Key differences in reporting standards
(Editor’s note: This is the second of two parts. Read Part One.)
In the first article in this series, we explained the concepts behind the American Institute of Certified Public Accountants release of its guidelines called Financial Reporting Framework for Small and Medium-Sized Entities (“FRF for SMEs”). The FRF for SMEs provides an alternative to U.S. GAAP for private companies. The Framework condenses all of its accounting rules into a 188-page document, which by its nature leaves significant room for judgment by the reporting company and its auditor. Let’s highlight some of the key differences between GAAP and the Framework.
Companies are curious about using these standards, but widespread adoption by smaller companies will depend on the acceptance of financial statements prepared under the Framework by banks. With more understanding of the Framework, perhaps banks will allow preparation of statements with the framework instead of GAAP for loan approval and compliance purposes.
Designed to provide more consistent rules than other types of non-GAAP accounting, the guidance is organized into one document. The document and implementation guidance can be downloaded by PDF for free here: www.aicpa.org/FRF-SMEs.
Market value and other differences
The model rarely uses fair value type concepts to determine the value of assets and liabilities on the balance sheet, and when it does it uses market value, not fair value. Market value is easier to estimate than GAAP compliant fair values, which often involve using an expensive outside valuation expert and complex assumptions. Market value is easier to calculate and is defined as “the amount of the consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act.”
The very limited circumstances in which market value is used are for business combinations, certain non-monetary transactions and marketable equity and debt securities that are held for sale.
There is no impairment test for any tangible or intangible asset. However, entities should write off assets no longer being used. The framework also has no concept of comprehensive income.
A company can elect to present consolidated financial statements or parent-only statements under the framework, based on how likely it is that users will want to see the statements. The Framework also has no concept of variable interest entities (VIEs), simplifying consolidation questions.
For income taxes, the reporting company can elect to use either the “taxes payable” method or the “deferred income tax” method and there is no requirement to account for or disclose uncertain tax positions (i.e., no FIN 48.)
With regard to leases, whether or not to capitalize leases as assets with a corresponding liability, the Framework allows traditional approaches, so leases will be classified as capital or operating, even after the FASB adopts the new standard requiring all leases to be shown as liabilities.
When recording the value of intangible assets and related amortization, all have a finite life. Similar to international standards, research costs are expensed, but companies can make a policy choice to capitalize development costs. There are no impairment tests for goodwill. Goodwill is amortized using a tax life or 15 years.
Revenue recognition has been a hot topic and there is new revenue recognition guidance that will soon be effective under GAAP. In the Framework, revenue guidance is principle-based. Revenue is recognized when performance of a service or delivery of good is achieved and collection is reasonably certain.
In terms of investments, the historical cost approach is used, unless the investment is being held for sale, in which case the market value should be recorded, with changes in the market value included in the income statement. As for derivatives, the only disclosure is required for open positions and the only accounting recorded is for cash settlements. Because of this, there is no hedge accounting or mark-to-market accounting.
These are the most significant differences between the Framework and GAAP, but there are many others. The AICPA guidance falls more in line with the principle based approach of international accounting standards, rather than specific bright line tests sometimes seen in US GAAP. The model uses a common sense approach that bridges less standardized non-GAAP methods such as the cash or income tax basis with more formal methods that are closer to GAAP. Ultimately the users of the statements will determine whether or not they are sufficient for small- to medium-sized private entities.