Objections to FRF for SMEs

I’ve been reading comments on the AICPA LinkedIn group about FRF for SMEs. Those comments include statements that FRF for SMEs will “increase fraudulent reporting” or that it will be “unenforceable.”

Here are my thoughts about those objections.

CPAs will continue to use the same audit standards and the same compilation and review standards. We have opined upon and reported upon OCBOA statements for decades, and I have never heard CPAs object – nor NASBA, nor the FAF.

And why have CPAs historically issued OCBOA statements? Simplicity and flexibility.

Why did the AICPA issue FRF for SMEs? Simplicity and flexibility.

Have we not had the modified-cash basis for a very long time? This basis of accounting has never been subject to public scrutiny (as FRF for SMEs was); it simply evolved by commonly accepted practice. And hasn’t the modified cash basis offered variations in presentation (again for decades)? It seems to me that this OCBOA has been “enforceable”; modified-cash basis statements have been subject to peer reviews since the genesis of the peer review idea.

Will it be more difficult to enforce? Yes. There is more to know. But aren’t FASB statements more difficult to enforce as new pronouncements are issued each year? Yes, but we handle this well.

How long will it take for the Private Company Council to make exceptions for private business GAAP? I’m not sure, but in the meantime, I will be using FRF for SMEs. I am already reading and learning about the new framework, and I must say, I like what I see.

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).

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Courtesy of iStockphoto.com

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?

No.

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?

Yes.

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.

 

PCC Chairman Makes Interesting Comments

The AICPA, through the Blue-Ribbon Panel, tried to get the Financial Accounting Foundation (FAF) to create a separate board to create private company standards, but was refused. Rather than a separate board, the FAF created the Private Company Council (PCC). The chair of the PCC is Billy Atkinson, a former Big Four partner who opposed differential standards.

The FAF designed the PCC with a FASB liaison (a FASB board member) to facilitate discussion between the FASB and the PCC. The PCC can only recommend exceptions to FASB standards which must be “endorsed” by FASB in order to become effective.

Mr. Atkinson recently spoke to the AICPA Council saying, “if we do have fixes, we should first evaluate the fixes from the standpoint of all the users, not just the private company users.” He went on to say,  “I’m not going to be a rebel or a deviant to that approach,” meaning FASB’s approach to standard setting.

This is not a good sign.

I thought the whole purpose of the PCC is to find exceptions to GAAP, those that accommodate private companies. If it does not do this, then is the PCC necessary?

Robert R. Harris, a former AICPA chairman stated, “this Council overwhelmingly endorsed this concept of differentiation…ten thousand of our members contacted FAF. You say you want input. We give input. And honestly I would tell you I would bet that all 10,000 members feel that we were not listened to by FAF.”

The PCC has not even met yet, and the chairman is speaking about a holistic approach – meaning making changes that affect all companies, both public and private – rather than creating exceptions for private companies. This sounds like more of the same FAF/FASB mindset.

I’m thankful that the AICPA is working on its Financial Reporting Framework for Small and Medium Sized Entities. This framework will provide private-company accounting relief; this framework should be available by mid-year 2013.

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). 

AICPA FAQ

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.”

Goal

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?

OCBOA Financial Statements

OCBOA is not a monster, although it does sound like one.

It is actually a kinder, gentler animal when compared to GAAP (generally accepted accounting principles) – also not a monster (though some accountants would beg to differ).

Types of OCBOA

OCBOA – other comprehensive bases of accounting – encompasses the following:

  • Cash basis
  • Modified-cash basis
  • Tax basis
  • Regulatory basis
Why OCBOA?

In a word: Efficiency.

Often OCBOA is used as a simpler substitute for GAAP and is most often used in compiled financial statements. For instance, an accountant may be compiling financial information to complete a tax return, so it may be easier to create financial statements on the tax basis – killing two birds with one stone. (Converting tax-basis financial statements to GAAP can, in many cases, require a great deal of time, and your client’s banker may be just as happy with tax-basis statements.)

Sources of OCBOA

So where does OCBOA come from?

There is no standard setter for OCBOA. The OCBOA reporting options have largely evolved from tax and governmental regulators and from client requests for cash or modified-cash statements.

The lack of a standard setter allows for a great deal of reporting flexibility, however, the down side is that there is little guidance on the application of the various OCBOA options.

Cash and Modified-Cash Bases of Accounting

A pure cash-basis balance sheet has only two accounts: cash and equity.

The modified-cash basis of accounting is the cash basis with selected modifications such as capitalizing property and equipment and recording any related debt (without accruing certain items such as trade receivables, prepaid assets, and deferred taxes). These modifications are selective rather than mandatory; consequently, if note disclosure is provided, the basis of accounting should be fully explained.

The modified-cash basis can involve so many modifications that the statements become GAAP-like; then the CPA needs to decide whether he or she should just present the statements in accordance with GAAP.

Tax-Basis of Accounting

Generally most tax-basis financial statements are prepared in accordance with federal tax guidelines (which include the cash and accrual bases of accounting depending on the business).

Where possible, the CPA should consider preparing tax-basis financial statements without disclosure. This option is appealing because there are no disclosures and no cash flow statement to prepare, and the resulting statements agree with the tax return.

Reporting and Work Paper Considerations

Remember to title your financial statements appropriately (e.g., statement of assets, liabilities and equity – income-tax basis). Accordingly, the engagement letter and representation letter (for review engagements) should incorporate the OCBOA financial statement titles.

Disclosures, if provided, should be prepared using GAAP as a guide and then modify the notes to dovetail with the OCBOA used. (Many notes required by GAAP would not be pertinent to or needed for OCBOA statements.)

AICPA OCBOA Coming

The AICPA is presently working on a new OCBOA that can be used in place of GAAP. At this time, we don’t know what this basis of accounting will entail, but it will allow CPAs to present financial statements on a simplified basis (avoiding thorny issues like variable interest entities).