The "Financial Reporting Framework for Small- and Medium-Sized Entities" (SME framework) from the American Institute of Certified Public Accountants (AICPA) is intended to ease reporting for smaller, privately held, owner-managed businesses that are not required to follow Generally Accepted Accounting Principles (GAAP). The goal of the framework is to help these businesses clearly and concisely report what they own, what they owe, and their cash flow.
Drawing on a blend of traditional methods of accounting and some accrual income tax methods, the SME framework addresses the issues and concerns stakeholders currently encounter when preparing financial statements for SMEs. The AICPA believes the SME framework to be a cost-efficient solution for management, owners, and others who require financial statements that are prepared in a consistent and reliable manner in accordance with a non-GAAP framework, one which has undergone significant public comment and professional scrutiny. Two of the most frequently used special purpose frameworks, the cash basis and tax basis of accounting, have not undergone such public exposure and professional scrutiny.
The SME framework has no official or authoritative status and the AICPA has made it clear that the SME framework is not meant to replace GAAP. It is for those entities that do not require GAAP reporting.
Advantages of the framework for non-GAAP businesses
In contrast to GAAP’s prescriptive, detailed standards and voluminous disclosure requirements, the new option is a streamlined framework providing the financial information that is relevant to owner-managed SMEs and their external stakeholders (including lenders), focused on the performance of the SME and its assets, liabilities, and cash flows. The key measures of a business and its creditworthiness that will be reported include profitability, cash available, and assets to cover expenses.
The framework is constructed of accounting principles particularly suited for a typical SME. It:
- Uses historical cost as its primary measurement basis; therefore, reducing the number of complicated fair value measurements required,
- Reduces book-to-tax differences,
- Does not require complicated accounting for derivatives, hedging activities, or stock compensation, and
- Targets its disclosure requirements to provide users of financial statements with the relevant information they need, while recognizing that those users can obtain additional information from management if they desire.
It also provides a degree of flexibility to allow SMEs to appropriately communicate their situations to financial statement users with those users’ specific needs in mind.
Who should use the framework?
The framework does not specifically define "SME" or provide quantified size criteria; however, the AICPA has identified several characteristics of typical entities that could use the SME framework – an entity that:
- Is not subject to regulatory reporting requirements that essentially require it to use GAAP-based financial statements,
- Does not intend to go public,
- Is for-profit,
- May be owner-managed, meaning a closely held company where the individuals with a controlling ownership interest are substantially the same people who run the company (as opposed to public companies where the ownership and the management are clearly separated),
- Has owners and managers who rely on a set of financial statements to confirm their assessments of performance, cash flows, what they own, and what they owe,
- Does not operate in an industry where it is involved in transactions that require highly specialized accounting guidance (for example, financial institutions or governmental entities),
- Does not engage in overly complicated transactions, and
- Does not have significant foreign operations.
Users of the entity’s financial statements are also considered in the AICPA’s cited characteristics. The framework could be appropriate if key users have direct access to the entity’s management and users are primarily interested in cash flows, liquidity, statement of financial position strength, and interest coverage. It could also be appropriate if the entity’s banker does not base lending decisions solely on financial statements, but also on available collateral or other evaluation mechanisms not directly related to the financial statements.
The framework is appropriate for entities in most industry groups and both unincorporated and incorporated entities. Moreover, the AICPA has stated that it does not intend to exclude entities that are not owner-managed from using the framework.
Additional private company proposals for GAAP businesses
On the same day the AICPA’s SME framework was released, the Financial Accounting Standards Board (FASB) endorsed three proposals from the Private Company Council (PCC) that would ease accounting requirements for privately held companies. The PCC is focused on modifications to GAAP for private companies that need or are required to have financial statements prepared in accordance with GAAP.
Both FASB and the PCC are working together through the Financial Accounting Foundation to identify opportunities to enhance the relevance to users and reduce the cost and complexity of preparing private company financial statements under GAAP.
The endorsed proposals would:
- Provide relief from requirements that certain intangible assets acquired in a business combination be separately recognized,
- Allow the amortization of goodwill and a simplified goodwill impairment model, and
- Allow two simpler approaches to accounting for certain types of interest rate swaps when a private company intends to economically convert the interest rate on its debt from variable to fixed.
Considering the AICPA’s SME framework
Due to the potential long-term implications of adopting the SME framework, companies should talk with their financial statement users and perform thorough analyses of adoption costs and benefits before reaching final conclusions on its appropriateness for their financial reporting needs.