Debt Covenants Changing?

Will debt covenants of some U.S. companies change in the near future? I think so.

Two dynamics will drive these changes.

  1. The lease accounting standard
  2. Use of the AICPA Financial Reporting Framework for Small- to Medium-Sized Entities (FRF for SME) – a new “other comprehensive basis of accounting”

The lease standard has not, as of yet, been adopted by FASB, but it looks like it will be in the near future. If leases with a term of more than twelve months are recorded as lease liabilities (as presently proposed), then the debt to equity ratio of some companies will, in some cases, be non-compliant with existing covenants. This change in lease accounting will be an impetus to changing debt agreements.

The second cause of changing debt covenants is the AICPA’s issuance of FRF for SME, a new other comprehensive basis of accounting that can be used by small- to medium-sized private companies. If debt covenants presently require GAAP, then debt agreements will need to be amended in order for companies to use FRF for SME.

What do you think? Will these factors result in changes to debt covenants?

FRF for SME – The Lowdown

Well the public brouhaha between NASBA and the AICPA seems to have settled down since the AICPA issued the Financial Reporting Framework for Small- to Medium-Sized Entities (FRF for SME). I won’t say they’re holding hands now, but at least the discussion has simmered.

Here’s a Q&A to help you digest some of the salient points of FRF for SME.

What is FRF for SMEs?

It’s an other comprehensive basis of accounting (OCBOA) that can be used as an alternative to generally accepted accounting principles (GAAP) as issued by the Financial Accounting Standards Board.

When can FRF for SME be used?


Who created FRF for SME?


What is the size of FRF for SME?

A little over 200 pages.

What is the size of GAAP?

Thousands of pages. (I have heard more than 20,000 pages. Correct me if I’m wrong.)

How often will FRF for SME change?

About once every three to four years. (That’s one of the beauties of it.) Stability? Yes.

Why was FRF for SME created?

GAAP had become too complex for small- to medium-sized private businesses, driving up the costs of creating GAAP-compliant financial statements. Existing OCBOA (e.g., modified-cash basis) lacked standardization.

Does FRF for SME define a small- to medium-sized entity? Is there a dollar threshold?

No. It’s subjective. There is no dollar threshold.

Is “FRF for SME” GAAP?

No. (It is not little GAAP. It is not GAAP at all – not intended to be.)

Can entities with debt covenants requiring GAAP use FRF for SMEs?

No. But they can see if the lender will amend the agreement.

Can financial statements created using FRF for SME be audited, reviewed or compiled?

Yes. Yes. Yes.

What are some of the characteristics of companies that might use FRF for SME?

  • For-profit
  • Closely-held
  • Not a public company
  • No regulatory requirements for GAAP
  • Individuals with controlling ownership also manage the company

What entities should not use FRF for SME?

  • Nonprofits
  • Those with complex transactions
  • Governments

Is FRF for SME principles-based?

Yes. Use the flexibility and disclose the policies used.

Do the FRF for SME financial statements look like GAAP statements?

Yes. This is a downside (at least to me). I do think a user might mistakenly believe the financial statements are GAAP. You will need to clearly disclose that FRF for SME is being used. Also your opinion or SSARS report will refer to FRF for SME (rather than GAAP).

What are some key points of FRF for SME?

  • No comprehensive income
  • Investments will be at historical cost (market value used when held-for-sale)
  • Derivatives (think swaps) are not recognized on the balance sheet (only disclosed); no hedge accounting
  • Goodwill amortized over the same period as that used for tax purposes or 15 years
  • Intangibles (all) will be amortized over their economic life
  • Income taxes recognized using taxes payable method (what you owe at period-end) or the deferred income tax method (as GAAP requires)
  • No requirement to accrue uncertain tax positions (no FIN 46)
  • Leases will be recognized as operating or capital leases (FASB’s presently proposed lease standard will require all leases of more than 12 months to be recognized as a liability; expect to see the FASB lease standard approved in early 2014)
  • Policy choice to consolidate subsidiaries or account for them using the equity method (parent-only presentation allowed; use equity method accounting for subsidiaries)
  • Variable interest entities will not be consolidated (disclosure of the relationship); can I get an Amen?
  • No assessment of long-lived assets for impairment
  • Going concern assessment required by management (this assessment is not required by GAAP – yet)
  • Revenue recognition is principles-based (disclose how you recognize revenue); percentage-of-completion is allowable for contractors
  • Stock-based compensation not booked as a liability (disclosure only)
  • Defined benefit plan liabilities can be recognized using contribution payable method (record current pension plan payments not made; no projected benefit obligation liability required)
  • Disclosure requirements are greatly simplified

Can’t I just continue issuing tax-basis financial statements?

Yes. But tax-basis statements do not incorporate some of the more traditional accounting concepts that FRF for SME does.

How will the use of FRF for SME change the peer review process?

No change; FRF for SME is just another OCBOA – like tax-basis or modified-cash basis.

Does the AICPA offer any implementation tools?

Yes. Click here for toolkits.

How About You? 

Will you and your firm use FRF for SME? Do you like it (or dislike it)?

FRF for SMEs – The New AICPA Accounting Framework

The AICPA just released the much anticipated Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). Its size is less than 200 pages (compared to several thousand pages for U.S. GAAP).


Courtesy of

A Short History

I still recall sitting in a University of Georgia graduate class in 1983 (back in the days of David Bowie, Prince, and Phil Collins) as we discussed the big-GAAP-little-GAAP issue. Even then there was a cry that GAAP had become too burdensome. It took thirty years, but we finally have relief – even though FRF for SMEs is not considered GAAP.

About five years ago the International Accounting Standards Board issued IFRS for SMEs, and I really liked it (and still do). It, like FRF-SMEs, is small in size (about 230 pages), but it never took root here in America. I’m not sure why. Canada also issued its own set of small business accounting standards.

About three years ago, the Blue Ribbon Panel – made up of representatives of the AICPA, the Financial Accounting Foundation (FAF), and the National Association of State Boards of Accountancy (NASBA) – recommended the establishment of “a separate private company standards board” under the FAF’s oversight.

The FAF (the parent of FASB) declined to follow the recommendation, and, in its place, created the Private Company Council (PCC) to work with the Financial Accounting Standards Board to create exceptions to U.S. GAAP for small businesses.

The AICPA, soon after the FAF’s PCC announcement, decided it would create the FRF for SMEs.

You might say the FAF and the AICPA diverged, but they have politely (and publicly) referred to the two approaches as complementary.

Interestingly, the day the AICPA issued FRF for SMEs, FASB voted to issue three PCC initiatives for public exposure.

Applauding the AICPA

I applaud the AICPA for creating and issuing FRF for SMEs. I believe it will provide CPAs (and their clients) with a long sought-after solution to the standards overload issue. Small for-profit businesses have enough problems without being burdened with overly complex accounting standards and the cost of creating compliant financial statements.

Will We (American CPAs) Use FRF for SMEs?

I’m now waiting to see the CPA community’s response to FRF for SMEs. Will we move forward with these standards, or will we ignore them, as was done with IFRS for SMEs?

Personally I believe CPAs around the U.S. will embrace FRF for SMEs. In scanning these new standards, I see the following interesting aspects (to name a few):

  • No other comprehensive income presentation
  • Lease accounting remaining much like our present GAAP rules
  • Consolidations not required
  • VIE standards not in play
  • Goodwill can be amortized
  • Simplified disclosures
  • More historical accounting; less fair value accounting

When GAAP is Required

Keep in mind that if your small business client needs GAAP-based financial statements (e.g., debt covenant requirement), they will still need to follow FASB guidance, but if there is no need for GAAP-based financial statements, the client will have the option to use the FRF for SMEs. (You may want to check with your clients to see if they have any debt agreements requiring GAAP financial statements.)

OCBOA – Still an Option

Of course clients still have the option to issue cash-basis, modified-cash or tax-basis statements.

How About You?

Will you and your clients use FRF for SMEs?

Use of Financial Reporting Framework for Small- and Medium-Sized Entities

The draft of the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF-SME) has been issued, and the AICPA has published a frequently asked questions (FAQ) document to support its issuance.

The following comments are made in light of the draft framework.

Who should use the FRF-SME?

The framework is designed to be used by owner-managed for-profit companies. The FAQ states that the term owner-managed is used to describe businesses where the majority-owners run the business.

The other term to note is for-profit; the standards are being created for small businesses. Nonprofit entities do not appear to be excluded, but the framework is not designed for nonprofits.

Are there any entities prohibited from using the framework?


How does the FRF-SME compare with IFRS for SMEs (international standards)?

The FRF-SME is being created to more closely align with the U.S. tax code. LIFO will be permitted.

How will FRF-SME be simpler than U.S. GAAP?

The following are examples of the simplification:

  • FRF-SME will use historical costs
  • FRF-SME will not require consolidation of variable interest entities
  • FRF-SME will use reasonable lease accounting (and not the proposed FASB lease requirements)
  • Goodwill will be amortized (normally using tax guidance or a period of ten years)
  • No complicated accounting for hedges, derivatives or stock compensation
  • Disclosure requirements will be reduced (as compared to GAAP)

Can companies create financial statements using FRF-SME knowing the statements will be compiled, reviewed or audited by a CPA firm?


How often will FRF-SME change?

The framework will change infrequently, thus companies will have more stable standards to follow (and the cost of developing financial statements should decrease relative to GAAP statements).

Who will accept FRF-SME statements?

Companies will need to check with external users (e.g., banks, bonding companies) to see if they will accept FRF-SME financial statements.

I believe in many cases banks will accept the FRF-SME statements (especially if collateral is sufficient).


AICPA Proposes Financial Reporting Framework for SME

The AICPA has issued the draft of the Financial Reporting Framework for SME (small and medium entities) which represents the Institute’s promise of a private-company alternative to GAAP.

Click here for prior post explaining how we got to this point.

Click here for a Journal of Accountancy article announcing the issuance of the draft.

Click here for the draft of the FRF-SME.

Click here for AICPA web page dedicated to FRF-SME.

I will be reading and providing you with a summary of FRF-SME.


AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities

The First Volley – The FAF

As I previously posted, the Financial Accounting Foundation (FAF) – the parent body of the Financial Accounting Standards Board (FASB) – did not create a separate board with authority to issue small-GAAP standards. Instead, the FAF has created the Private Company Council which will propose exceptions to FASB standards; these exceptions will be the basis for private-company standards relief – FASB’s version of small GAAP.

The Second Volley – The AICPA

At the time the FAF made its announcement about the Private Company Council, the AICPA returned the volley stating it would create a private-company special purpose framework.

The new special purpose framework is formally titled: Financial Reporting Framework for Small- and Medium-Sized Entities (FRF-SME). 


The AICPA issued a frequently asked questions (FAQ) document to clarify the purpose of the special purpose framework (the new term for OCBOA). 

The FAQ states that the AICPA does not define small- and medium-sized entities (SMEs), but the document states “estimates put the number of SMEs in the United States at approximately 20 million.”


The FRF-SME will allow the development of financial statements in a more efficient manner.

Don’t We Already Have This?

Many argue that CPAs already have available special purpose frameworks (OCBOA) options in the form of tax-basis and modified-cash bases of accounting, but as the FAQ states, “there have been no definitive requirements for SPF financial statements” and “the FRF-SME will undergo public exposure and professional scrutiny.”  The significant differences in FRF-SME and the tax-basis or modified-basis of accounting  are (1) the conventions of the modified-basis of accounting are more or less pick and choose and (2) the tax-basis of accounting is not subject to public exposure and professional scrutiny.

The hope is that the FRF-SME “will result in a reliable and consistently applied financial framework.”

The FAQ also states that the FRF-SME, once approved, will not change for “three to four years.”

Who Will Use the New Standards?

I anticipate that the FRF-SME will largely be used for compiled and reviewed financial statements, just as OCBOA (e.g., tax-basis) has been used in the past.

And I believe the Private Company Council exceptions (GAAP for private companies) will mainly be used by private companies that are audited.

Differences in U.S. GAAP and FRF-SME

We don’t know all the differences between U.S. GAAP and FRF-SME (since FRF-SME is in development at this time), but here are few differences specified by the FAQ:

  • The FRF-SME will use historical cost and depart from the increased use of fair value
  • The FRF-SME will not require complicated accounting for derivatives, hedging or stock compensation
  • The FRF-SME will greatly reduce disclosure requirements

Key Consideration

If you intend to use FRF-SME, you may want to check your client’s loan and other legal agreements to see if they require financial statements in accordance with U.S. GAAP. The FRF-SME is not GAAP; therefore, its use may run afoul of loan (or other) agreements.

When Will FRF-SME Be Available?

The FAQ states that a draft will be available in the fall of 2012 with the final document being issued in the first half of 2013.

What About Your Firm?

Will your firm use the FRF-SME? How do you feel about this option?