Much Ado About Nothing?: New Financial Reporting Framework Draws Mixed Reaction

Last year, the American Institute of Certified Public Accountants (AICPA) released a new type of special purpose financial reporting framework: “Financial Reporting Framework for Small- and Medium-Sized Entities” (FRF for SMEs). The organization’s intent was to ease reporting for smaller, privately held, owner-managed companies that aren’t required to follow Generally Accepted Accounting Principles (GAAP).

The news got plenty of coverage and was widely discussed in accounting and business circles. But is the framework a noteworthy step forward or much ado about nothing?

Where the story began

Alternatives to GAAP are nothing new. Privately held businesses have long had the option of choosing between GAAP and alternative frameworks commonly referred to en masse as other comprehensive basis of accounting (OCBOA).

In fact, OCBOA has existed as an alternative to GAAP for more than 40 years. It has, for example, allowed small to midsize companies to choose between a tax basis of accounting or cash basis of accounting to report financial results. This past June, the AICPA added the FRF for SMEs to the mix.

The latest framework isn’t required of any business, and it holds no priority or authoritative status over any other form of financial reporting. The FRF for SMEs is, essentially, just another item on a fairly long menu of choices for business owners.

But not everyone found it immediately appetizing. The National Association of State Boards of Accountancy (NASBA), for instance, didn’t support the framework upon its release. About a month and a half later, however, NASBA and the AICPA released a joint statement stating that they’re “committed to engaging in an effort to ensure that the FRF for SMEs … is not confused with GAAP and that entities that utilize GAAP or a non-GAAP solution do so in a suitable and transparent manner.”

What they’re up to

So what was the AICPA up to when it built the framework? In the organization’s view, it was addressing the challenges private companies face when trying to generate substantive, informative financial statements without going all the way to conforming to GAAP.

The more-than-200-page FRF for SMEs blends traditional accounting approaches with accrual income tax accounting methodology. The result, according to the AICPA, is a more efficient, streamlined format for owners of small to midsize businesses to report their financials.

The framework focuses primarily on the performance and creditworthiness of the subject company, as well as its assets, liabilities and cash flow. Key metrics include profitability, cash available and assets to cover expenses. Also important is the FRF for SMEs’ use of historical cost as its measurement basis. This allows users to avoid having to calculate complex fair value measurements.

In short, simplification is the name of the game. The framework doesn’t require complicated accounting for items such as derivatives, hedging activities or stock compensation. Thus, there are fewer book-to-tax differences and a diminished need for multiple adjustments.

Who might adopt it

As its name indicates, the FRF for SMEs is aimed at small to midsize companies. Narrowing down precisely what types of businesses is a little trickier. The AICPA didn’t want to discourage use of the framework by being too specific regarding who should use it. The organization did, however, lay out some guiding principles.

First and foremost, the FRF for SMEs is not for any business required to issue GAAP-based financial statements. Even those that aren’t required to use GAAP but essentially have to do so to convey complex financial transactions shouldn’t consider the framework. It’s also unsuitable for nonprofits, public or soon-to-go-public companies, or businesses with foreign operations.

The AICPA provided a little further insight in an August 7 blog post on its website. A member CPA wrote:

Many owner-managed companies are small or micro in size. They often are called Main Street businesses, mom-and-pop shops or suburbia’s business districts. The [FRF for SMEs] was designed to serve this segment.

So, clearly, many small businesses could find the framework suitable. Where this leaves midsize companies, which generally aren’t considered “mom and pop” operations, is unclear.

What’s next

If you’ve been looking to fine-tune your financial statements, the FRF for SMEs could be a good way to use the latest OCBOA to streamline your reporting. Then again, as noted, it’s not for everyone. So the ideal next step is to contact your financial advisor and discuss the framework to determine whether it would truly suit your needs.