Introducing the Financial Reporting Framework for Small and Medium-Sized Entities (Little GAAP)
By Lawrence Montgomery, Manager, Assurance Services
In the United States, owners of many companies have long been complaining about the complexities and intricacies of accounting principles generally accepted in the United States of America (US GAAP). US GAAP was developed largely with the interests of large public companies in mind, which is understandable as the transparency of a company’s financial condition is never more important than when protecting the public investors.
The vast majority of companies in the US consist of non-public entities that, up until now, have had to follow the same accounting rules as the “big guys” which are the large public filers. The time has come where the “little guys” now have their own accounting framework called the Financial Reporting Framework for Small- and Medium-Sized Entities (“FRF for SME’s”), which was developed by a task force and staff of the American Institute of Certified Public Accountants.
The FRF for SME’s is a non-GAAP framework and is considered an other comprehensive basis of accounting (OCBOA) which primarily uses the accrual basis of accounting with some income tax basis concepts, and stresses the use of professional judgment.This would provide companies with a simple and constant set of accounting rules that would not undergo frequent changes or amendments, along with less disclosure requirements and complex rules.The accounting guidance is maintained in one 188 page book, which contains substantially less information than the current US GAAP literature.
The following are some highlights of the significant differences between the FRF for SME’s and US GAAP that would provide relief and reduced costs to owners:
- Stock based compensation – No expense is recognized for these transactions. A fair value calculation, which is commonly performed with a Black-Scholes model, is no longer necessary.
- Pension liabilities - Companies have the option to record the current contribution payable for defined benefit plans and do not need to value and record the benefit obligation for financial reporting purposes.
- Income taxes – There are no accounting or disclosure requirements for uncertain tax positions. Further, companies have the option to record only the current taxes payable and avoid having to calculate and record a deferred tax asset/liability.
- Goodwill – This is to be amortized over the tax life of the asset, which is generally 15 years.An annual impairment evaluation is no longer necessary.
- Consolidations – Companies will now have the ability to elect to consolidate subsidiaries or account for them under the equity method, which would no longer require companies to consolidate a variable interest entity.
- Acquisition accounting – During a business acquisition, the value of intangible assets purchased by the acquirer does not need to be separately identified and valued, and should be recognized as goodwill.
- Measurement basis – The framework’s primary measurement basis is historical costs which alleviate the burden and sophistication for fair value measurements.
These are typical accounting transactions that all companies, regardless of their size, generally need to hire outside valuation and accounting specialists. The added time and costs would no longer be necessary.
The question remains just how much this new accounting framework will be used.This optional framework is mainly intended for non-public, for-profit, owner-managed companies that generally undergo simple transactions with no special reporting requirements (i.e. government, bank or SEC mandates) or foreign operations. This would mean the framework does not apply to public filers, not-for-profit entities, employee benefit plans and foreign companies.This only leaves for-profit, private US based companies.
A vast majority of private companies that currently have financial statements prepared under US GAAP for external reporting purposes are required to do so under the terms of bank financing agreements. The use of the FRF for SME’s framework is largely dependent on the acceptance in the banking community. At present, all of a bank’s lending decisions are based upon information from US GAAP financial statements. A new accounting framework would be asking bankers to amend previously executed agreements, take the time to learn about the new rules and modify their own financial calculations when making lending decisions. Private company owners will also need to evaluate their long-term business plans and whether that includes the intentions to sell the business or go public in the future. If this is the case, maintaining their financial statements in accordance with US GAAP would be the better option. This will all take time to implement and accept; however, once this does happen, the new framework will provide a cost effective alternative to financial reporting.