What are K2 and K3?

In 2004, the Danish Accounting Board began work on something called the K project, which involved the development of comprehensive regulatory frameworks for different categories of companies and forms of business.

K is simply an abbreviation of category, and by the time the project was completed, four different K regulations had been developed (K1, K2, K3 and K4) containing all the rules relevant to the espective category. Thus, it can be said that the K-regulations present different types of accounting rules.

K1 deals with companies that prepare simplified annual financial statements and K4 deals with consolidated financial statements in accordance with IFRS (International Accounting Standards). K2 and K3, on the other hand, are the most common and popular regulations, which is why we will focus only on these from now on.

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So, K2 and K3 are two different regulations for annual reports and financial statements. They treat the valuation of revenues, expenses, assets and liabilities in slightly different ways and differ mainly in the way the accounts are to be closed and the size of the company. Briefly, it can be said that K2 is a simplified version of K3, but let's take a closer look at the differences.

What are the differences between K2 and K3?

The big difference between K2 and K3 is that K2 is a rule-based regulatory framework while K3 is a principle-based regulatory framework. In Swedish, this means that K2 is a simplified regulatory framework with standardized rules and flat rates to be based on, while K3 is a more comprehensive regulatory framework with fewer standardized rules.

This in turn means, above all, that K2 is much easier to apply, since you basically start from a given template. At the same time, you become more constrained with K2, as the standardized nature of the regulatory framework makes it difficult to adapt your accounting to your business or your needs.

By the same logic, this means that K3 opens up more opportunities to adapt accounting according to one's own operations. At the same time, the lack of standardised rules in the K3 acquis means that the annual accounts are more comprehensive and therefore more complicated to prepare.

Another important difference between K2 and K3 is the possibility of being able to “activate expenses”, that is, the ability to record an expense as a fixed asset on the balance sheet instead of posting it as a direct expense. In K2, activation is generally prohibited, while K3 offers significantly greater possibilities for this. This means that when applying K3, you can take the cost of fixed assets in the form of depreciation in the years you are expected to use the asset, which can have a significant impact on the performance of the business.

Who can use K2 and K3?

Listed companies must use K3 and the general advice is usually that even all non-listed companies I want to use K3. However, this is not a requirement, but smaller companies are allowed to use K2 if they so wish. However, in order to be classified as a small company, there are some criteria to be considered. These are found in the definition for a larger company:

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- the company is listed, or:

- The company has had an average number 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 net sales 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 a larger company and must apply K3. This means, by extension, that those companies that do not meet the criteria are considered as smaller companies, and thus may choose to apply either K2 or K3.

Pros and cons of using K2

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Below we list some advantages and disadvantages of applying K2, respectively:

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Advantages

- Requires less administration

- Easier to apply

- Contains flat rates and simplification rules

Disadvantages

- 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 expenses.

Pros and cons of K3

Below we list some advantages and disadvantages of applying K3, respectively:

Advantages

- More choices and thus easier to adapt accounting to the business.

- The accounting becomes more detailed and gives external stakeholders a better basis to understand your business.

- You do not need to change the regulatory framework if or when your company becomes a larger company.

Disadvantages

- Takes longer to set up and requires more administration.

- Requires higher skills.

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Is it possible to switch freely between K2 and K3?

It is always allowed to switch from K2 to K3. However, you can only switch from K3 to K2 once. Should you wish to make the switch from K3 to K2 more times, special reasons are required for the change. One such reason could be, for example, that you sold off a large part of the business.

It is also worth noting that it is not allowed to apply parts of K2 and K3 at the same time, but both regulations must be followed in full.

Which regulatory framework should you choose?

If you run a larger company, you don't have many options; then K3 applies. However, for those who run a company that is classified as smaller, you have the option to choose between K2 and K3.

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Most smaller companies that use K2 do so for the simple reason that it is easier to apply. It requires less administration and thus creates more time to focus on your own business. At the same time, there may still be reasons for smaller companies to choose K3, despite the fact that it places higher demands on the skills. If you as an entrepreneur, for example, have growth plans, it may be a good idea to apply K3 from the very beginning. Not only because the step of changing the regulatory framework once the company is classified as larger does not become as large, but above all because the accounting becomes more detailed, which can be important for lenders or investors to make decisions that benefit the business.

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Another reason for choosing K3 is that the regulatory framework, as I said, provides greater scope for interpretation and better opportunities to adapt the accounting according to the needs of the business. This may be particularly important if, for example, the company carries out major repairs, maintenance on properties or reworks its own intangible fixed assets. In K2, these types of costs must be recorded as direct costs, which can have large negative profit effects. In K3, instead, these costs can be written off, giving rise to a more equitable outcome.

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The best advice is to choose the regulatory framework that gives the fairest picture of your business and that best suits your needs.

Hard to make up your mind?

Do you need someone to play with? If there's something we at Saldo love more than accounting and business development, it's seeing our customers achieve their goals. As a knowledgeable partner, we are happy to provide you with advice and new ideas so that you can find the best solutions for you and your business. Get in touch and we'll take it from there.