Issue 5, 2016. October-November



Andrew Coxshall, KPMG

From June 2016 onward, a new law closely approximating EU legislation requirements is highly regulating the accounting and auditing profession in Georgia. Considering that before the new Law on Accounting, Reporting and Auditing came into effect, Georgia had one of the least regulated accounting/auditing professions in the world, this is a huge change. These changes are partly a result of Georgia signing the Association Agreement with the EU and partly a result of the World Bank project to improve the financial reporting, accounting and auditing environment in Georgia.

"All very interesting," I hear you say, "But why is this of interest to me as a business owner/CEO?" Well, one other aspect of the new law is that it introduces sweeping changes for the preparation, auditing and filing of the financial statements of all companies in Georgia.

Key Changes:

For the year ending 31 December 2017, all Medium and Large Entities (see the table below for their definitions), along with what are known as Public Interest Entities (PIEs) will need to prepare their financial statements in accordance with International Financial Reporting Standards (IFRS) or IFRS for SMEs.

These financial statements must be audited (in accordance with International Auditing Standards).

In addition, these financial statements will need to be filed and published on a website.

The last point will be of concern to many businesses, as this website will be open to the public, and hence, anyone will be able to access the information, see what profit a company made and also see the financial position of that business.

For Small and Very Small Entities, there are less onerous requirements that come into effect for the year ending 31 December 2018. The table below summarizes the new requirements, and the notes following explain some of the specific nuances.

The Challenge for Businesses

For many medium-sized businesses the big challenge will be to prepare their financial statements in accordance with IFRS or IFRS for SMEs. The full text of the current version of IFRS runs to several thousand pages and can be very complex and difficult to implement for the first time. The average set of IFRS financial statements for a normal company in Georgia runs to about 40 pages (most of which are taken up with detailed note disclosures). IFRS for SMEs is essentially a slimmed-down version of IFRS. However, their use in Georgia is almost non-existent, as most businesses that currently have an audit do so because they are obliged to (e.g. banks and insurance companies) or because lenders or investors demand audited financial statements, and the former mandate IFRS, and the latter want to see the full version of IFRS being used.

Time to Get Ready?

31 December 2017 may seem like a long way off, but to transition properly to IFRS, businesses will need to start the process now. A "full set" of IFRS financial statements are required to be prepared and audited for the year ending 31 December 2017.

A full set means the current year and the comparative (prior) year. Thus the figures for the year endimg 31 December 2016 (which will be comparative figures for the year ending 31 December 2017) will also need to be prepared in accordance with IFRS.

For companies that have previously not prepared their financial statements under IFRS, this means that they will need to comply with IFRS 1: First time adoption of IFRS. This could entail getting property, plant and equipment (PPE) valued to determine what is known as the deemed cost. Also, for auditors to be able to give a "clean" opinion on the 2017 financial statements, they will probably have to carry out procedures on the 2016 figures (especially if a company has a lot of PPE and/or inventory). So this means that many companies will need to start the process of preparing IFRS financial statements and getting them audited in 2016.

Part of a Bigger Plan?

Although the process to approximate Georgia's auditing and accounting law with EU requirements started several years ago, the timing of this law now seems to be part of a bigger plan by the Government. The introduction of the Estonian Tax model (with effect from 1 January 2017) effectively does away with the annual corporate profit tax return and hence the need to keep "tax" books. Hence, the tax authorities will have less idea of the revenues and profits that companies are generating. However, if more businesses must have an audit this will give the tax authorities some comfort that the figures being reported in the monthly declarations are reasonable. Whether or not the tax authorities make use of these audit reports remains to be seen. In addition, under the new tax model, the moment of taxation is basically shifted from when profits are earned to when they are distributed (usually as dividends). Although the tax legislation is not clear, the implication is that the amount that could be distributed is based on the profit available for distribution in accordance with IFRS/IFRS for SMEs.

The Challenges for the Accounting and Auditing Profession

One of the issues that was raised by the accounting and auditing profession when the new law was being drafted was the lack of suitably qualified professional resources to either prepare or audit the financial statements as required under the new law. So simply finding enough competent people to prepare financial statements in accordance with IFRS/IFRS for SMEs could be a real challenge in the next few years.

Another major issue that caused concern during the drafting of the legislation amongst the biggest audit and accounting firms (known globally as "The Big Four") was the level of quality control the small audit and accounting firms exercised. The new law tackles this issue by setting up a proper registration, certification and quality-control process for all auditors. Although this part of the law will take several years to take full effect, the overall outcome is expected to be an increase in the general level of quality, since those firms that do not have the right systems and processes in place will not be permitted to carry out audits.

Short-Term Costs but Longer-Term Benefits

So, in the short term, companies will have to invest in getting their financial statements prepared and audited. Medium-term investments will be needed in systems, training and processes to ensure companies can prepare their financial statements in accordance with IFRS. However, larger companies should expect, or even demand, a decrease in the cost of borrowing, as lenders will have audited financial statements on which to rely when making their lending and pricing decisions. For other stakeholders, these changes should result in greater transparency, as more information, such as ownership (and ultimate beneficial ownership), profitability, tax paid, directors' remuneration, etc., becomes available to the public.

Overall, this is a lot of change to deal with in a short period of time, but change that should ultimately lead to improvements in audit quality, transparency, reliability of financial statements and lower borrowing costs.