Current Situation of Using IFRS for SMEs in the Czech Republic and Ukraine

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1 International Journal of Arts and Sciences 3(7): (2010) CD-ROM. ISSN: InternationalJournal.org Current Situation of Using IFRS for SMEs in the Czech Republic and Ukraine Müllerová Libuše, University of Economics, Prague, Czech Republic Paseková Marie, Tomas Bata University, Zlin, Czech Republic Čiževská Ludmila, Zhytomyr State Technological University, Ukraine Abstract: SMEs create one third of the gross domestic product in the European Union and two thirds of jobs. They are a backbone of the European economy. To enhance their competitiveness, excessive bureaucracy and barriers in business have to be removed. Cross-border activities of SMEs are limited by many obstacles. The biggest obstacle is existence of 27 different systems of accounting within the European Union, which have to be harmonised. The International Accounting Standards Board (IASB) issued the International Financial Reporting Standard (IFRS) on 9 July 2009, designed for Small and Medium Enterprises (SMEs). The Board hopes that application of the standard will improve comparability of financial reports and will improve confidence in financial reports of small and medium enterprises. Specific problem for the Czech Republic and Ukraine is that the national legislation does not allow it to specify the income tax base from the statements prepared according to IFRS standards and thus the companies have to prepare the statements according to national legislations in parallel, which represents a tremendous administrative burden. The aim of this paper is to compare the experience in standardizing financial reporting in SMEs in the Czech Republic and Ukraine. Keywords: International Financial Reporting Standards (IFRS), Small and Medium-sized Enterprises (SMEs), Czech Republic, Ukraine, Financial Statements Introduction In the global economic environment which is characterized by continuous structural changes and increasing competitive pressure, the Small and Medium-sized Enterprises (SMEs) sector plays a very important role. It is a driving force of the sphere of business, of growth, innovations as well as competitiveness. It plays a decisive role in job creation and, in general, is a factor of social stability and economic development. On the other hand, SMEs have often difficulties to obtain capital or credits which are caused by the continuing unwillingness of financial markets to take the risk and through insufficient guarantee which SMEs can offer to banks. Limited sources of financing can also make the approach to more information difficult, especially information on new technologies and potential markets. In the Czech Republic, the participation of SMEs in employment is around 61.52% and in book value added by %. SMEs represent % of the total number of active business entities.

2 In Ukraine small and medium businesses make up 91 % of the total number of enterprises. The employed at small and medium businesses make up 56.8 % at the number employed. Definition of Small and Medium-sized Enterprises (SMEs) To support and develop these businesses, the European Union has introduced a new definition of small and medium-sized enterprises valid from 1 January They are defined by three major criteria: the number of employees, annual turnover in millions EUR and total value of assets in millions EUR. Table 1. EU Definition of SMEs Size Number of Turnover in Balance Sum in Employees EUR EUR Medium enterprise max. 50. mil. Max. 43 mil. Small enterprise mil. 10 mil. 2 mil. 10 mil. Micro-enterprise (small entrepreneur) below 10 up to 2 mil. up to 2 mil. Source: Together with these indicators a small and medium-sized enterprise should also fulfill a criterion of independence, which means that no other subject should participate in its basic capital or voting rights by more than 25 %. Differences between a small and a big enterprise are as a rule defined not only by the above mentioned quantitative criteria, but also by qualitative criteria. The borderlines between small and large enterprises also depend on different conditions in individual regions and they also change with time. Basic differences between a small and medium enterprise and their interactions can be traced in several spheres. The differences are in: organizational and legal forms and in-house structures, relation between owners (entrepreneurs) and companies management, possibilities of sales and application of marketing strategies of small and large companies, capital availability and approach to outer sources of financing. Strength of SMEs (small and smaller medium enterprises in particular) consists in their higher flexibility and to a certain point also in their innovative creativity. Next to a relatively unfavorable general business climate in the Czech Republic (tax burden level, complexity and non-transparency of legislation, problematic recovery of law etc.), whose negatives bear on SMEs with a higher intensity, a lot of specific factors influences them. The term small and medium-sized entities has different meanings in different territories. The definition in the context of the IFRS for SMEs is entities that do not have public accountability and publish general purpose financial statements for external users. Every entity has some form of accountability, if only to its owners and the local tax authorities.

3 Public accountability is defined to cover entities with or seeking to have securities traded in a public market or that hold assets in a fiduciary capacity as their main business activity. Note that size is not the determining factor as to which entitles can use the IFRS for SMEs the applicability is based entirely on whether the entity has public accountability or not. In the Business Code of Ukraine it is stated that small businesses are legal entities which the average number of employees during the reporting period does not exceed 50 people and the total turnover for this period does not exceed 70 millions hryvnas ( ). Under such criteria statistic observations are carried out. Along with it, the other standard of tax legislation is in force, stipulating that the simplified taxation system, accounting and reporting systems may be applied by legal entities with a staff not exceeding 50 people and annual revenue not more than 1 million hryvnas ( ). Thus, not every small business entity in Ukraine may switch to simplified taxation system. Harmonization of Financial Reporting of SMEs in the EU Companies operating in the EU member countries keep accounts and report according to the accounting system of the given country, i.e. according to national regulations which respect historical development, traditions, prevailing economic and legal environment. Companies quoted on European capital markets have been accounting and reporting compulsorily according to IRFS since 2005, when the European Union decided by its decree No. 1606/2002 to apply International Financial Reporting Standards in companies emitting securities registered on regulated capital markets. One of the pillars of the EU business environment is the single European market. The reasons of low integration of SMEs in business activities on the single market (cross-border activities), compared to big companies are mainly the following: (Nerudová & Bohušová, 2006): differences in legal regulations of individual member countries, non-existence of unified accounting standards for these enterprises (until July 2009) non-existence of unified taxation of these enterprises, limited offer of capital and financial sources, insufficient support of SMEs business activities on the single market, cultural and language differences, lack of information. It seemed that the single EU market needed unified legal standards and standardization in the sphere of financial reporting for SMEs. For this reason important initiatives started at the beginning of the new millennium with a purpose to provide SMEs with knowledge and tools necessary for crossing the local borders and entering other EU countries but also countries outside the EU and for easier export of products and services.

4 International Standard of Financial Reporting for SMEs The question if SMEs need consistent harmonization has already been discussed for more than ten years. Even in SMEs, there are foreign investors for whom the need of orientation in financial statements is vital. In addition, many of those enterprises are part of consolidating group where same rules, comparable accounting methods and standard procedures are applied. In 2003, the International Accounting Standards Board (IASB) started building of international accounting standards for SMEs. It came out from a presumption that these standards have to: represent a simple, high-quality, understandable and enforceable system of accounting standards suitable for SMEs worldwide, minimize difficulties in compiling financial statements according to these standards, build these standards on identical conceptual frame with IFRS, enable an easy transition to full IFRS for bigger enterprises or for the case when some enterprises decide to use them, come out from the needs of users of the financial statements. IASB had prepared a draft of the standard which was presented for external marking up in 2006, with anticipated issue in 2007 and entering into effect from 1 January The biggest opponent of the upcoming standard was the European Financial Reporting Advisory Group (EFRAG). It adopted a very critical approach to the IASB standard for SMEs. The EFRAG even considered the name of this standard as very unsuitable (Standard for Financial Reporting of SMEs) because it pointed out to the fact that this name could also be used by large, non-listed companies. Opponents to this standard claimed that it should leave references to full IFRS standards and should include more simplifications compared to IFRS. Based on public discussion, IASB had decided to provide a new definition of accounting units for which the international accounting standard should be issued. The accounting entities are defined as units which are not a subject of public interest or are non-publicly accountable entities. They are enterprises which do not trade their liabilities or equity capital tools on public market or which do not want to offer these tools on public market and do not hold considerable assets of a wide group of clients. A standard for such enterprises was issued on 9 July 2009 as IFRS for SMEs and it came into effect immediately. The standard has 230 pages (it is ten times less than the full IFRS) and it is adapted for the needs and abilities of smaller enterprises. Parts of the standard are the explanatory report and implementation manual which includes an example of financial reports of SMEs, presentations of financial statements and a list of requirements for disclosing. Many principles from full IFRS concerning recognition and appreciation of assets, liabilities, revenues and expenses were simplified; some items which did not relate to SMEs were left out and the number of requirements for disclosing was considerably simplified. This

5 standard will further be simplified and will be revised every three years. The standard is based on individual spheres which are further divided into sections. The IFRS for SMEs react to strong international demands of both developed and newly arising economies to introduce considerably simpler accounting standards for SMEs, compared to IFRS. IASB claims that this standard will: enable better comparability for financial statement users, improve overall trust in financial statements of SMEs, drop important expenses connected with maintaining standards on instate level, enable easy transition to full IFRS for growing enterprises which are preparing to join capital markets. Benefits of SMEs in the Czech Republic and Ukraine during the transition to IFRS Financial statements prepared in accordance with international standards provide a high level of transparency and comparability. Companies which comply can achieve many benefits. Use of international standards will reduce investor uncertainty and can thus reduce the cost of capital. It can significantly improve the communication between business users and all their statements. Higher quality outputs from the accounting system can strengthen the management to take timely and effective measures in management. The cost of the transition to reporting according to international standards can be maintained for businesses at an acceptable level through the simplification and userfriendliness IFRS for SMEs. Difficulties of SMEs in the Czech Republic and Ukraine during the Transition Process to IFRS A key problem of accounting based on IFRS is the tax basis which is obtained from the accounting profit in the Czech Republic. For this reason, the accounting entities which account and report according to IFRS by law, for the purposes of calculation of the profit tax payable, have to transform the business result to such a result which they would have if they accounted and reported according to the Czech regulations. If SMEs were forced to account and report according to IFRS, even if simplified, this would mean adopting new accounting legislation. Then the enterprises would have to train their accountants and prepare them for a new approach to accounting, or teach them new approaches to accounting thinking. All this would mean at least in the beginning a huge administrative as well as financial burden for these enterprises.

6 Next to this, the majority of SMEs are less interested in true and fair view provided by accounting. The enterprises want the financial accounting to provide them mainly with data necessary for specifying the profit tax basis; they use accounting information for the purpose of management very rarely. This fact is also documented by the following research. Upon initial recognition there are used historical costs according to Ukrainian national accounting legislature and companies shall measure all assets also at historical costs upon balance sheet date. The only exemption is measurement of finished goods and work in process that are not revaluated upon balance sheet date. However, it shall be stated that majority of balance sheet items are reported in one item and investors do not have the information about the value of each of the assets or liabilities. Results of Questionnaire Research 115 enterprises took part in our research from the Czech Republic and 50 enterprises from Ukraine. We involved businesses with less than 250 employees in the SMEs category. Structure of respondents by type of activity is summarized in Table 2. Tab. 2: Structure of respondents by type of activity Country Czech Republic Ukraine Production 26,1 % 38,0 % Type of Trade 25,2 % 30,0 % activity Services 48,7 % 32,0 % The principle question of the questionnaire is aimed at the problems of reporting, i.e. if the company also reports according to any other accounting system than national. Only three Czech companies and none Ukrainian company report also under non-national framework. Out of these, three Czech companies report according to IFRS, and one Czech company according to the French system. In connection with this, we wanted to know if the company is somehow connected to foreign entities. Figure 1 shows that nearly 47 % of companies have this type of connection, 17,4 % of companies have an important foreign supplier, 17,4 % of companies have an important foreign customer, 10,4 % of companies are linked to a foreign parent company.

7 Figure 1. Connection of Companies to Foreign Entities in the Czech Republic Figure 2. Connection of Companies to Foreign Entities in Ukraine

8 Figure 2 shows that 22 % of companies have this type of connection, 14 % of companies have an important foreign customer, 4 % of companies have an important foreign supplier, and 4 % of companies are linked to a foreign parent company. The following question concentrated on specific areas of reporting where the company makes modifications during the process of transition from the national accounting system to another accounting system. The Czech companies which reported also according to another system than Czech alter assessment of assets and leases, they alter provisions, exchange rates, corrections, depreciation, valuation of inventories, financial assets and accruals. None of Ukrainian companies reports in other than a national system. Further processing of the results of the questionnaire is aimed at companies reporting at present only according to national accounting standards. It is therefore by 112 companies from the Czech Republic and 50 companies from Ukraine. To find out if the companies are interested in reporting according to IFRS in the future, there were questions asking if they expect usage of IFRS in the future, if they expect some advantages from this use and if they are interested in trainings or courses on IFRS. Answers to these questions were evaluated both comprehensively and independently for companies with different types of business. Relative frequency of positive answers is provided in the chart in Figure 3 and 4. Figure3. Per Cent of Positive Answers Connected with the Future Use of IFRS in the Czech Republic

9 Figure 4. Per Cent of Positive Answers Connected with the Future Use of IFRS in Ukraine In both countries, the proportions of positive responses to the three questions provided by the companies with different types of activities are relatively the same. An interest in training issues of IFRS is evident. The frequency of positive answers is approximately two times higher for Ukrainian companies than for the Czech ones. As far as the difficulties of companies transition to reporting according to IFRS are concerned, the respondents were asked to specify the key areas of their accounting practice and the spheres of accounting which they consider as problematic. The questionnaire included the following list of financial reporting items: long-term assets, financial assets, liabilities, inventories, accruals, expenses, receivables, equity capital and revenues. Relative frequencies of accounting items chosen are provided in Fig. 5, 6, 7 and 8. Again, the answers were evaluated comprehensively and independently for companies with different types of activity. Rates of representation of items considered important are very similar in both countries. Generally, a lower proportion of Ukrainian companies rate individual spheres of accounting as important. The Ukrainian companies claim in accordance with Czech companies that items important for their accounting practice are liabilities, inventories, expenses, receivables and revenues.

10 Figure 5: Frequency of Accounting Items Considered as Important in Per Cent in the Czech Republic Figure 6. Frequency of Accounting Items Considered as Important in Per Cent in Ukraine

11 Receivables, inventories and expenses also appear among items considered as potentially problematic. The problematic items also include long-term and financial assets and accruals. It is interesting that revenues which are often mentioned as important are not considered problematic by companies. Unlike Czech companies, the Ukrainian companies claim that items important for their accounting practice are liabilities, inventories, expenses, receivables and revenues. Receivables, inventories and expenses also appear among items considered as potentially problematic. The problematic items also include long-term and financial assets and accruals. It is interesting that revenues which are often mentioned as important are not considered problematic by companies. Figure 7. Frequency of Accounting Items Considered as Problematic in Per Cent in the Czech Republic The Czech companies consider the inventory, financial assets and receivables items important, among the problematic items for Ukrainian companies emerge expenses, receivables, revenues, payables and inventories. Discussion According to the results of this research there could be stated that SMEs, which are not obliged to prepare financial statements according to IFRS, are not interested in IFRS. It is probably due to the fact that these companies concentrate mainly on the current state, the question of their future development (in unspecified future) is not so important for them.

12 Figure 8. Frequency of Accounting Items Considered as Problematic in Per Cent in Ukraine It is also due to disadvantageous proportion between the expenses invested and the revenues obtained. Czech companies reporting under IFRS framework find the biggest problems when reporting long-term assets, leases, provisions and exchange rate differences. The imperfection of available database on small and middle-size businesses does not allow accomplishing the complete analysis of development and significance of the small entrepreneurship in the forming of macroeconomic indices in Ukraine. It can be explained by the fact that there are no unified criteria for small business entity for the purpose of statistics and financial accounting. Conclusion Special standards would require SMEs to change their opinion on high-quality accounting in general, where instead of stressing correct accounting procedures and methods, the emphasis is placed on the presentation of results - financial statement. They would have the obligation to prepare Cash flow statement, Statement of changes in equity, to get used to somewhat various kinds of measurement bases and a broader range of supplementary and explanatory information in the Notes. A stress upon the final product of accounting,

13 statements, requires understanding of the consequences and relationships among transactions and their reflection in accounting, because no set rules will be available any more. All this requests for increased demands upon qualification of professional accountants and upon change in their accounting thinking. If at present, some small companies prepare financial statements according to any other accounting rules than national (Czech or Ukrainian), then it is because the foreign owners require understandable and comparable data, often also for the need of consolidation. In this case they adapt accounting information from financial statements made according to national regulations on the basis of precisely specified and prescribed concern rules. Taking into consideration the changes in IFRS and lack of the unanimous opinion of EU member countries concerning the prespectives of applying IFRS for SMEs we believe it is necessary to form the national conception of simplifying the accounting system and financial reporting. Acknowledgements Authors would like to thank to the Czech Science Foundation (GA CR) No. 402/09/0225 IAS/IFRS Usage in Small and Medium-sized Enterprises and its Influence on Performance Measurement for financial support to carry out this research. References IFRS for SMEs. [on-line ] c2009, [cit ] available on-line at < Nerudová, D. & Bohušová, H. (2006) Překážky v podnikání SME na jednotném evropském trhu. In Evropské finanční systémy Proceedings of papers from international science conference. Masaryk university, Brno. p The new SME definition. (2006) User guide and model declaration. European Commission.