar
By Abster
04th Aug 2010 15:27

The future is IFRS (US GAAP)!!

As far as I have understood whilst we continue to plug along with IFRS and wanting a standardisation of accounting frameworks, the USA and China persist in not joining in unless on their terms. Forgive my cynicism but I imagine that by the time we finish up we will be closer aligned to US GAAP.

Thanks (0)
avatar
By Edward Beale
05th Aug 2010 18:38

Repeat of comment on article "Dissidents call for ‘rethink’ on I

 The letter correctly points out some of the problems with IFRS, however politicians are not the right people to set accounting standards.  The ASB is reviewing the future of GAAP and is developing proposals based on the IFRS for SMEs.  There is a very short questionnaire on its web site seeking evidence of the impact of its proposals - see the ASB page on The Future of UK GAAP.Please respond to this questionnaire as the more evidence the ASB has, the more likely it is that it will produce sensible proposals.Respondents may wish to considerwhether the ASB's proposed solution is an improvement on existing requirementswhether the ASB has sufficient information to enable it to put forward a targeted and proportionate solution (the recent consultation only had 1 response from a user of SME accounts),whether the volatility of reported profits in holding company, subsidiary and group accounts will be acceptable,whether a variant on the IFRS for SMEs, with simplified accounting for financial instruments and deferred tax, and reduced use of fair value, would be more suitable for all companies applying UK GAAP that are too large for the FRSSE,whether medium sized companies should be able to apply the FRSSE, and if so whether there are additional issues that the FRSSE would need to cover,whether the ASB should accept without enquiry the IASB's unsubstantiated assertion that the IFRS for SMEs is unsuitable for publicly accountable entities,whether accounting standards will have any impact on the availability of investment finance or cost of capital,the cost of transition bearing in mind that the cost of transition to full IFRS was often greater than anticipated,how training can sensibly be provided to users of accounts to help them understand an IFRS based approach, andwhether now is the right time to change

Thanks (0)