Change Country

Tax & Assurance Guidance

5 Things You Need to Know about the AICPA’s Financial Reporting Framework for Small and Medium Sized Entities

Posted on September 23, 2014 by

Tim Finerty

Tim Finerty

Share This

It’s been a little over a year since the AICPA issued the Financial Reporting Framework for Small and Medium Sized Entities (“FRF for SMEs”) as an alternate reporting option to Generally Accepted Accounting Principles (“GAAP”) financial statements. We have seen multiple clients switch to this framework in order to have more relevant financial statements for the users, without the needless complexity that often comes when small and medium sized businesses are forced to follow the complex requirements of US GAAP.

We have been working proactively with  local and regional banks so they can make the necessary internal changes to allow financial statements under the FRF for SMEs in place of the US GAAP statements previously required by loan documents.

Below is an outline of what the framework is all about and why many accountants, business owners, and bankers are excited about the FRF for SMEs reporting option.

There is no standard definition of an “SME.” The framework makes sense for a broad range of companies.

There is no size or other criteria that a company needs to meet in order to be considered an “SME” and to use the framework as their reporting method. However, based on the details of the framework, it makes more sense for certain types of companies than others.

As a general rule, companies that plan on going public, are operating in an industry with specialized accounting guidance (i.e. financial institutions), or have significant foreign subsidiaries would not find it beneficial to switch to this framework. Otherwise, if a company is a for-profit entity that is owner managed, this framework may be the answer to their complex financial reporting problems.

The framework allows companies to tailor their accounting to match the needs of their financial statement users. This is accomplished by providing various accounting principle options that US GAAP does not have.

The first option the framework provides that is not found in US GAAP relates to consolidation. Companies have the option to present “parent only” financial statements in circumstances where the financial statement users do not find it beneficial to have the financial results of a subsidiary consolidated into the parent companies financial statements. This is accomplished by allowing companies to choose to consolidate majority owned subsidiaries1 or elect to account for these subsidiaries using the equity method of accounting, limiting the financial statement impact of the subsidiary to a few distinct lines.

The framework also provides an option to account for income taxes on what is called the “taxes payable method” instead of the deferred tax method1. This option is useful to companies and financial statement users who do not find value (or really even understand) in reporting deferred tax assets and liabilities, values that often require complicated analyses and computations.  Under the taxes payable method, only current income tax assets and liabilities are recognized, giving financial statement users more of a cash-flow oriented financial statement.

Complicated US GAAP concepts were omitted from this framework.

There is no concept of uncertain tax positions and or variable interest entities (“VIEs”) under the FRF for SMEs (reinforcing the “parent only” financial statement concept). Also, purchase accounting and goodwill requirements have been significantly reduced in terms of the documentation needed. The creators of this framework believed that while these concepts may add value to large corporations, they add significant burden and needless complexity to small and medium sized entities.

The omission of the VIE concept is an area where there is a significant potential benefit for companies and financial statement users. The most common VIE relationship for small and medium sized businesses is where a company is leasing their building from a company related through common majority ownership. In many cases the lessor entity is considered a VIE of the leasing entity. Bankers and other users of financial statements are often aware of the company’s VIE and don’t need to see the VIE consolidated into the company’s financial statements or an US GAAP exception is already taken for the company’s VIE. Information related to companies’ related party activity will be included in the footnotes, so financial statement users will still be provided with details about these transactions.

Under the framework, most assets acquired and liabilities assumed in an acquisition are recorded using “market value” instead of fair value1. This change allows companies to record assets acquired and liabilities assumed at the arm’s length transaction price, with any remaining amounts paid applied to goodwill (no need to break out other intangibles). This change from US GAAP gives companies the potential to account for acquisitions without obtaining costly third party valuations. Further, impairment testing on goodwill is no longer required  unless a triggering event has occurred.

The omission of these concepts allows management to focus their time on financial reporting areas critical to the company’s operations, areas of value to the company, and financial statement user.

Some fair value adjustments have been moved off of the financial statements.

Another area of focus for the AICPA when creating this framework was the complicated fair value adjustments associated with derivatives and stock and other equity compensation. Under the framework, unsettled derivatives and equity compensation options are only disclosed in the notes to the financial statements.

This means financial statement users have access to information about the derivative (objective, contract amount, and net settlement amount) and equity compensation options (terms and awards under the plan) in the financial statement notes. Once the derivative or equity compensation option is settled, it will be recorded on the financial statements at the executed value, but until then, there won’t be any fair value adjustment that skews the financial statement results of
the company.

Companies can avoid the potential onerous implications of the new revenue recognition standard and potential lease changes that will be required under US GAAP.

The FRF for SMEs was designed to be a stable framework that doesn’t undergo frequent updating. The framework uses traditional accounting methods for both revenue recognition and lease accounting, concepts that mirror current US GAAP requirements. Companies that believe they may need significant time to understand the impact of the upcoming revenue recognition and lease changes to US GAAP should consider whether switching to this framework would allow for a cost effective, timely, and more relevant financial report to be provided to their financial statement users in the future.

So far we have seen this framework implemented in a broad range of industries and revenue levels. Companies, lenders, and other financial statement users have all benefited from the simplified reporting requirements that put more focus on the company’s cash flow position.

The AICPA has additional resources and information available that is tailored for company management, business professionals, and CPA firms interested in learning more about the framework. Refer to aicpa.org/FRF-SMEs for additional information.


1 This method is currently required by US GAAP.

Share This

Tim Finerty

Shareholder

Tim provides tax, accounting and consulting support to help industrial automation companies maximize profitability.

Related Insights

Tax & Assurance Guidance

New Corporate Transparency Act Reporting Requirements

Posted on September 30, 2022 by

Sue Tuson
Learn about the new Corporate Transparency Act reporting requirements that go into effect on January 1, 2024, including beneficial owners, company applicants, exempt entities and due dates.

Tax & Assurance Guidance

Keeping Up With Digital Taxes

Posted on September 6, 2022 by

Miroslav Georgiev
Sue Tuson
To the uninitiated, selling digital products and services can seem like a much easier business model than selling physical goods. While there may be advantages to skipping inventory and warehouse needs, the digital tax landscape can be tricky to navigate. 

Tax & Assurance Guidance

Insights from Washington: Inflation Reduction Act Signed

Posted on August 19, 2022 by

Sarah Russell
On August 7, 2022, the U.S. Senate approved the Inflation Reduction Act of 2022, a bill to finance climate and energy provisions and an extension of the enhanced Affordable Care Act (ACA) subsidies totaling $369 billion in additional spending.

The Sound of Automation Podcast

Industrial automation businesses are the driving force behind Industry 4.0, and Clayton & McKervey is here to help.

Skip to content