AICPA Issues a New Financial Reporting Framework
Small businesses now have another alternative framework to use for their financial statements. Until now, small businesses that did not require a financial statement prepared in accordance with accounting principles generally accepted in the United States of America (”GAAP”) had the option of presenting their financial statements using a Cash, Modified Cash or Income Tax Basis of Accounting. These other comprehensive bases of accounting (“OCBOA”) each had their own advantages and disadvantages but were the only alternative to a GAAP basis financial statement.
The new framework, known as the Financial Reporting Framework for Small- and Medium-Sized Entities (“FRF for SMEsTM” or the “framework”), was developed by the American Institute of Certified Public Accountants (“AICPA”) “…to provide consistent and simpler financial statements for small and medium-sized entities where GAAP is not required.” It was developed because the market demanded a framework tailored to small businesses that was cost effective and did not require extensive disclosures that were often irrelevant to the financial statement user.
Although the framework does not define a small- or medium-sized entity, it does include some characteristics of an entity that would consider using the new framework. Some of the characteristics are:
- Small or medium-sized entity.
- Entity is owner managed/for profit.
- Entity can be in any industry group.
- Entity can be unincorporated or incorporated.
- Entity does not operate in a regulated or highly specialized industry (e.g., a utility or a financial institution).
- Entity does not engage in overly complicated transactions or have significant foreign operations.
- Financial statement users may are primarily interested in cash flows, liquidity or debt coverage.
Some of the key features of the framework are as follows:
- Standalone framework.
- Blend of traditional accounting methods (e.g. historical cost) and accrual income tax methods.
- Avoids excess narrative in note disclosures.
- Uncomplicated and understandable.
The framework, which can be used immediately, needs to be understood and accepted not only by management of reporting entities but by users of the financial statements such as financial institutions. The AICPA believes that the framework will be widely used and accepted once it is widely understood. Accordingly, the next few months there will be a lot of time and effort spent on educating the management of business entities and potential financial statement users about the framework.
The FRF for SMEs should not be confused with the work being done by the Private Company Council (“PCC”) of the Financial Accounting Foundation. The PCC is starting with GAAP and making suggestions about changes and the elimination of certain disclosures for small business entities. However, financial statements prepared using the PCC’s modifications will still be considered GAAP financial statements. The FRF for SMEs is not a GAAP presentation and should only be used by entities that do not require GAAP financial statements.
The key principles of the framework are based on traditional and widely accepted concepts in accounting and tax. Some of the key principles of the framework are as follows:
- Historical Cost – Historical cost is objective, verifiable and a relevant and reliable measurement basis. It is well suited for evaluating an entity’s cash flow or its overall performance.
- Optionality – The framework will still allow for choices in some financial presentations so that they will be relevant to the entity’s operations. Some of the available options are:
- Income tax accounting – Taxes payable method or deferred income taxes method.
- Subsidiary accounting – Consolidation or equity method. “Parent company only” financial statements are allowed.
- Joint venture accounting – Equity method or proportional consolidation method.
- Long-term contracts – Percentage of completion or completed contract methods.
- Intangible assets acquired in a business combination – separately recognize assets or combine all into goodwill.
- Interest costs – expense or capitalize interest costs related to certain items of inventories, internally-generated intangible assets, and property, plant and equipment.
- Inventory – FIFO, LIFO, weighted average, standard cost, etc.
- Targeted Disclosures – The framework has an appropriate and adequate amount of disclosure requirements that are streamlined to avoid excess detail, complexity and extraneous information.
- Users generally have some information about the company.
- Users have direct access to management.
- Pertinent information is readily evident.
- Disclosures are clear, understandable, relevant, and transparent.
The expected use of the framework is not without controversy. The National Association of State Boards of Accountancy (“NASBA”) has advised private companies not to use the framework because NASBA believes that the Private Company Council is making significant progress toward the goal of modifying GAAP for small businesses and the Association is troubled that the AICPA is proposing a non-authoritative financial reporting model that would weaken the reporting by private companies.
NASBA points out that 40 years ago the Securities and Exchange Commission and the AICPA agreed that the FASB, which is independent of special interests, would be the single, duly-authorized body to promulgate accounting standards. NASBA also points out what it considers to be certain deficiencies in the framework, including the belief that the framework does not require disclosure of the differences between the framework and GAAP.
The AICPA, which supports the work of the PCC, defends its position by pointing out that the FRF for SMEs will further improve upon existing OCBOA and that it believes that the new framework meets the needs of small- and medium-sized businesses. The AICPA recently released guidance on the use of the cash basis and income tax basis of accounting and that for many years it has promulgated generally accepted standards relating to how a CPA reports on financial statements.
The accountants and advisors of EisnerAmper LLP are following these issues closely. We strongly advise that you speak to your professional before taking any actions.