Main Street businesses now have a new option for non-GAAP financial reporting. The AICPA Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) was created to answer demands of CPAs, small business owners and managers, and their bankers and other stakeholders.
The accounting framework is designed to offer:
- A unique alternative in non-GAAP reporting;
- Relevant, cost-effective, simplified financial statements; and
- Tailored, meaningful financial reporting for smaller businesses.
The FRF for SMEs framework is built for CPAs serving or employed at small and medium-size private companies. It is designed to allow CPAs to prepare streamlined and cost-effective financial statements that clearly and concisely report what a client owns, what it owes, and its cash flow. It provides CPAs with an opportunity to apply traditional and relevant accounting methods that reinforce a CPA’s value as a trusted business adviser. For those engaged as small business controllers, CFOs, and accounting managers, the framework is designed to offer reliable financial information to inform business decisions and outside stakeholders. Moreover, it was created to provide a way of working smarter and controlling costs in the accounting area.
If a client or employer does not need GAAP financial statements, the FRF for SMEs accounting framework may be a useful financial reporting option. This article takes a look at the framework’s key technical features.
The FRF for SMEs is a special-purpose framework. Commonly referred to as an other comprehensive basis of accounting, or OCBOA, special-purpose frameworks include cash basis, modified cash basis, income tax basis, regulatory basis, contractual basis, and other non-GAAP bases of accounting. Special-purpose frameworks use a definite set of logical, reasonable criteria applied to all material items appearing in the financial statements. The FRF for SMEs framework is designed for smaller to medium-size for-profit private businesses. It is suitable criteria for general-use financial statements.
ACCRUAL-BASED, TRADITIONAL, AND COMPREHENSIVE
The framework uses the accrual basis of accounting and comprises traditional and relevant accounting principles for SMEs. In addition, some income tax accounting methods are blended into the framework, which results in fewer book-to-tax adjustments. The framework provides guidance on accounting and financial reporting topics typically encountered by small and medium-size private entities, but it eschews prescriptive, detailed rules. Designed as an intuitive and understandable framework for small business owners and the users of their financial statements, the framework lays out principles that encourage the use of professional judgment in the particular circumstances of a transaction or event.
The framework requires that financial statements be prepared primarily using the historical cost basis of measurement whereby transactions and events are recognized in financial statements at the amount of cash or cash equivalents paid or received when the transaction took place.
Historical cost is a relevant and reliable measurement basis for the financial reporting needs of small and medium-size private entities and their financial statement users. Small business owner-managers, their lenders, and other financial statement users tend to focus on cash flow. Historical cost is well-suited as a metric for evaluating an entity’s cash flow and serves as a sound basis for financial forecasts. Moreover, historical cost measures are objective, verifiable, and straightforward. Historical cost directly relates to the past experience and past decisions of an entity, and therefore the staff and task force that developed the framework concluded that it is the best measurement basis to help evaluate the performance of a small business.
ALTERNATIVE ACCOUNTING POLICIES
The FRF for SMEs accounting framework offers a degree of optionality in the selection of accounting policies to enable a more relevant and tailored approach to financial reporting. To be sure, financial statements prepared based on the FRF for SMEs are intended to answer the common informational needs of small business owner-managers and external stakeholders and therefore are suitable for general use. Nevertheless, AICPA staff and the FRF for SMEs task force recognized that owner-managed businesses have different financial statement users who have varying informational needs. To answer those needs, staff and the task force built into the framework certain accounting policy alternatives in appropriate areas to enable financial reporting that is truly representative of the underlying economics of a small business and provide users with the most decision-useful information.
Alternatives in selecting accounting policies is nothing new, whether using GAAP or another special-purpose framework. Today, accounting professionals choose among alternative accounting policies that are the most appropriate for their circumstances and reporting needs. Whether choosing among alternative inventory cost-flow assumptions, selecting among different depreciation methods, or selecting accounting policies in other areas, accounting professionals serving or working at small and medium-size businesses are accustomed to having a degree of optionality in an accounting framework.
AICPA staff and the FRF for SMEs task force incorporated a degree of accounting policy optionality into the FRF for SMEs framework. This enables more tailored financial reporting and is appropriate in the small business community where financial statement users, such as bankers, commonly have direct access to management. That access often allows users to obtain additional financial information and analyses, and can allow them to better communicate their unique financial reporting needs to management. This optionality, in areas important to users, doesn’t take away from the quality of the framework, the staff and task force believe, but rather enhances the relevance of the framework to small business owners and their financial statement users.
PRIMARY ACCOUNTING POLICY OPTIONS AND OTHER RELEVANT ACCOUNTING POLICIES
Besides the usual accounting policy choices such as those related to depreciation methods and inventory cost-flow assumptions, the primary accounting policy options in the FRF for SMEs accounting framework are:
Income tax accounting. Management can select either the taxes-payable method or the deferred-income-taxes method. This option was built into the framework because some users are telling CPAs that they don’t consider deferred taxes useful information.
Subsidiary accounting. Management can choose to consolidate its subsidiaries or account for its subsidiaries using the equity method. Parent-only financial reporting is permitted. Additionally, the concept of needing to consider variable-interest entities for consolidation is not included in the FRF for SMEs. This option and policy was built in because many users have told SME owners that they want to see parent company statements only.
Long-term contracts and service contracts. In the case of long-term contracts, contract revenue can be determined using either the percentage-of-completion method or the completed-contract method in certain circumstances.
Startup costs. Management can elect to either expense startup costs as incurred or capitalize startup costs and amortize the amount over 15 years. This option was added to help reduce accounting differences between book and tax.
Defined benefit plans. Management can choose to account for defined benefit plans (except multiemployer plans, for which an entity should recognize pension cost as an expense for the period) using either the current-contribution-payable method or one of the accrued-benefit-obligation (ABO) methods. If using an ABO method, management can follow either the immediate-recognition approach or the deferral-and-amortization approach. This option was added because some financial statement users have told SME owners and managers that simplified accounting and targeted disclosures for defined benefit pensions would be useful.
In addition to some of the options described above, the FRF for SMEs also incorporates relevant accounting in the area of goodwill. Small business owners and some financial statement users told the AICPA staff and task force that testing goodwill for impairment is not useful or relevant to the financial statements. As a result, the framework simplifies the accounting by amortizing goodwill over a period of 15 years as compared with a fair value impairment approach.
The FRF for SMEs includes these and other accounting policies and options in an effort to provide management with a greater ability to clearly communicate financial information in a manner that reflects the unique aspects of the business and mainstream industry practices.
An overriding goal in developing the FRF for SMEs accounting framework was to deliver relevant, simplified, and cost-effective financial reporting to small businesses and those who rely upon their financial statements. Elemental to achieving that goal was requiring only targeted disclosures in the financial statements so stakeholders would receive the pertinent, understandable information they need without excess narrative or irrelevant “noise” in the financial reports. The disclosure requirements in the FRF for SMEs were designed to achieve that goal.
The external users of a small business’s financial statements often possess a familiarity and knowledge about the entity. As stated earlier, external users often have direct access to the management of the entity and interact with it during the course of the year. The value of financial statements to such users lies in their capacity to confirm and supplement a user’s knowledge and expectations about the business. As such, the AICPA staff and task force built into the framework an amount of baseline disclosure requirements designed to be appropriate and adequate to ensure that users of the financial statements receive the significant information they need. The staff and task force streamlined the disclosure requirements to avoid excess detail, complexity, and extraneous information.
The resulting accounting framework produces financial disclosures that the staff and task force believe are relevant, transparent, clear, and decision-useful. The framework is designed so that a financial statement user won’t have to sift through voluminous information in search of pertinent information. If a user requires additional information about the business, management can tailor the nature and extent of disclosures to suit those needs.
CHALLENGING AREAS FOR THE TASK FORCE AND STAFF
The task force and staff that developed the framework encountered a number of areas that presented challenges and required careful consideration to ensure that the principles and requirements were the most appropriate for small and medium-size entities. Some of those areas were accounting for business combinations, defined benefit plans, push-down accounting, joint venture accounting, and the impairment of long-lived assets.
As an example, the exposure draft of the FRF for SMEs included a requirement to assess long-lived assets for impairment when the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. In addition, the exposure draft included a requirement to reverse impairment losses for any subsequent increase in fair value. Based on the comment letters received and upon thoughtful reconsideration, the task force and staff decided to remove impairment-related requirements from the framework. It was decided that an impairment concept is more consistent with a fair-value-based framework than a historical, cost-based approach. In addition, impairment assessments would add unnecessary complexity to the framework without providing significant benefit to financial statement users.
MEETING THE NEEDS OF SMALL BUSINESS STAKEHOLDERS
The AICPA developed free educational resources that explain the features of the framework for businesses that do not need GAAP financial statements. For more information and a free toolkit that will help CPAs and firms educate staff, clients, bankers, and others on the framework, visit the AICPA webpage devoted to the framework at tinyurl.com/bql5o8e. Many state societies and CPA firms are engaging in efforts to drive awareness and acceptance along with the AICPA.
The AICPA staff is also developing a decision tool to help owners and managers of small and medium-size entities and practitioners who serve those clients. The tool is being developed in response to requests for guidance in adopting the FRF for SMEs framework. The tool will aid those considering adopting the framework by presenting relevant considerations that should be weighed in deciding upon an accounting framework. The National Association of State Boards of Accountancy—which expressed concerns to the AICPA about the adoption of the framework—agreed to provide input on the decision-making tool.
The key technical features built into the FRF for SMEs accounting framework form the cornerstone of this new non-GAAP reporting option for millions of owner-managed businesses. Upon that foundation are built the principles and criteria that make up the FRF for SMEs and are designed to help yield financial reporting that meets the needs of small business stakeholders in a changing and complex world.
Task Force Brought Knowledge, Experience
Eight local firm practitioners and one community banker composed the task force that developed the FRF for SMEs accounting framework.
The task force was chaired by David Morgan, a managing partner who served on the Blue-Ribbon Panel on Standard Setting for Private Companies and is a former AICPA board member. The other practitioners come from across the country and have years of experience serving Main Street businesses. They possess a wealth of knowledge about the financial reporting needs of small businesses and their financial statement users. Theresa Bible, the task force’s senior banking executive, brought years of credit management and decision-making expertise to the development process.
Moreover, the task force members have served in key roles within the profession, including chairing senior AICPA committees and holding leadership positions with state CPA societies. In addition to the task force, the FRF for SMEs project was staffed by three AICPA employees—two accounting and technical directors and one technical vice president, who has 25 years of experience serving SMEs.
AICPA FRF for SMEs Task Force (2012–13)
David Morgan, Chair
Kenneth R. Odom
Eric P. Wallace
Thomas A. Ratcliffe
The AICPA unveiled its Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) on June 10. The framework provides a new alternative in non-GAAP financial reporting and is designed to provide a mechanism to create financial statements that are simplified, relevant, and cost-effective.
As a special-purpose or other comprehensive basis of accounting (OCBOA) framework, the FRF for SMEs uses the accrual basis of accounting and is based on accounting principles that the AICPA staff and task force that developed the framework believe have proven effective over time. Some income tax methods are incorporated into the framework in an effort to minimize the amount of book-to-tax adjustments.
Financial statements prepared under the framework will primarily use the historical cost basis of measurement, which the staff and task force believe typically is the most relevant and reliable basis for small business owner-managers, their lenders, and other financial statement users.
Optionality is built into the FRF for SMEs to allow CPAs and business owners to choose accounting policies that will enable more relevant financial reporting that is tailored to their specific needs.
Robert Durak (firstname.lastname@example.org) is director–Private Company Financial Reporting for the AICPA.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, senior editor, at email@example.com or 919-402-2112.
“A Quest for Relevance: New Framework for SMEs Balances Costs and Benefits in Financial Reporting,” Dec. 2012, page 32
“Back to Basics: Proposed Framework for SMEs Geared for Reliability and Simplicity,” Nov. 2012, page 32
“FRF-SME: A Framework for Simplicity”
“Financial Reporting Framework for SMEs,” which includes free educational resources, information, and a free toolkit that will help CPAs and firms educate staff, clients, bankers, and others on the framework
AICPA, FAF-led Private Company Efforts Target Different Segments
by Ken Tysiac
Two processes designed to ease the burden of private company financial reporting are being developed separately and target different types of clients served by CPAs.
The Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs accounting framework), released in June, was designed by the AICPA for owner-managed businesses that do not need GAAP financial statements.
Meanwhile, the Private Company Council (PCC) began its work in December creating alternatives for private companies within U.S. GAAP that do prepare financial statements in accordance with GAAP. The PCC process was created by the Financial Accounting Foundation (FAF). (Exhibit 1 provides a brief comparison of the purposes of the PCC and the FRF for SMEs.)
During a webcast in June, FASB member Russell Golden, who became the board’s chairman July 1, described the differences between what he called the two “very important initiatives.”
“The AICPA is in the process of developing a framework … really primarily for smaller, owner-managed businesses on Main Street,” he said. “Whereas the FASB is focused with our new Private Company Council to identify areas in U.S. GAAP that can be improved.”
The FRF for SMEs framework is intended for companies that do not need to prepare GAAP financial statements and is complementary to the PCC process. The FRF for SMEs is meant to help smaller, owner-managed businesses prepare financial statements that clearly and concisely report what a business owns, what it owes, and its cash flow.
During a presentation in May at the 12th annual Baruch College financial reporting conference, AICPA Director of Accounting Standards Dan Noll, CPA, cited the example of a small company where a user doesn’t find tax-basis or cash-basis financial statements appropriate, but whose circumstances and related loan covenants do not require GAAP financial reporting. Financial statements prepared in accordance with the FRF for SMEs could be ideal for such a small entity, Noll said.
AICPA President and CEO Barry Melancon, CPA, CGMA, has emphasized during his public appearances that the FRF for SMEs is not a GAAP framework.
“This is not GAAP,” Melancon said during his annual presentation at the Institute’s spring governing Council meeting. “It is not intended to be GAAP. It is not intended to be pseudo-GAAP. It is, in fact, an other comprehensive basis of accounting. The reporting guidelines and materials … reflect that. It is transformative because it is another option in the marketplace for private company reporting.”
In a comment letter written during the framework’s exposure period, the firm CliftonLarsonAllen stated that there is a need for a special-purpose framework focused on the decision-making needs of SMEs and their financial statement users.
“Both [SMEs and users] are most concerned with operating performance, cash flow, and liquidity, but not the fair value of assets and liabilities that are not held for sale,” CliftonLarsonAllen wrote. “However, they often are concerned about the realizability of receivables and inventory, which is something the most common special-purpose frameworks do not address.”
This is the void the AICPA is seeking to fill with the FRF for SMEs. The framework’s goals are reliability, relevance, consistency, and simplicity. As a non-GAAP framework, it targets a different type of business from the PCC, which has proposed changes designed to make GAAP more appropriately reflect the private company environment. The modifications will be an optional financial reporting path for private companies.
PCC Proposes GAAP Changes
In June, FASB voted to issue three PCC initiatives for public comment. The PCC proposed alternatives to GAAP for private companies that would include:
- Relieving private companies from separately recognizing certain intangible assets acquired in a business combination.
- Allowing private companies to amortize goodwill and use a simplified goodwill impairment model.
- Allowing two simpler approaches to accounting for certain types of interest rate swaps when a private company intends to economically convert the interest rate on its debt.
The PCC advanced another GAAP alternative in July, proposing to exempt private companies from applying consolidation guidance for variable-interest entities under common control leasing arrangements. Any alternatives for private companies approved by the PCC must be endorsed by FASB before they are issued for public exposure and ultimately are written into GAAP.
Melancon said at the spring Council meeting that the exposure was “a very positive step forward.”
“The fact that they’ve [gotten to this point] is a very positive statement,” he said. “We’re very encouraged from that standpoint. We continue to support the PCC, and we hope they can be very successful attacking some of the issues that have been targeted.”
“We’re very pleased,” FAF President and CEO Terri Polley said during a recent phone interview. “We really think they’ve gotten off to a great start.”
—Ken Tysiac (firstname.lastname@example.org) is a JofA senior editor.