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International Financial Reporting Standards - The Future for Private Companies?

January 06, 2011

Christopher Ernest
Supervisor - Accounting and Auditing

During 2008, the Securities and Exchange Commission (SEC) set 2014 as the target date whereby large public companies would be required to submit all reports using International Financing Reporting Standards (IFRS).  Although the original timeline has been revised and the earliest possible adoption date is now 2015, it is clear that the requirement for public companies to transition from U.S. Generally Accepted Accounting Principles (GAAP) to IFRS is on the horizon and coming quickly.  With this public company requirement looming, management of private companies have begun to ask, "How will IFRS affect our financial statements?"

A 230-page simplified, standalone version of IFRS was released in 2009, intended to meet the needs of private company financial statement users.  These modified standards are referred to as the IFRS for Small and Medium Sized Entities (SMEs).  An SME is defined as a company which publishes financial statements for third parties, but is not subject to the SEC public company reporting requirements, thus a private company, but not a non-profit or government entity.  The development of the IFRS for SMEs focused on the needs of mid-size companies and addressed the full IRFS reporting burdens through a need and applicability review of each standard.  The goal of this review was to make a potential transition as painless and inexpensive as possible.  In addition, in 2008 the American Institute of Certified Public Accountants approved the use of IFRS for SMEs as an alternative to GAAP and the recognition of the International Accounting Standards Board (IASB) as an authoritative body for purposes of establishing international financial accounting and reporting principles. 

Currently, private companies in the U.S. are not required to use a particular basis of accounting when preparing financial statements.  Instead, the company can choose to prepare their statements in accordance with GAAP or another comprehensive basis of accounting such as cash or income tax basis, or even IFRS for SMEs based on the needs of the users.  The choice is usually driven by contractual obligations with third-party users, including banks, bonding companies, state agencies, etc.

Since private companies currently have reporting options and a requirement to implement the IFRS for SMEs has not been established, one may ask, "Why bother converting to IFRS?"  The answer is simple, the global economy.  In a world of incredible technology and infrastructure, doing business and initiating credit beyond borders has become increasingly common.  In addition, mergers, acquisitions and capital-raising activities are no longer limited to a company's home country.  As a result of these and other global transactions, the need for standardized reporting has become increasingly important and IFRS creates more comparability between companies.  In addition, GAAP will likely become less accepted in the future as public companies in the U.S. convert to IFRS.

Generally, GAAP and IFRS for SME's are similar when it comes to basic accounting concepts; however, there are some key differences such as:

  • IFRS for SMEs is principles- and judgment-based while GAAP is based on specific rules
  • IFRS for SMEs is approximately 230 pages compared to the 17,000 page Financial Accounting Standards Board's (FASB) codification of GAAP.  As a result, many transactions and circumstances when using IFRS for SMEs are not specifically addressed, resulting in many challenges for financial statement preparers.
  • IFRS for SMEs will only be updated every two to three years while GAAP is continuously updated
  • IFRS for SMEs do not allow the use of the LIFO (last-in, first-out) inventory accounting method
  • Goodwill and other similar intangibles are amortized over a period not to exceed ten years.
  • Impairment and write-down charges can be reversed
  • Borrowing costs are typically expensed as opposed to capitalized and amortized

With the standards established and approvals obtained, the remaining hurdles before a private company can initiate a conversion to IFRS for SMEs are only to overcome the resistance of management and to educate third party users about the standards.  This will be difficult, however, considering that private company owners, managers and financial statement users in the U.S. have no experience reviewing IFRS statements, and the cost to educate them could be time-consuming and costly.  Not to mention, the educators themselves are still learning about international standards, making it difficult to find adequate and/or inexpensive training.  In short, converting from GAAP to IFRS for SMEs requires management commitment and funding.

Based on the recent activities described above, there is little doubt that the international standards are the future of financial reporting.  In addition, the FASB and IASB have already initiated convergence efforts to more closely align GAAP with IFRS before a definitive conversion occurs, including changes to revenue recognition, lease accounting and financial statement presentation.  All of these efforts imply that changes are coming for both public and private companies, and while no requirements to adopt IFRS for SMEs have been considered, private company owners and managers should monitor the continued developments in order to be ready when convergence happens. 



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