(Published in Business First, September 13, 2013)
Question: What is a good financial reporting option for a small or medium-sized business?
Answer: The short answer is: It depends.
The best place to start is to introduce the basic options or frameworks for financial reporting.
Generally accepted accounting principles (GAAP) are the accounting principles with which all public companies in the United States must comply.
International financial reporting standards (IFRS) are accounting standards developed by the International Accounting Standards Board (IASB) that eventually might be the global standard for the preparation of public company financial statements.
Another option is to select an other comprehensive basis of accounting (OCBOA), which consists of a series of reporting frameworks other than GAAP. Historically, the most common OCBOA methods included cash basis and the income tax basis.
But in June, the American Institute of CPAs (AICPA) released a new option known as the financial reporting framework for small- and medium-sized entities (FRF for SMEs).
In general, GAAP or IFRS, which I will refer to collectively as GAAP, are considered to be the gold standard of financial reporting and often are required by statute or contractual arrangement with lenders or other stakeholders of a company.
But when GAAP-based financial statements are not required, it might not be the best solution for a small to medium-sized business.
Because of the inherent complexity that sometimes is required to fully implement GAAP, the preparation often can be overly complicated and resource-consuming, and it includes information that users of the financial statements often don’t need or care about.
In those cases, OCBOA may be a better alternative.
Historically, if a small or medium-sized business chose not to use GAAP, the business typically would report under the cash basis or income tax basis of accounting, both of which have been the most commonly used reporting options under OCBOA despite the inherent limitations associated with them.
New framework is a ‘compelling’ option
The newest framework, the FRF for SMEs, now is a very compelling OCBOA option to consider. The FRF for SMEs was designed to provide robust, accrual-based financial statements, including statements of financial position, operations, changes in equity and cash flow that closely resemble traditional GAAP financial statements.
Informative, but not extraneous, note disclosures are required.
The framework was constructed by the AICPA to be a more cost-effective alternative to GAAP. Historical cost is the primary measurement versus costly fair value measurements.
It does not include requirements for complicated and expensive accounting for matters such as variable interest entities, hedging, derivatives, fair value, asset impairment, stock compensation, reporting of comprehensive income, etc.
It also provides simplification and more flexibility in options to account for income taxes, leases, goodwill and other intangible assets, and consolidation of related companies.
The intended outcome is less cost, more simplified accounting, clearer disclosures and a more stable reporting environment without significant changes needing to be implemented on a regular basis, which generally is the norm with GAAP.
“I think this new accounting framework is exactly what business owners, CPAs and community bankers have been looking for as a viable and reliable alternative to the options already available,” Rich Caturano, chairman of the AICPA board of directors and a national leader at McGladrey LLP, said in a news release.
“The FRF for SMEs expands the accounting options for CPAs and private companies, while providing comprehensive, consistent and cost-beneficial financial statements,” Caturano said.
Businesses may want to revisit financial reporting model
Many owner-managed companies that may have continued to follow GAAP because of the limitations of the other OCBOA alternatives likely will want to revisit the selection of their financial reporting model, potentially in favor of the FRF for SMEs.
There is no definition of what a small to medium-sized entity is. In fact, any private company can adopt the FRF for SMEs as an individual decision about what is the best financial reporting option for them.
When evaluating whether FRF for SMEs is the right choice, a thorough analysis of the initial conversion costs and the future potential costs and complexity that could occur if the entity is subsequently required to prepare GAAP-based financial statements should be weighed against the benefits of adopting the FRF for SMEs.
