A New Reporting NON-GAAP Choice

On June 10, 2013 the American Institute of Certified Public Accountants (AICPA) issued the "Financial Reporting Framework for Small- and Medium-Sized Entities" (FRF for SMEs). The FRF for SMEs was produced in response to the demand from the U.S accounting profession and non-public business owners and users of their financial statements for a more robust and reliable accounting framework when Generally Accepted Accounting Principle (GAAP) financial statements are not required.

On June 10, 2013 the American Institute of Certified Public Accountants (AICPA) issued the "Financial Reporting Framework for Small- and Medium-Sized Entities" (FRF for SMEs).  The FRF for SMEs was produced in response to the demand from the U.S accounting profession and non-public business owners and users of their financial statements for a more robust and reliable accounting framework when Generally Accepted Accounting Principle (GAAP) financial statements are not required.

GAAP is considered to be the standard for financial accounting in the US.  GAAP, as prescribed by the Financial Accounting Standards Board (FASB), is used to guide accountants through the business of recording, summarizing and preparing financial statements.  One of the most contested issues over the past three decades regarding the development and application of GAAP is the matter of private versus public companies.

It has been noted that many of the GAAP elements that apply to public companies have lesser or even no utility for private ones.  Many users of privately held businesses find GAAP to complex or unnecessary, but are forced to use it because that is the only option/standard accepted for banking or other requirements/purposes.  This debate has evolved to an ongoing conversation which his often referred to as “BIG GAAP vs. Little GAAP”; with the concept of FASB developing a separate GAAP for non-public entities that is more reflective of the reporting needs and requirements of those entities.

While progress has been made by FASB through its Private Company Financial Reporting Committee, whose mission was and is to help create standards for private companies that would improve the quality and consistency of reporting, the issue of what to do with GAAP and if and how it should be applied to both public and private companies has not been resolved to the satisfaction of many of the stakeholders.

The FRF for SMEs is intended address this issue and to ease reporting for smaller, privately held, owner-managed businesses, incorporated or unincorporated, that are not required to follow Generally Accepted Accounting Principles (GAAP) and for which Companies past adherence to GAAP had been complicated and time-consuming and often resulted in financial statements that contained information that Company ownership/management and the users of their financial statements did not need or understand.

Through this framework, Businesses that are not required to have their financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP) now have the option of using a new financial reporting framework that may better suit their needs and that of their financial statement users.  The FRF for SMEs is an alternative to the non-GAAP options that are currently available (Cash basis, modified cash basis, tax basis, regulatory basis, contractual basis).  The use of the FRF for SMEs is purely optional, a decision of the entity’s management and its financial statement users.

We at The VanderBloemen Group LLC wholeheartedly welcome this additional reporting option and have the ability to offer our clients that reporting option.

The goal of the framework is to help these businesses clearly and concisely report what they own, what they owe, and their cash flow and most importantly, provide useful and relevant information to owners of private companies and other financial statement users in a consistent, simplified, cost-effective way.

The newly released FRF for SMEs is a great choice for owner-managers who need financial statements that reliably report what they own, what they owe and cash flows. The FRF for SMEs is simple yet grounded on solid principles; consistent yet flexible; and is not unnecessarily complex yet provides financial statement users with the information they truly need.

Highlights of the FRF for SMEs

· The FRF for SMEs was designed to deliver financial statements that provide useful, relevant information in a consistent, simplified way.

· While many small businesses today use cash or tax-basis special purpose frameworks as an alternative to GAAP (and can continue to do so), the FRF for SMEs is an option providing comprehensive information that closely aligns with how businesses are run.

· FRF for SMEs has been subject to professional scrutiny and input from the public.

· FRF for SMEs is made up of traditional accounting principles blended with accrual income tax accounting methods, offering a reliable framework that can be consistently applied.

· FRF for SMEs will be a stable framework, revised only as needed to incorporate significant developments in financial reporting and will remain unchanged for 3-5 years.

· As a result of all these factors, it will be easier for small and medium sized companies - and the users of their financial statements - to familiarize themselves with the FRF for SMEs.

· In contrast to GAAP’s prescriptive, detailed standards and substantial disclosure requirements, the FRF for SMEs is a streamlined framework providing the financial information that is relevant to owner-managed SMEs and their financial statement users (including lenders and sureties), focused on the performance of the SME and its assets, liabilities, and cash flows. The key measures of a business and its creditworthiness that will be reported include profitability, cash available, and assets to cover expenses.

FRF for SMEs Accounting Principles

The framework is constructed of accounting principles particularly suited for a typical SME. It:

  • Uses historical cost as its primary measurement basis; therefore, reducing the number of complicated fair value measurements required,

  • Financial statements will more closely align with income tax returns because there will be fewer book-to-tax differences,

  • Offers a number of accounting policy options, like the ability to choose the current taxes payable method or the deferred tax method, which will allow management to select what is best for their purposes and those of their financial statement users

  • Contains principles that are most relevant to SMEs and simplifies accounting in several ways, including:

    • No other comprehensive income
    • No variable interest entities (VIE’s); parent only financial statements are allowed
    • No requirements relating to complicated accounting for derivatives, hedging activities, or stock compensation,
    • Accounting for long-lived assets follows an amortized/depreciated cost approach and does not require impairment testing
    • The criteria for capitalizing a lease for tax purposes generally matches the criteria for FRF for SMEs
    • Goodwill is amortized over the same period as for federal tax purposes and no impairment testing is required.

  • Targets its disclosure requirements to provide users of financial statements with the relevant information they need, while recognizing that those users can obtain additional information from management if they desire.

It also provides a degree of flexibility to allow SMEs to appropriately communicate their situations to financial statement users with those users’ specific needs in mind.

Who should use the framework?

The framework does not provide a quantifiable definition of an "SME" (i.e. there is no dollar amount of revenues or number of location criteria etc.).  The term “SME” is intuitive and its application is based on an evaluation of the entity’s characteristics.  The AICPA has identified the following characteristics of typical entities and user of entity financial statements that could be appropriate for the use of the FRF for SMEs (the list is not all-inclusive and an entity does not have to have these characteristics in order to utilize the framework):

Entity Characteristics

  • The entity is not subject to regulatory reporting requirements that essentially require it to use GAAP-based financial statements,

  • The entity does not intend to go public,

  • The entity is a for-profit entity,

  • The entity is owner-managed, meaning a closely held company where the individuals with a controlling ownership interest are substantially the same people who run the company (as opposed to public companies where the ownership and the management are clearly separated),

  • The entity has owners and managers who rely on a set of financial statements to confirm their assessments of performance, cash flows, what they own, and what they owe,

  • The entity does not operate in an industry where it is involved in transactions that require highly specialized accounting guidance (for example, financial institutions or governmental entities),

  • The entity does not engage in overly complicated transactions, and

  • The entity does not have significant foreign operations.

User Characteristics

  • The entity’s key users of the entity’s financial statements have direct access to the entity’s management (i.e. the lender had the ability to contact management and obtain an Accounts Receivable aging report to augment information provided in the financial statements and note disclosure).

  • The entity users are primarily interested in cash flows, liquidity, statement of financial position strength, and interest coverage.

  • It could also be appropriate if the entity’s banker does not base lending decisions solely on financial statements, but also on available collateral or other evaluation mechanisms not directly related to the financial statements.

Full Disclosure – Concerns Raised by the National Association of State Boards of Accountancy (NASBA)

While the FRF for SME’s was a welcome reporting alternative by many in the business world and a substantial portion of the public accounting profession, the reaction has not been unanimous and owner-mangers and users of the financial statements that would consider the use of the FRF for SMEs option should be aware of the opposing view point.  The National Association of State Boards of Accountancy (NASBA) has raised three main concerns that have been addressed by the AICPA:

  • NASBA: The FRF for SMEs represents non-authoritative guidance and therefore will be very difficult to regulate or enforce.

AICPA: The FRF for SMEs designation, as non-authoritative, is no different than other OCBOAs that have been issued and are also non-authoritative. CPAs remain regulated by boards of accountancy for the work that they do and will be expected to comply with the high expectations of their regulators and their clients and must, in the performance of audits, reviews and compilations, adhere to the same standards when reporting on other GAAP Special Purpose Frameworks.

  • NASBA: The scope, "small and medium size entities," is undefined. As such, any private company, regardless of size or financial backing, could potentially adopt the FRF.

AICPA: The private market can determine which basis of accounting is appropriate. They do not need a regulatory trade group making that decision. For many small and medium-sized enterprises, GAAP (including modifications for private companies) will be appropriate, but for others, the FRF for SMEs and other OCBOAs will be more appropriately suited. The AICPA believes that decision is best resolved between businesses and those that use their financial statements, without interference from outside parties.

  • NASBA: It allows the use of GAAP financial statement titles, yet does not require disclosure of differences with GAAP, which will cause confusion and invite fraud and abuse.

AICPA: The FRF for SMEs framework does not use the terms "balance sheet" or "income statement" in the framework. In fact, the framework uses titles that are not typically considered GAAP. Additionally, the framework requires disclosures that very clearly state that it is not GAAP and therefore will not be confused by a user, whether that user is a private business or a potential lender. Also, any report (audit, review, or compilation) on the framework by a CPA will also state in the report that the FRF for SMEs is not GAAP.

NASBA believes GAAP should be modified by FASB to meet the financial reporting needs of private companies and are urging companies not to adopt FRF for SMEs.

In addition to NASBA, the Institute of Management Accountants (IMA) also opposes FRF for SMEs.  IMA states that “This optional framework does not require small businesses to use U.S. GAAP but instead use a set of standards developed by the AICPA. IMA opposes these standards, saying that an ‘accounting association body (in this case the AICPA) should not be setting what could be perceived as authoritative standards, which in fact are non-authoritative and thus difficult to regulate or enforce.”

While NASBA and IMA’s, among others, opposition to the FRF for SME’s has not been resolved, their position does not, in any way prevent an entity in any state to utilize the FRF for SMEs option presented by the AICPA.  Only the facts and circumstances of the entity and the requirements of the users of the financial statements can preclude the use of this reporting option.

Considering the AICPA’s SME framework

At The VanderBloemen Group LLC, we believe, in the appropriate circumstances, the FRF for SMEs offers a viable alternative to GAAP based financial statements and can provide businesses and its interested parties with meaningful financial information without needless complexity and result in a more cost-effective produced financial statement.

The evaluation and decision to utilize FRF for SMEs requires analysis and consultation with lenders, sureties and other stakeholders, with a consideration among all parties of the potential cost-benefit factors of producing non-GAAP, potentially more useful and applicable financial statements.

If you would like more information regarding FRF for SMEs or would like to discuss this with us, please contact us at 262-574-0374

or at our website thevanderbloemengroup.com.