by Glenn Cheney

London -- The International Accounting Standards Board has launched a project to write special global accounting standards for small and midsized entities. Meanwhile, the New York-based International Federation of Accountants has issued guidance to assist auditors in applying international audit standards to small companies.

The IASB SME project is on a fast track, with a working deadline of June 30, 2004 — though the board acknowledges that that date is “admittedly optimistic.” The goal of the project is to reduce the burden of disclosure for smaller companies, while preserving the recognition and measurement principles of international standards. The standards may go further, however, if the board sees cost-benefit justifications for a simplified standard.

Paul Pacter, IASB director for small and midsized entities, said that the IASB is concerned that if the board doesn’t provide these international financial reporting standards, individual national standard-setters will do it themselves, producing a hodgepodge. The European Union, which will have 25 members next year, is committed to adopting IFRS in 2005. The EU has an estimated 5 million companies with sales of under $20 million.

“It is not realistic to expect any country to require generally accepted accounting principles as complex as full IFRS to be followed by these small companies,” Pacter said. “The reality, therefore, is that either the IASB will develop a body of accounting standards appropriate for these SMEs, or allow each individual country to develop its own.”

One big decision that the board must make is how to define the companies that are covered by the separate rules. The board has already rejected the notion of a strictly quantitative “size test.” The determining criteria are more likely to relate to qualitative factors, such as public accountability and the needs of the users of a company’s financial reports. Another big decision is whether, or to what extent, to simplify recognition and measurement. IASB member James Leisenring doesn’t think that it would be a good idea to go beyond simplified disclosure to meddle with generally accepted definitions of assets and liabilities.

“The real purpose of this project is to go through all the disclosure parts of international standards and see if non-public companies need to make the same disclosures as public companies,” Leisenring said. “It’s not likely that we’ll see differential accounting for recognition and measurement, but there will be pressure for us to do that.”

The need for SME standards is seen as more necessary in countries that require all companies, public and private, to file financial statements that meet generally accepted accounting principles. Many countries already allow millions of companies to report only on a tax or cash basis.

The IASB project found tacit approval in a survey that the board distributed to the national standard-setters of 40 countries. The 28 respondents were virtually unanimous in their recommendation that the IASB issue a global set of standards for SMEs and that the standards should comprise a stand-alone document, not addendums to broader international standards.

All but one of the respondents felt that the SME standards should include disclosure and presentation simplification, and 24 favored simplification of some recognition and measurement principles.

Emerging economies

The IASB believes that the standards will be of special relevance and benefit to countries with emerging economies but, so far, the board has not considered the possibility of special standards for companies in those countries. Some countries have already warned that they have enough trouble rising to full participation in the international economy without being saddled with a different accounting system.

Meanwhile, IFAC’s International Auditing and Assurance Standards Board has recognized the special needs of audits of smaller companies. The board has not developed different standards for the audits of these companies, but it has issued special guidance on how such audits differ from those of larger entities.

IFAC International Auditing Practice Statement 1005, Special Considerations in the Audit of Small Entities, was written for practitioners who are already familiar with international audit standards. It amends an earlier document to apply to standards issued from March 1999 to March 2003.

In the future, the IAASB will include similar guidance within each new standard. IFAC senior technical manager Alta Prinsloo said that the guidance should be of some use even to American auditors who work with the standards of the Public Company Accounting Oversight Board rather than international standards.

“Although IAPS 1005 assists auditors in the application of international standards on auditing to the audits of small entities, the characteristics of small entities and the impact that they have on the audits of these entities should not differ significantly from country to country,” Prinsloo said. “As a result, American auditors may find the guidance useful.”

The IFAC document does not precisely define “small,” but entities covered under the document must have a concentration of ownership and management and at least one of the following qualities: few sources of income, unsophisticated record-keeping, and limited internal controls with the possibility of owner/manager overrides.

The guidance discusses a common problem in the audit of small companies — inadequate information or other lack of sufficient evidence for the formation of an opinion. The guidance recommends either declining an engagement at a company with insufficient information or producing a qualified opinion.

Despite an auditor’s close relationship with and knowledge of the client, adequate working papers are required. One of the longest sections relates to International Auditing Standard 240, on consideration of fraud and error.

The IASB and IAASB efforts come as the American Institute of CPAs is restructuring and reorienting its Auditing Standards Board to consider developing special standards for the audits of non-public companies. The new board will meet in December.

Prinsloo pointed out that the AICPA is apparently moving toward the setting of auditing standards for all U.S. companies not registered with the Securities and Exchange Commission. The IAASB guidance applies to some, but not all, of those companies — in fact, only to those defined as “small.”

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