Why IFRS for SMEs is failing early stage technology startups

I’ve recently written to the IASB (International Accounting Standard Board), the independent accounting standard-setting body of the IFRS (International Financial Reporting Standards) framework regarding the recognition of intangible assets under IFRS for SMEs and the implications this section has for technology startups.  

Under IFRS for SMEs, Section 18 disallows the recognition of internally generated assets, and therefore all research and development costs are to be expensed. Full IFRS however, allows for a distinction between costs incurred in the research phase versus costs incurred in the development phase of internally generated assets. Development expenditure that meets the specified criteria can be recognised as the cost of an intangible asset. 

For technology startups, arguably their most valuable asset is their internally generated intellectual property (the digital product or platform the company is building, which could be anything from software, cash-generative websites, algorithms, etc.). Under IFRS for SMEs, a technology startup won’t be able to recognise any development expenditure related to building this intellectual property. 

My argument is that it’s critical for technology startups to be able to recognise internally generated intangibles, in order to present to users of financial statements, specifically investors and financial institutions (where debt financing is used), a financial picture that is complete (includes all intangible assets, the most valuable assets in the company, recognised at cost), relevant (recognising intangibles will make a difference to the decisions of the users of the financial statements, particularly banks and venture capital investors) and faithfully represents (recognising intangibles captures the economic substance of a tech startup, which is to create a digital product of value to the market) the financial position and performance of the company.   

The simple solution is for the tech company to transition from IFRS for SMEs to full IFRS, under which development expenditure that meets a specified criteria can be capitalised, but it’s also an expensive solution. Full IFRS demands lists of onerous disclosure requirements, making the bookkeeping and financial reporting process more complex. A tech startup that should be allocating resources to building and shipping product, would have to spend a lot more on their finance and accounting function in order to produce financial statements in line with full IFRS. This was ultimately the only viable option for us at EduOne, where I had to shift my focus away from product and business development for months to take lead on this transition from IFRS for SMEs to full IFRS.  

IFRS for SMEs plays an important role for small businesses across the world, providing a simple yet effective framework to account for all transactions. Importantly, the framework needs to be revised for the millions of digital upstarts and nimble technology companies that rely on IFRS for SMEs to provide an accurate and complete financial picture of their business.