Private Company Reporting Options – “FRF for SMEs” vs. “Private Company Council GAAP”
Tim Finerty
The private company financial reporting landscape has changed. With new acronyms like “FRF for SMEs” and “PCC,” it can be hard for companies to decide which reporting option is right for them. Here’s a quick overview of the alternatives and benefits for each.
What reporting options are available for private companies?
Besides a traditional United States Generally Accepted Accounting Principles (“US GAAP”) financial statement, private companies have two options they didn’t have a few years ago. These reporting options are tailored for private companies so they don’t have to spend time (and money) on financial reporting areas that don’t bring value to the financial statement users.
- The Financial Reporting Framework for Small and Medium Sized Entities (“FRF for SMEs”) is a special purpose framework based on the principles of US GAAP but tailored to meet the needs of privately held businesses and their financial statement users. What does that mean? It means this framework is focused on cash flow.
- The Private Company Council (“PCC”), on the other hand, is a committee appointed by the Financial Accounting Standards Board (“FASB”) that has established US GAAP reporting alternatives for private companies. These reporting alternatives must be endorsed by FASB, which means the process for approval of a new standard can take a very long time.
How are these options different than US GAAP?
While FRF for SMEs is not GAAP, there are minimal differences between the two frameworks for everyday accounting issues. Also, keep in mind that although these are different reporting options, the level of assurance of an audit or review stays the same no matter what reporting option is used. Meaning if a company obtained an audit for an FRF for SMEs financial statement, the relevant auditing procedures would still be as strong as they would for a US GAAP financial statement.
The main areas where the private company options differ from GAAP are:
1. Variable Interest Entities (“VIEs”)
| US GAAP | PCC | FRF for SMEs | ||
| All related party relationships must be analyzed and primary beneficiaries (“PBs”) must consolidate all VIEs. | Follows US GAAP, except one exception where there is no consolidation required in the case of common control leasing arrangements. | No concept of VIEs. No analysis of consolidation required. |
The PCC has one exception to the VIE literature in the case where a business owner has two entities – an operating entity and an entity structured to own the building the operating entity uses. In this case (a common control leasing arrangement), the operating entity is not required to consolidate the building entity into their financial statements like they would under US GAAP requirements.
FRF for SMEs has substantially lessened the reporting burden for private companies by eliminating the concept of VIEs. This was done because private companies have a much closer relationship with the users of their financial statements than public companies do. Users of private company financial statements have direct contact with company management and can request financial statements of related entities as needed without having to skew the financial results of the operating company. In the FRF for SMEs framework, all related party transactions are disclosed, so financial statement users will still know whenever related party transactions are occurring.
2. Derivatives
| US GAAP | PCC | FRF for SMEs | ||
| Measured at fair value. | Simplified hedge accounting for plain-vanilla derivatives – measurement at settlement value. All other derivatives are treated in accordance with US GAAP requirements. | Not recognized until settled (carried at historical cost). Footnote disclosure of objective, contract amount, and net settlement amount at financial statement date. |
While the PCC has a simplified accounting option for plain-vanilla (fixed-rate conversion) swaps, FRF for SMEs provides a simplified option for all types of derivatives. Further, while the PCC allows plain-vanilla swaps to be measured at settlement value (an easier measurement than fair value), FRF for SMEs allows for derivatives to be carried at historical cost with no complicated revaluing as of the balance sheet date. Instead, relevant information like the settlement amount of the derivative is included in the notes to the financial statements.
3. Goodwill
| US GAAP | PCC | FRF for SMEs | ||
| No amortization of goodwill. Trigger based impairment testing. | Goodwill is amortized over a 10 year period or less. Simplified version of GAAP impairment testing requirement. | Goodwill is amortized over the tax life, or 15 years. No impairment testing requirement. |
Both the PCC and FRF for SMEs have amortization of goodwill, unlike US GAAP. In a lot of private company lending decisions, goodwill is backed out of various covenant calculations so the PCC and FRF for SMEs statements are presenting more relevant financial statements by amortizing goodwill. The benefit of FRF for SMEs in this case is there will be no book-to-tax timing difference for goodwill amortization that needs to be taken into consideration when preparing tax returns and calculating deferred taxes. Also, since goodwill is amortized, the impairment testing requirements are lessened. The PCC has limited impairment testing while FRF for SMEs doesn’t require testing.
4. Income Tax Accounting
| US GAAP | PCC | FRF for SMEs | ||
| Deferred tax method required. Uncertain tax positions must be analyzed. | Same as US GAAP. | Option to account for taxes under either the deferred tax method (same as US GAAP) or the income taxes payable method. No concept of uncertain tax positions. |
The reason FRF for SMEs offers the income taxes payable method as an option is because of the framework’s emphasis on cash flow. If financial statement users aren’t comfortable with that option, the company can choose the traditional deferred tax method instead.
For private companies, uncertain tax positions are an area where US GAAP requires analysis, but rarely is there any liability making its way to the balance sheet. Therefore, the elimination of this concept in FRF for SMEs allows companies and their accountants to spend more time on value-added areas of the financial statements.
For private companies, the FRF for SMEs and
PCC reporting options aren’t inferior reporting frameworks – they’re designed to specifically meet the needs of private companies and their financial statement users. While some of the key principles of each option are outlined here, there’s still more to the story.