Is the Financial Reporting Framework for SMEs Good for Real Estate?
The Financial Reporting Framework for Small and Medium-Sized Entities (“FRF for SMEs”) is a self-contained financial reporting framework issued by the American Institute of CPAs (“AICPA”). It is a Special Purpose Framework that was designed to be useful and manageable. In comparison to the Financial Accounting Standards Board’s (“FASB’s”) codification, which is approximately 8,000 pages, the framework consists of approximately 200 pages of guidance. It was first issued in 2013 and has had several subsequent updates. The AICPA released the FRF for SMEs as an alternative to accounting principles generally accepted in the U.S. (“GAAP”) with the goal of making it easier for privately owned businesses to prepare their financial statements.
Does my company qualify as a small or medium-sized entity?
The task force and AICPA staff that developed the framework did not quantify size criteria for determining what constitutes a small or medium-sized entity because they determined that size tests were not effective at describing the kinds of entities for which the framework is intended. However, the AICPA did identify the following characteristics that are typical of SMEs:
- It does not have regulatory reporting requirements requiring it to use GAAP-based financial statements.
- Owners and management have no intention of taking the company public.
- It is for-profit.
- It does not operate in an industry in which transactions require highly specialized accounting guidance (e.g., financial institutions and governmental entities).
- It does not engage in overly complicated transactions or have significant foreign operations.
- Financial statements users have greater interest in cash flows, liquidity, statement of financial position strength, and interest coverage.
How does my company apply the framework’s principles and concepts?
The framework was developed to address transactions that are typical for private, for-profit, and small and medium-sized entities. If the framework does not specifically address a transaction, other event or condition, management should use its judgement and apply the general principles, concepts and criteria contained in the framework when developing accounting policies. The use of the framework is purely optional, and there are no effective implementation dates. In the year of adoption, the company would restate opening balances using the new framework and then apply the framework to the current year.
How does the framework differ from the Private Company Council (“PCC”)?
The AICPA and FASB are both committed to the private company financial reporting constituency, however, their objectives differ. The PCC focuses on modifications to U.S. GAAP for private companies that need or are required to have financial statements prepared in accordance with GAAP. The FRF for SMEs framework is a concise, highly relevant framework that can be used when U.S. GAAP financial statements are not required.
How does this framework differ in application for the newer revenue recognition and leasing standards?
The FRF for SMEs retains its existing and familiar accounting for revenue recognition and leases, offering approaches that are well-known and long used by entities. The GAAP changes in those areas create another opportunity for smaller to medium-sized, for-profit private entities that are not required to use GAAP to consider whether the FRF for SMEs framework suits their financial reporting needs.
How does FRF compare to GAAP (and PCC) in the areas most relevant to my real estate company?
|The new revenue recognition standard is a broad, principles-based revenue recognition model that fundamentally changes the approach to accounting for revenue that replaces industry-specific guidance. It is effective as of 2018 for public companies and 2019 for private companies.
|Broad, principle-based guidance on revenue recognition. Revenue should be recognized when performance is achieved and ultimate collection is reasonably assured (1) for goods, performance is achieved when the entity transfers the risks and rewards associated with the goods to a customer; (2) for services, performance should be determined using either percentage of completion or completed contract. Performances should be regarded as having been achieved when reasonable assurance exists regarding the measurement of the consideration that will be derived from rendering the service or performing the long-term contract.
|Lessee accounts for leases as gross asset (right-of-use asset) and liability (right-of-use liability) reported on the balance sheet. Leases are classified as either financing or operating leases. The new standard is effective in 2019 for public companies and 2020 for private companies (although the FASB recently proposed delaying the effective date for private companies to 2021). Lessors account for leases as financing or a sale.
|Traditional accounting approach. Lessee classifies leases as either operating or capital. Lessor classifies leases as sales type, direct financing, or operating.
|Long-lived assets are tested for impairment upon a triggering event. Goodwill and indefinite-lived intangibles are subject to annual impairment tests.
|Impairment test should be performed upon a triggering event.
|No assessment of impairment of long-lived assets required. A depreciated or amortized cost approach is followed. Assets no longer used are written off.
|Consolidation is required for a reporting entity with a controlling financial interest in another entity. The variable interest entity (VIE) model must be used when control is achieved through arrangements that do not involve voting interests.
|When considering whether to consolidate a common control entity, a private company can elect not to apply the VIE model to lessor entities. Effective for years ending after December 15, 2020 (early adoption is permitted), this election will apply to all qualifying common control arrangements for private companies.
|Policy choice to consolidate subsidiaries or account for them using the equity method. A subsidiary is defined as an entity in which another entity owns more than 50% of the outstanding residual equity interests. The concept of VIEs does not exist.
|Deferred income tax method is used. Uncertain income tax positions must be evaluated and accrual made if certain conditions are met.
|Policy choice to account for income taxes using either the taxes payable method or deferred income taxes method. No evaluation or accrual of uncertain income tax positions is required.
|Recognized intangible asset is amortized over its useful life unless determined to be indefinite. Intangible assets subject to amortization are tested for impairment upon a triggering event. Indefinite-lived intangible assets are subject to an annual impairment test.
|All intangible assets are considered to have a finite useful life and are amortized over their estimated useful lives. In accounting for expenditures on internally generated intangible assets during the development phase, management should choose to either expense as incurred or capitalize expenditures as an intangible asset.
|No amortization. Tested for impairment at least annually or upon a triggering event.
|An entity may elect to amortize goodwill on a straight-line basis for the lessor of 10 years or the useful life of the asset. An impairment test should be performed upon a triggering event.
|Amortized over 15 years. No impairment testing is required.
Due to the reporting requirements by lenders and investors, it is highly recommended that real estate investors, developers and others in this sector consult with their business advisors to select the most appropriate basis of accounting.
* See “FRF for SMEs: The GAAP Alternative That Can Save the Day” for additional information on these topics under the framework.
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