Lenders express confidence in FRF for SMEs

By Ken Tysiac

For small and medium-size businesses with low credit risk, an AICPA reporting framework would be nearly as effective as GAAP in producing financial statements that would give lenders confidence to provide a loan, according to a study.

The AICPA debuted its Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) in 2013. The framework is designed to provide owner-managed, privately held businesses that are not required to use GAAP with an alternative that would produce relevant, simplified financial statements that are cost-effective.

In an experimental study with 157 lenders published in the July issue of the Journal of Accounting and Public Policy, researchers concluded that the FRF for SMEs is a viable alternative to GAAP when credit risk is low. In situations with low credit risk, lenders also significantly preferred the FRF for SMEs to the tax basis of accounting.

The study was published by researchers F. Todd DeZoort of the University of Alabama, Anne Wilkins of the University of Tennessee at Chattanooga, and Scot E. Justice of Appalachian State University. In the study, lenders rated on a scale of 0 (low) to 100 (high) the likelihood that they would approve a loan in various circumstances.

When credit risk was low, they rated loan approval likelihood at 75.29 for GAAP-based financial statements, 71.86 for financial statements based on the FRF for SMEs, and 50.86 for tax-based financial statements.

The lenders also rated the interest rates they would award in low-credit-risk situations as nearly identical for GAAP-based (50.07 on the 0 to 100 scale) and FRF for SME-based (50.59) financial statements. They said tax-based financial statements (64.40) would result in interest rates that would be significantly higher.

“There was no significant difference in the loan approval rate or the interest rate between these two frameworks [GAAP and the FRF for SMEs],” Wilkins, the Tennessee-Chattanooga researcher, said during a phone interview.

A low-credit-risk situation in the experiment was defined as a company with a stable product line that has experienced consistent sales in the last three years, with all vendors having been paid within terms. A high-credit-risk situation was defined as a company that has experienced declining sales in the last three years and a small but growing number of late payments to vendors.

“If you’re high-risk, lenders are not really looking to make you a loan anyway [based on those parameters],” Wilkins said.

In situations with high credit risk, financial statements prepared according to GAAP (67.67) were seen as highly preferable to those prepared according to the FRF for SMEs (56.46) or the tax basis (56.20). There were no significant differences in interest rates among frameworks in the high-risk scenarios.

Lenders are not as familiar with the FRF for SMEs as they are with GAAP and the tax basis. On a scale of 0 to 100, they rated their knowledge of GAAP as 84.58, tax basis as 47.88, and FRF for SMEs as 26.11.

“I anticipate that as lenders become more familiar with the framework that it will be an even stronger alternative,” Wilkins said.

Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.


Get your clients ready for tax season

These year-end tax planning strategies address recent tax law changes enacted to help taxpayers deal with the pandemic, such as tax credits for sick leave and family leave and new rules for retirement plan distributions, as well as techniques for putting your clients in the best possible tax position.


Keeping you informed and prepared amid the coronavirus crisis

We’re gathering the latest news stories along with relevant columns, tips, podcasts, and videos on this page, along with curated items from our archives to help with uncertainty and disruption.