According to European Union (EU) regulations in effect since 2005, listed companies – international corporations or midsize firms – are already obliged to produce their annual reports according to IFRS. In addition, IAS and IFRS apply all over the world to international, listed companies because the large stock exchanges mandate this form of accounting.
As long as they are not oriented toward capital markets, small and midsize companies have so far not been required to follow these guidelines. “But in the future, even midsize companies that are not oriented to the capital markets will be unable to avoid creating their balance sheets according to IFRS,” says Thomas Dräger, who is responsible for the midsize area within the International Reporting Group at the auditing firm of PricewaterhouseCoopers (PwC). First, various countries already require accounting according to IFRS. Second, the goal of the EU is to create uniform rules and comparable regulations for annual reports of midsize companies throughout its economic area.
Changeover to IFRS Improves Competitiveness
According to Dräger, midsize companies can actually profit from a changeover. In particular, adherence to IRFS will simplify communication between lenders and investors, increasing opportunities to attract international capital. Comparisons with competitors (often listed) will be simpler. And IFRS lead to improved company management, less expensive financing (Basel II), an increased ability to integrate and cooperate, and efficient internal communications.
Nevertheless, many midsize companies ask what direct benefits IFRS have for them. One of the many advantages stems from globalization. Norbert Winkeljohann, director of the business area for midsize companies at PwC, explains. “When a German automobile supplier has to present its American customer with an annual report, for example, the supplier has a bad hand of cards if the report has been produced according to German commercial law” (HGB in its German abbreviation). And international midsize companies also find it difficult to get an HGB-compliant annual report from a subsidiary in the United States. At the international level, mergers and acquisitions are usually based on IFRS. And an early changeover enables firms to drive their internationalization strategies more quickly and gain the required external capital more easily.
Midsize Companies Hesitate to Convert
But how can a midsize company evaluate the costs and benefits of a changeover to the new rules, which is still voluntary? “There’s no clear-cut answer,” says Dräger. Various studies confirm his opinion. According to a study by PwC and the German Chambers of Industry and Commerce (DIHK in its German abbreviation), companies with annual revenues of more than 60 million show significantly more interest in working according to IFRS in the future than smaller firms do. The same findings apply to international midsize companies with subsidiaries in various countries.
Mazars, a French consulting firm, worked out the country-specific differences in a Europe-wide study. The survey included listed and non-listed midsize companies in seven countries: Germany, Belgium, Luxembourg, Spain, France, Italy, and the United Kingdom. On average, most of the surveyed companies, including the non-listed firms, want to convert to IFRS in the near future. For example, approximately 80 percent of companies surveyed in the Benelux countries and 60 percent of companies in Italy are quickly laying the groundwork for a changeover to IFRS. And 57 percent of midsize companies in France are open to adopting IFRS. But 90 percent of the surveyed companies in Germany want to wait until the changeover is unavoidable from a legal standpoint. The DIHK/PwC study produced similar results, reporting that 79 percent of German companies see no need to convert from HGB to international regulations. The Mazars study shows similar reservations toward the new regulations among midsize companies in the United Kingdom, where 73 percent of companies want to hold off.
Despite this country-specific divergence, the Mazars and DIHK/PwC studies clearly show that midsize companies across Europe regard the changeover to IFRS as a lengthy and rather cost-intensive process. A study of the Institute for Accounting and Controlling at the University of Zurich (IRC in its German abbreviation) of more than 300 midsize Swiss companies calculates the cost of a changeover from Euro 64,500 to Euro 322,000, depending on the firm’s size and complexity. The IRC identified the costs involved as the reworking of the accounting manual, personnel costs for training, and internal restructuring. “And there are additional expenses for external consulting and for converting the company’s IT systems, especially for financial accounting,” says Dräger.
Complex and Comprehensive Rules
An additional consideration is that “the current edition of IFRS is a comprehensive and complex set of rules specifically created for accounting in large, listed companies,” says Dräger. The current rules encompass approximately 2,400 pages. For smaller midsize companies that are not oriented toward international markets, a changeover is therefore not only cost-intensive but complex and difficult to achieve. “These kinds of complex accounting procedures can hardly be expected of non-listed midsize companies,” he explains. “The information in their annual reports is intended for a limited audience – the owners of the company, creditor banks, or customers.”
The International Accounting Standards Board (IASB) is responsible for the IFRS. The board has responded to criticism from associations of midsize companies by announcing plans to issue a condensed version of the complete regulations, “IFRS for Small and Medium-Sized Entities (IFRS for SMEs).” A first draft should appear by the end of June 2006. The IASB wants to publish the complete “IFRS for SME” in June 2007. David Tweedie, chair of the IASB, addressed the problem in a statement before the European Parliament, published in early 2006. According to his presentation, IFRS reflect the complexity of the modern (read “global”) economy. Nevertheless, the IASB has noted that the overwhelming majority of firms in Europe and elsewhere are small and midsize companies. According to Tweedie, these companies find it difficult to adhere to a set of regulations created for companies that operate in international capital markets. That’s why the IASB is now working on simplified standards for midsize companies and anticipates that most countries will accept them.
Integrated Software Saves Costs
But changeover to accounting according to IFRS demands more than changes to the balance sheet and evaluation in external reporting: above all, it requires adjustments to the IT systems in use. Such adjustments include processes to capture the required data according to IFRS, harmonization of internal and external reporting if needed, and the ability of IT to support the harmonization. “Midsize companies that operate internationally and are considering producing their balance sheets according to IFRS must also focus intensely on the problem of data capture during the changeover because they will usually have several subsidiaries in-country and abroad,” Dräger explained. Insofar as individual subsidiaries do not operate with uniform accounting in their IT systems, the software must be adjusted to meet any additional requirements. As a rule, the changes cost not only time but money.
In a study of midsize companies undertaken in 2004–05, the consulting firm FAS concluded that an integrated accounting system is the best option because many midsize companies operate internationally. Companies that already have appropriate software from an international supplier such as SAP have advantages here because of the following:
- Internal and external reports are harmonized by an integrated foundation of structure and data.
- The low number of settlement processes leads to near-time information for decision makers in management.
- Resource-intensive processes must be abbreviated with a fast close and thus save costs.
An SAP solution also offers all the required functions for parallel accounting (in accordance with HGB/IFRS and IFRS), but adjustments are still required in almost all applications and components: financial accounting (presentation of reserves), asset accounting (parallel valuation according to HGB and IFRS), controlling (segment information for the annexes), and materials management (valuation of long-term production orders and inventory valuation). In addition, in terms of typical scenarios for midsize companies, SAP Best Practices for IAS and IFRS suggests business processes and the related technical settings of the SAP software involved. The best-practices offering implements a typical selection from IAS/IFRS, such as valuation of assets and stocks (goods), receivables and liabilities, liquid funds, cash flow accounting (incoming and outgoing invoices), and determination of profit.
“The ball is now in play for midsize companies to decide on producing their balance sheets according to IFRS,” emphasizes Dräger. “If and when a company picks up the ball to use IFRS advantageously depends on the individual situation.”