Article 1 in a 3 part series
For years there has been the “Big GAAP vs. Little GAAP” debate and whether there should be differential standards for the large public companies as compared to their smaller, privately-held counterparts. The increasing complexity of the GAAP standards has resulted in increasing internal and external compliance costs, while also increasing the number of qualifications in audit reports for smaller companies. These combined impacts have had smaller entities and the users of their financial statements questioning the need for a more simplified financial reporting framework which could reduce costs while increasing relevance to the users of the financial statements.
While this debate has been ongoing for quite some time, there is finally some reason for encouragement as both the American Institute for Certified Public Accountants (AICPA) and the Financial Accounting Standards Board (FASB) have made recent progress in their financial reporting projects aimed at non-public entities and the users of their financial statements. While both the AICPA and FASB are working towards the same goal, each organization has taken a separate path. These two separate projects provide non-public entities with two distinct options, which are at different stages of implementation.
The AICPA made the first move on June 10th of this year by issuing a Special Purpose Framework entitled Financial Reporting Framework for Small and Medium- Sized Entities (FRF for SMEs). The framework does not define a “small and medium-sized entity,” but does give some guidance as to entities that may, or may not be considered a SME. These guidelines include the following characteristics:
- The entity does not have regulatory reporting requirements that essentially require it to use GAAP- based financial statements.
- A majority of the owners and management of the entity have no intention of taking the entity public.
- The entity is for-profit.
- The entity may be owner-managed, which is a closely-held company in which the people who own a controlling ownership interest in the entity are substantially the same set of people who run the company.
- Management and owners of the entity rely on a set of financial statements to confirm their assessment of performance, cash flows, and of what they own and what they owe.
- The entity does not operate in an industry in which the entity is involved in transactions that require highly-specialized accounting guidance, such as financial institutions.
- The entity does not engage in overly complicated transactions.
- The entity does not have significant foreign operations.
- Key users of the financial statements have direct access to the entity’s management.
- Users of the entity’s financial statements may have greater interest in cash flows, liquidity, balance sheet strength, and interest coverage.
- The entity’s financial statements support applications for bank financing when the banker does not base a lending decision solely on the financial statements but also on available collateral or other evaluation mechanisms not directly related to the financial statements.
The AICPA’s FRF for SMEs provides latitude in determining certain key accounting policies and simplifies financial reporting in a number of particularly complex areas (i.e., equity-based compensation, income taxes, impairment testing and consolidation). However, this framework may not comply with certain investor or creditor agreements, which require financial statements issued in accordance with Generally Accepted Accounting Principles (“GAAP”). Entities that are required to issue GAAP-based financial statements will either need to continue reporting in accordance with the GAAP framework, or request a waiver to issue statements in accordance with the FRF for SMEs. This framework is available for adoption immediately.
The FASB has taken a different approach by designating a sub-committee (the Private Company Council, or PCC) charged with identifying specific areas in which financial reporting under the GAAP framework is particularly burdensome for private companies. The PCC specified that an entity is not a private company if it:
- Files or furnishes financial statements with a regulatory agency for purposes of issuing securities in a public market or issuing securities that trade in a public market;
- Is a for-profit conduit bond obligor for conduit debt securities that trade in a public market; or
- Is an employee benefit plan.
On July 1st of this year, the PCC issued its first proposed guidance by issuing three separate proposed Accounting Standards Updates (ASUs). These proposed standards would allow private entities the flexibility of adopting simplified accounting and disclosure treatment for business combinations, goodwill and certain interest swap agreements. At present, the PCC is also in the process of proposing amendments for consolidation of certain entities under “Common Control Leasing Arrangements.” If ratified, these ASUs would become part of the GAAP framework and would thus comply with investor or creditor requirements for GAAP-based financial statements. There is no timetable for when, or if, these ASUs will be ratified by the FASB.
Next month’s article will focus further on the AICPA’s FRF for SMEs and summarize some significant differences between this framework and GAAP. A later article will focus on the PCC’s proposed amendments to GAAP. Stay tuned!
Questions on this topic? Contact your Keiter representative. | 804.273.6242
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.