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Small fish wriggle on IFRS hook.

Financial Times – 25/3/2008 –Surveys ICA1 -Page 2You might expect a system to simplify financial reporting in smaller companies would be universally supported and acclaimed. After all, complaints about the complexities of international financial reporting standards (IFRS) are common.

But proposals from the International Accounting Standards Board (IASB) for an IFRS-related system for small and medium-sized companies (SMEs) have become some of the most hotly argued-over ideas in the IASB’s short history.

The fiercest arguments have been in Europe.

Back in 2005 the European Commission said it supported the IASB’s efforts. Yet two years later, once the IASB’s draft proposals had been published, the Radwan report from the European Parliament said it was “unclear who gave a mandate to the IASB to suggest such an IFRS for SMEs”.

The parliamentaries suggested it was “even questionable whether there was ever a need or demand for such a standard”.

Around the rest of the world there is clearly a demand for the proposals.

South Africa was so enthusiastic it decided not to wait for the final standard and instead implemented the draft proposals last year.

The attitude within the European Parliament has upset practitioners. “There is an element of ‘not invented here’,” says Brian Shearer, senior technical partner with Grant Thornton International.

“We are disappointed,” says Richard Aitken-Davies, deputy president of accounting body, the ACCA, and chairman of its financial reporting committee.

And to some the European stance is irrelevant. “I don’t take the European position all that seriously,” says Peter Holgate, senior technical partner with PwC.

“Even if they end up not endorsing it, various countries could adopt it in their national generally accepted accounting principles, (GAAP). If a few major players do that you have it brought in by a different door even if the EC doesn’t want to play ball.”

But the proposals are likely to be refined and then approved as a final standard by the end of the year. At the IASB, the period for comments on the original draft has just closed and it has some 160 comment letters to deal with.

“Reaction to the proposals is generally favourable,” says Paul Pacter, director of standards for SMEs at the IASB. “In those countries that have required full IFRS for small companies, or that have closely converged their national GAAP to full IFRS, the IASB’s SME proposal is viewed with a great sigh of relief.”

“We believe there is value in going down that route,” says Mr Aitken-Davies. “There is a value of an element of global comparability even for small companies. It helps to level the playing field for companies and it makes it easier to transfer accounting skills across borders.”

The end result is likely to be a three-tier system in most countries around the world.

Listed companies will produce their figures under the full IFRS system. The remaining larger companies would follow the route of the SME standard and the smallest end of the corporate world would either produce no accounts at all or accounts under a further streamlining of the system.

This is where the problems really lie.

The smallest of companies may only need its accounts to convince its bank of its stability.

“At the bottom end of the market,” says Phil Coleman, national head of audit at accounting firm RSM Bentley Jennison, “accounts are produced for the taxman or the banks or the credit reference agencies.”

“The bottom tier is almost so irrelevant that it doesn’t matter what they do,” says Mr Holgate.

Different countries have different rules and it can be hard, for fundamental legal reasons, to change the system.

“In some countries,” says Mr Pacter, “there are obstacles to adopting the IFRS for SMEs, particularly where SME standards are written into law or where financial reporting and tax reporting are traditionally linked.

“As a private sector body, the IASB cannot tell any jurisdiction that it must adopt the IFRS for SMEs. Each jurisdiction will have to make that assessment based on its assessment of the public interest and local needs.”

The experience following South Africa’s early adoption is likely to be influential.

“South Africa is a massive real-life case study,” says Mr Holgate. “It is so much more valuable than armchair theorising and comment letters.”

“We are getting a mixed reaction,” says Sue Ludolph, project director for accounting at the South African institute of chartered accountants (SAICA).

“We used to have only one financial framework for every company, from the listed to the fish shop. We now have a second tier for SMEs and that includes anything not listed.

“The larger companies stepping down to that level are enthusiastic and are reporting huge benefits. But the micro-entities are unhappy. It is still too much of a step up for them.

“They feel they are accounting for things which are not relevant to them when the owners of the business are a few shareholders and the users of the accounts are the bank.”

So further simplification is likely before the proposals are finalised.

And the end result may have greater consequences than originally intended. Expressing IFRS principles in a simpler form could bring pressure on the full IFRS system which has been so heavily criticised for its complexity.

“The end product will be simpler and more concisely expressed,” says Mr Holgate, “so why can’t that example influence big IFRS? Why do we need something complex and hard to deal with?

“Once the SME standard is established the pressure will be on for IFRS to become simpler.”

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