What is FRF for SMEs?
The Financial Reporting Framework for Small and Medium Sized Entities (FRF for SMEs) is an alternative accounting framework to the accounting principles generally accepted in the United States of America (US GAAP). FRF for SMEs is based on the principles of US GAAP, but it provides a simpler solution for privately held businesses that are happy with their financial statements just the way they are—if it’s not broken don’t fix it as the saying goes. This framework was designed not to change very frequently and is intended to provide essential accounting information such as what a company owns or owes, what their cash flow is, and other relevant disclosures.
Who Should Use This Framework?
FRF for SMEs is intended to be used by for-profit businesses that are owner-managed, do not anticipate going public and do not operate in industries with highly specialized accounting guidance such as insurance and financial institutions. These owners are happy with their current system of facilitating financial statements that already provide all the information their stakeholders could need and are not interested in absorbing the burden of adopting and adhering to new standards as they emerge under US GAAP. For example, a new standard went into effect for periods beginning after December 15, 2021 that significantly updated accounting for leases under US GAAP (ASC 842) and has created additional work for companies to adopt and ensure ongoing compliance with this standard. FRF for SMEs is an alternative that would allow business owners to avoid this burden.
What is the New Lease Standard?
The new lease standard is a component of US GAAP under ASC 842 that went into effect for periods beginning after December 15, 2021. The new lease standard has substantial impacts on balance sheets for lessees and contains updates to align lessor accounting with the new revenue recognition standard (ASC 606). This new standard will have some impact on nearly all business entities.
Impact on Client Accounting for Leases
Under the updated model, lessees must classify a lease as operating or finance, similar to existing lease accounting guidance. Both operating and finance leases will require recognition of a right-of-use asset and a lease liability on the balance sheet. The right-of-use asset is measured at the present value of future lease payments. For operating leases, the right-of-use asset will be straight line amortized over the duration of the lease. Finance leases will result in amortization of the right-of-use asset as well as an interest component, like the treatment of long-term debt.
The new model does not require an overhaul for lessor accounting, and lessors will continue to classify leases as operating, direct financing or sales-type leases. There is, however, a newly established requirement for lessors to assess the collectability of their lease payments and align recognition of lease revenue with the new revenue recognition standards under ASC 606.
Adding right-of-use assets and lease liabilities to the balance sheet will result in changing the financial metrics based on those financial statements such as debt covenants, which must be addressed. Businesses will need to review how changes to the financial statements will be impacted by both existing and future leases. Accounting staff will also need to be educated on the new standard to accurately report leases in their financial statements. It may make sense to transition away from financial reporting under US GAAP to reporting under FRF for SMEs. It will be important to communicate the impact of changes related to adoption of ASC 842 or transition to FRF to SMEs to financial statement users, such as the bank.
Continue the Conversation
Whether you think your company would be better served by reporting under FRF for SMEs or US GAAP, Clayton & McKervey is well-versed in both reporting frameworks and will help you make the best choice for your business. We provide accounting services for leases under the new standard and assist with the most challenging aspects of transitioning from US GAAP to FRF for SMEs. To learn more about the ways we can help optimize your company’s reporting practices, contact us today.