Big GAAP vs. Little GAAP vs. No GAAP

The AICPA Issues the Financial Reporting Framework for
Small- and Medium-Sized Entities

In June 2013, the American Institute of CPAs issued the Financial Reporting Framework for Small- and Medium- Sized Entities (FRF for SMEs), a new option for businesses that do not need to prepare US generally accepted accounting principles (GAAP)-based financial statements. Small businesses have looked for relief from the overwhelming requirements of GAAP for several years. The FRF for SMEs is a self-contained framework, designed to be a cost-effective solution for owner-managed, for-profit businesses to provide relevant, streamlined reporting for users of their financial statements.

Since the FRF for SMEs is not GAAP, its use is completely optional and there is no effective date for implementation.

What is the FRF for SMEs?
The FRF for SMEs presents a third option, i.e. “No GAAP”, for businesses by presenting a framework that falls under the definition of “other comprehensive bases of accounting” (OCBOA). It is designed to simplify the process of preparing financial statements by reporting clearly what a business owns, what it owes and its cash flow. In general, the FRF for SMEs is a principles-based framework that primarily uses historical cost as its measurement basis. While incorporating many traditional accounting principles, it also incorporates some accrual income tax accounting methods. In some cases, alternative accounting methods are provided, which gives management the flexibility to choose the accounting method most suitable to the entity’s facts and circumstances.

Excluded from this framework are, for example, concepts such as other comprehensive income, variable interest entities and other GAAP concepts that make many small- to medium-size company owners and controllers question whether GAAP has relevance to their financial statements.  If the framework does not specifically address a particular transaction, management would use its judgment and apply the general principles and concepts contained in the framework when developing accounting policies.  The goal is to provide financial statements possessing the four principle qualitative characteristics of Understandability, Relevance, Reliability and Comparability.

The framework is also intended to be a stable platform that does not undergo frequent amending or updating.  However, it still needs to be responsive to the reporting needs of small- and medium-sized entities and will be modified as needed.

What types of companies might find the FRF for SMEs beneficial?

• No regulatory or contractual reporting requirements that essentially require it to use GAAP-based financial statements
• No intention of going public
• For-profit
• Owner-managed (closely held company in which the people who own a controlling ownership interest are substantially the same set of people who run the company)
• Rely on financial statements to confirm performance, cash flows, what they own and what they owe
• Key users of financial statements have direct access to management
• Bank lending decisions are based on available collateral or other evaluation mechanisms not directly related to the financial statements.

Going forward
The release of this framework comes out just as the Financial Accounting Standards Board (FASB) voted to issue three Private Company Council (PCC) initiatives for public exposure.  If approved, these proposals would create GAAP changes for private companies related to recognition of certain intangible assets acquired in a business combination, amortization of goodwill, use of a simplified goodwill impairment model and allow for two simpler approaches to accounting for certain types of interest rate swap agreements. Private companies have argued that current GAAP requirements related to these areas have little relevance to their financial statement users.

In addition, International Financial Reporting Standards (IFRS), which is being considered by the SEC for eventual implementation here in the USA, has a version available for small to medium-sized companies.  Applying international standards to a company’s financial statements would not be incompliance with GAAP, but would be another option eventually available.

The bottom line is accounting standard setters are considering ways to make financial reporting for privately held companies simpler and more meaningful to financial statement users.  Business owners and management of these companies should work closely with their advisors and the users of their financial statements and carefully consider what is best for their circumstances as it relates to their financial reporting needs.

Contact us if you would like more information or wish to determine if your company is a good candidate to prepare its financial statements under the FRF for SMEs framework.