Everyone has to report. But there are different ways to write your annual report. The most common sets of rules for annual accounts are called K2 and K3. But what is the difference between them? And is there anything to be gained by using one over the other? Let's clear up a few questions.
What are K2 and K3?
In 2004, the Accounting Board started working on something called the K-project, which involved developing a comprehensive set of rules for different categories of companies and business forms.
K is simply an abbreviation of category, and by the end of the project, four different K frameworks (K1, K2, K3 and K4) had been developed, containing all the rules relevant to each category. It can therefore be said that the K frameworks present different types of accounting rules.
K1 deals with companies that prepare simplified annual accounts and K4 deals with consolidated accounts according to IFRS (International Financial Reporting Standards). K2 and K3, on the other hand, are the most common and popular frameworks, so we focus only on these hereafter.
So, K2 and K3 are two different sets of rules for annual accounts and financial statements. They deal with the valuation of income, expenses, assets and liabilities in slightly different ways and differ mainly in the way the accounts are closed and the size of the company. In short, K2 is a simplified version of K3, but let's look at the differences.
What are the differences between K2 and K3?
The main difference between K2 and K3 is that K2 is a rules-based framework while K3 is a principles-based framework. In English, this means that K2 is a simplified framework with standardised rules and lump sums to work from, while K3 is a more exhaustive framework with fewer standardised rules.
This in turn means that K2 is much easier to apply, as you are basically working from a given template. At the same time, K2 makes you more constrained, as the standardised nature of the framework makes it more difficult to adapt your accounting to your business or your needs.
By the same logic, this means that K3 opens up greater possibilities to adapt accounting to one's own activities. At the same time, the lack of standardised rules in the K3 framework means that the annual accounts are more comprehensive and therefore more complicated to prepare.
Another important difference between K2 and K3 is the possibility to "capitalise expenditure", i.e. to record an expense as a fixed asset in the balance sheet instead of recording it as a direct expense. In K2, capitalisation is generally prohibited, whereas K3 offers much greater scope for this. This means that under K3 you can depreciate fixed assets over the years in which you expect to use them, which can have a significant impact on your business results.
Who can use K2 and K3?
Listed companies must use K3 and the general advice is that all non-listed companies should also use K3. However, this is not a requirement, smaller companies may use K2 if they wish. However, in order to be classified as a smaller company, there are a number of criteria to be met. These can be found in the definition of a larger company:
- The company is listed, or:
- The company has had an average of more than 50 employees in the last two financial years.
- The company has had a balance sheet total of more than SEK 40 million in the last two financial years.
- The company has had a net turnover of more than SEK 80 million in the last two financial years.
If the company is listed or if it meets at least the same two criteria described above, it is considered to be a larger company and must apply K3. This means that companies that do not meet the criteria are considered to be smaller companies, and may therefore choose to apply either K2 or K3.
Advantages and disadvantages of using K2
Below we list some advantages and disadvantages of applying K2:
- Requires less administration
- Easier to apply
- Contains flat rates and simplification rules
- Fewer options and choices.
- External stakeholders may need more detailed information than K2 can provide.
- May lead to misleading or varying results, as it is not allowed to activate expenditure.
Advantages and disadvantages of K3
Below we list some advantages and disadvantages of applying K3:
- More options and therefore easier to adapt the accounting to the business.
- The reporting will be more detailed and provide external stakeholders with a better basis for understanding your business.
- You don't have to change the regulatory framework if or when your company becomes a larger company.
- Takes longer to set up and requires more administration.
- Requires higher skills.
Can I switch freely between K2 and K3?
You are always allowed to switch from K2 to K3, but you can only switch from K3 to K2 once. Should you wish to make the switch from K3 to K2 a second time, special reasons are required. One such reason could be that you have sold off a large part of your business.
It is also worth noting that it is not allowed to apply parts of K2 and K3 at the same time, but the two sets of rules must be followed in their entirety.
Which framework should you choose?
If you run a larger business, you don't have many options; K3 is the way to go. However, if you run a business classified as smaller, you have the option of choosing between K2 and K3.
Most smaller companies that use K2 do so for the simple reason that it is easier to apply. It requires less administration and therefore creates more time to focus on their own business. At the same time, there may still be reasons for smaller enterprises to choose K3, even though it places higher demands on skills. For example, if you are an entrepreneur with plans for growth, it may be a good idea to apply K3 from the outset. Not only because the step of changing the regulatory framework once the company is classified as larger will not be as great, but above all because the accounting will be more detailed, which may be important for lenders or investors to make decisions that benefit the business.
Another reason for choosing K3 is that, as mentioned above, the regulatory framework leaves more room for interpretation and better possibilities to adapt the accounting to the needs of the business. This may be particularly important if, for example, the company carries out major repairs, maintenance on buildings or builds up its own intangible assets. In C2, these types of costs have to be recorded as direct costs, which can have a significant negative impact on the result. In C3, these costs can instead be written off, giving rise to a more accurate result.
The best advice is to choose the framework that gives the most accurate picture of your business and best suits your needs.
Difficult to decide?
Need someone to talk to? If there's anything we at Saldo love more than accounting and business development, it's seeing our clients achieve their goals. As a knowledgeable partner, we're happy to contribute advice and new ideas so you can make the decisions that are best for you and your business. Get in touch and we'll take it from there.