On June 10, 2013, the AICPA released its Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). This is an optional, comprehensive basis of accounting for businesses that are not required to use US GAAP. In its own words, the AICPA describes the framework as “a cost-beneficial solution for management, owners, and others who require financial statements that are prepared in a consistent and reliable manner in accordance with a non-GAAP framework that has undergone public comment and professional scrutiny.”
The framework was designed to respond to the unique financial reporting needs of small and medium sized entities. The current authoritative accounting literature, Generally Accepted Accounting Principles (GAAP), has a very broad scope that does not distinguish between the simple transactions of small- and medium-sized entities and the complex transactions of large entities. The authoritative GAAP standards have been written in a way that makes them difficult to understand and cost prohibitive to apply to small and medium sized entities.
The Financial Accounting Foundation (FAF) is the oversight board for FASB. In an effort to address the needs of small and medium sized entities, the FAF established the Private Company Council (PCC). The PCC is charged with determining whether exceptions or modifications to existing GAAP are needed to meet the needs of smaller privately held companies. The PCC’s actions, if approved by FASB, would actually amend existing GAAP. The AICPA fully supports the efforts of the PCC for GAAP reporting but has created the FRF for SMEs as an alternative when GAAP is not required.
The framework does not define a small- and medium-sized entity but describes the target entities as having the following characteristics (this list in not all-inclusive and the criteria are not required to be met):
- The entity is not required to prepare GAAP-based financial statements
- The entity does not plan to go public in the foreseeable future
- The entity is a for-profit entity
- The owner of the entity is also involved in running the entity
- There is no highly-specialized accounting guidance for the industry in which the entity operates
- There are no overly complicated transactions
- There are no significant foreign operations to report in the financial statements
- Financial statement users have direct access to management
There are many differences between the new framework and US GAAP. The framework primarily uses historical cost basis, steering away from complicated fair value measurements. The principles in the framework are simplified, staying away from complex US GAAP accounting rules such as derivative/hedge accounting and stock based compensation. A partial overview of some key differences between US GAAP and the FRF for Small- and Medium-sized entities is as follows:
- Reporting subsidiaries – FRF for SMEs allows the parent entity to choose to consolidate or use the equity method to account for subsidiaries. The guidance allows parent only financial statements and the concept of Variable Interest Entities isn’t recognized in the FRF for SMEs. US GAAP requires that all subsidiaries are consolidated if the parent has control over the entities. US GAAP also requires a reporting entity that is the primary beneficiary of a VIE to consolidate the VIE.
- Goodwill amortization – When using the FRF for SMEs, goodwill is amortized over 15 years. US GAAP requires impairment testing of goodwill and no amortization.
- Comprehensive Income – There is no concept of comprehensive income or items of other comprehensive income included in the FRF for SMEs. US GAAP requires certain items to be classified as other comprehensive income and displayed as such in the financial statements.
- Leases – The FRF for SME’s accounting for leases is similar to how an entity would account for leases for tax purposes. The framework states that if a lease transfers substantially all of the benefits of risk and ownership to the lessee, the lease is a capital lease, otherwise it is an operating lease. US GAAP applies more stringent tests to determine proper lease classification.
- Income tax accounting – Using the FRF for SMEs, the entity can elect to use the taxes payable method or the deferred income taxes method and there is no evaluation or accrual of uncertain tax positions. US GAAP only permits the deferred income tax method and uncertainty in income taxes must be considered in accounting for income taxes.
The objective of the new framework is to provide owner-managers comprehensive, reliable and understandable financial information to make informed business decisions and to provide the lending community and others financial statements that provide the information to make sound business and credit decisions. There are millions of small businesses in the United States that struggle with the complex accounting standards approved by the FASB that are costly for small businesses to implement and difficult to understand. This framework may provide a good reporting alternative for these businesses.
Additional resources and information are available at aicpa.org/FRF-SMEs.