Spotting the differences between IFRS for SMEs and full IFRS

Thu, May 20, 2010

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Since 2005, listed groups in the UK and Ireland have been required to prepare their consolidated financial
statements in accordance with International Financial Reporting Standards ("IFRS"). Almost all other entities have
had a choice in that they can follow IFRS or UK/Irish GAAP. If they are small, they have the further option to apply
the Financial Reporting Standard for Smaller Entities ("FRSSE"). However from 2012/13, the options are likely to
change. UK/Irish GAAP is expected to be replaced by the new IFRS for Small and Medium-sized Entities ("IFRS
for SMEs").

Until recently, the International Accounting Standards Board ("IASB") has focussed on developing standards for
entities trading on public capital markets. The resulting standards are relatively complex and contain many
disclosure requirements.

Over one hundred countries make use of IFRS but there has been a growing demand for the IASB to produce a
regime more suited to entities without public accountability. As a result, the IASB introduced a new standard for
non-publicly accountable entities, the IFRS for SMEs, a much simplified version of full IFRS.

With the UK (and Ireland) Accounting Standards Board proposing to replace UK/Irish GAAP with this new
standard, the choice for the majority of UK and Irish companies above the small companies thresholds will be
whether to apply IFRS for SMEs or full IFRS. These companies include:
companies which are listed and have not adopted IFRS in their individual financial statements;
subsidiaries in listed groups which have not adopted IFRS throughout the group;
all public companies which are not publicly accountable; and
all private groups and companies, except those which may qualify as small.
This article seeks to highlight the key differences between the two sets of standards, and to encourage finance
professionals in industry to carefully consider, where available to them, the choice of which to apply as the resulting
accounting treatments can in many cases be at opposing ends of the spectrum.

Simplification
As you would expect, the IFRS for SMEs is a much simplified version of the full IFRS. It was designed by the IASB
with the needs of users of non-publicly accountable entities and the costs and benefits of compliance in mind. As a
result, it is smaller in comparison to IFRS and has approximately one tenth of the disclosure requirements contained
within full IFRS. The main format differences are illustrated as follows:

Full IFRS IFRS for SMEs

Full IFRS IFRS for SMEs
Standards numbered as published Organised by topic
Almost 3,000 pages Under 300 pages
Around 3,000 disclosure points About 300 disclosure points
Updates almost monthly Updated every 2 or 3 years
While the detailed accounting provisions are broadly consistent with full IFRS, there are key differences and
simplifications. The following are the key simplifications made:
Some topics in full IFRS are omitted because they are not considered relevant to SMEs. These include segmental
reporting, assets held for sale and earnings per share.
Some accounting policy treatments in full IFRS are not allowed because a simplified method is available to
SMEs.
Easing of recognition and measurement principles in full IFRS.
Some of the more detailed provisions are discussed further below.

Key areas of accounting impact
Transitioning to either IFRS for SMEs or full IFRS for an entity is likely to mean changes in the recognition and
measurement of a number of items in the financial statements. The list which follows is by no means exhaustive in
its comparison of the two standards but seeks to indicate the more significant accounting differences resulting from
the simplification of full IFRS.

Topic Full IFRS IFRS for SMEs
Goodwill and
Intangibles
Capitalisation of development costs mandatory.
Goodwill and indefinite life intangibles are not amortised but subject to an annual impairment test.
All internally developed intangibles, including development costs, must be expensed.
Acquired intangibles (including goodwill) must be amortised. Default useful life 10 years.
Investment Propoerty Option to use cost or fair value through profit and loss ("FVTPL"). Use cost unless fair value can be measured reliably without undue cost or effort in which case use FVTPL.
Property Plant and
Equipment
Option to revalue through the comprehensive income statement. Mandatory cost model, no option to revalue.
Borrowing costs Mandatory capitalisation. Must be expensed as incurred
Financial Instruments Complex mixed cost/fair value model using four asset categories, recycling of gains from equity,
separation of embedded derivatives and restrictive hedging rules.
Only two classifications: cost and FVTPL.

Topic Full IFRS IFRS for SMEs
"basic" financial instruments (e.g. cash, trade receivables) are measured at cost or amortised cost using the effective interest
rate method. Equity investments with a quoted price at FVTPL.
"Complex" financial instruments (e.g. derivatives such as options and forward contracts) are measured at FVTPL.
No separation of embedded derivatives.
Simplified hedging requirements.
Option to use full IFRS for recognition and measurement (but retaining reduced disclosure).
Defined benefit pension
schemes
Net liability approach using projected salaries. Spreading of actuarial gains/losses permitted. Net liability approach based on present value of future obligations. Simplification of the calculation allowed by omitting
certain variables e.g. future salary increases. No spreading of actuarial gains/losses.
Business combinations Acquisition method using a fair value exchange approach - attributable costs are expensed, and
adjustments to contingent consideration generally to the profit and loss.
Acquisition method using a cost approach - attributable costs capitalised, and adjustments to contingent consideration against
goodwill.
Income tax Temporary difference approach. Limited rules on tax uncertainties * Temporary difference approach. Specific rules on tax uncertainties *
* See below for further tax specific impacts.
Example
The following example considers the impact of the differing treatments under the standards for internally generated
and acquired intangibles.

In financial year 20X0, a private company spends /2m on product development costs. In addition, it acquires a
customer list from a competitor for /1m on the first day of FY 20X0.

a) Under IFRS for SMEs the company will expense the development costs through the profit and loss in FY 20X0. It
will capitalise the cost of the customer list at /1m and amortise it over (a maximum) period of 10 years from the
date of acquisition (/100k per annum).

b) Under full IFRS, the company will capitalise both the development costs and the customer list in the balance
sheet, recording assets of /3m. At each period end, the company will carry out an impairment review on the
carrying value of the assets, debiting any impairment through the profit and loss.

The position at the end of 20X0 under each would therefore be as follows:
Full IFRS IFRS for SMEs
/ /
Balance Sheet
Intangible assets 3,000,000 900,000

Profit and Loss
Development costs - (2,000,000)
Amortisation - (100,000)

As can be seen from the simple example above in one particular area of the standards, the process of simplification
has resulted in very different results.

Key areas of taxation impact
In terms of current tax, the tax section of the new standard includes no significant differences between the IFRS for
SMEs proposals and the current IAS 12 standard. However, there are potentially significant differences when a
company's deferred tax position is considered. These include:

Tax basis for deferred tax calculations - under IFRS for SMEs, the tax basis of an asset is determined based on the
tax consequences associated with selling the asset for its carrying amount. Under full IFRS, the tax basis is
calculated by reference to the expected manner of recovery. As a result, the recognition and measurement of
deferred taxes under IFRS for SMEs is likely to differ from full IFRS and the requirement to determine tax basis by
reference to sale could mean that the tax basis may not reflect the underlying economic circumstances associated
with the asset.

Uncertain tax positions - all tax positions need to be measured using a 'probability weighted average amount' of all
potential outcomes (on the basis that the relevant Revenue authority has full knowledge of all relevant information).
Under full IFRS there is less prescriptive guidance on uncertain tax positions.

However the IFRS for SMEs standard currently does not apply a threshold to the recognition of uncertain tax
positions. Assessing every tax position taken is an area which could potentially be costly and time consuming for
companies and has already received significant negative feedback from many respondents.

Valuation allowance - under IFRS for SMEs there is a requirement that the net carrying amount of a deferred tax
asset equals the highest amount which is more likely than not to be recovered. The expected realisable figure
however has not to be discounted, unlike full IFRS which provides for discounting of deferred tax.

Perhaps more importantly, companies will need to consider the potential tax implications associated with the areas
of accounting impact noted above. These will include:
the requirement to expense internally generated goodwill and intangibles should allow a company to obtain an
upfront tax deduction for all such costs
greater applicability of the complex Disregard Regulations in relation to financial instruments

Conclusions
It is likely that IFRS for SMEs will replace UK/Irish GAAP in 2012 or 2013. Non-publicly accountable companies
will have the ability to choose whether to apply this new standard or full IFRS. As discussed above, there are
significant differences resulting from the simplification process applied by the IASB which companies should bear
in mind when considering which route to select. They will need to weigh up the pros and cons of both regimes to
their particular circumstances, and, as well as the accounting differences in recognition and measurement and the
differences in disclosure requirements between the two regimes, there are a number of other factors to consider e.g.
Is the company considering a listing in the near future? What are competitors doing? How complex is the company?
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