A new financial reporting framework (FRF) designed for privately held, small- and medium-sized entities (SMEs) was released for public comment last week. The idea behind the framework, which was developed under the auspices of the AICPA, is to provide a less complicated, less costly accounting framework for SMEs that don’t require financial statements based on Generally Accepted Accounting Principles (GAAP). In addition, the framework seeks to “align with the needs of bankers who are the primary users of small business financial statements,” without being needlessly costly for business owners, according to the AICPA.
The framework also allows owners of smaller, private companies to prepare their financial reports “in a consistent and reliable manner in accordance with a framework that has undergone public comment and professional scrutiny,” according to an FAQ on the proposal. Accounting professionals who have experience working with smaller and mid-sized organizations helped to develop the framework.
One feature of the proposal is an emphasis on the use of historical costs, rather than fair value accounting. The popularity of fair value accounting grew in the 1980s, due largely to some companies – say, the S&Ls – showing over-valued assets on their balance sheets. However, fair value accounting often is less relevant to smaller companies, given their tendency to focus more on cash flow, as the AICPA notes. In addition, the framework will not require complicated accounting for derivatives, hedging transactions or stock compensation.
And, the framework requires fewer disclosures, as well as fewer adjustments to reconcile tax return and book income than typically is the case with GAAP, according to the proposal. And, because it’s principles-based, it can be used across industries and by both incorporated and unincorporated entities. At the same time, AICPA says the framework permits “reasonably consistent measurements,” and is thorough, requiring all the information a user of the financial statements might need in order to reach an informed opinion of the performance and health of an organization.
One example of the FRF’s principles-based approach can be seen in its guidance on depreciation. The section on depreciation starts with this: “Depreciation should be recognized in a rational and systematic manner appropriate to the nature of an item of property, plant and equipment with a limited life and its use by the entity.” The framework goes on to identify the factors to consider when estimating the useful life of a piece of property, plant and equipment. It also recommends that each major category of plant, property or equipment include a disclosure of its cost, the amount of accumulated depreciation, and the depreciation method used.
It’s important to point out that this framework differs from that being developed by the Financial Accounting Foundation’s Private Company Council, which will focus on modifying U.S GAAP in ways that suit private companies that still need to have financial statements prepared according to GAAP. Similarly, International Financial Reporting Standards for small and medium enterprises, or IFRS for SMEs, also tends to be an alternative for smaller companies that require GAAP financial statements, the AICPA says.
The comment period for the proposal ends January 30, 2013; any comments submitted to the AIPCA will be publicly available for the following year. The AICPA says it plans to issue the final framework in the first half of 2013.