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Home / Expert Opinion / Keeping Your Balance: Be on the lookout for FRF for SMEs

Keeping Your Balance: Be on the lookout for FRF for SMEs

Ryan Snyder

Ryan Snyder

The American Institute of Certified Public Accountants has accepted a new financial reporting framework referred to as Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). It is important to be familiar with this terminology and to be aware of some key differences from traditional accounting in accordance with Generally Accepted Accounting Principles.

The new framework is designed to simplify the financial reporting process and reduce excess costs of reporting for certain entities. The framework also removes certain accounting requirements and disclosures that can add complexity to financial statements without providing additional benefits to the financial statement users.

By design, there is no standard definition for SMEs as the framework’s authors wanted the standards to be flexible. Characteristics of a SME would be an entity with no plans to go public with financing agreements that allow for the framework to meet covenants. These financing agreements typically emphasize collateral, such as inventory, plant or compensating balances, as much as they consider the entity’s financial performance.

SMEs are typically owner managed, which means a closely held company in which the people who own a controlling interest in the entity are substantially the same people who run the company. This category represents the majority of businesses in the United States.

As noted above, FRF for SMEs is designed to provide for efficient, meaningful financial statements without the added complexity and costs of traditional GAAP financial statements. Some key differences include removing the requirement to assess long-lived assets for impairment. Assets no longer utilized in the business are written off. The assessment of impairment of long-lived assets can be costly and require independent appraisals or valuations.

The framework also provides for the removal of Other Comprehensive Income from the financial statements which is required in certain instances for GAAP. The display of OCI adds complexity to the financial statements and can often add confusion to the financial statement user trying to assess operating results. Investments are carried at cost except for those held for sale. These investments are marked to market through net income.

This is a simplified approach compared to GAAP, which requires three separate categories of investments with varying reporting requirements. Further, hedge accounting is eliminated by the framework with financial derivatives (e.g. interest rate swaps) are recognized at settlement, cash basis. No assets or liabilities are recorded on the balance sheet, however, disclosures are required.

FRF for SMEs provides the option for entities to utilize the equity method of accounting for subsidiaries where the entity has a controlling interest versus full consolidation as required by GAAP. This results in a simplified approach. Further, it does not consider the impact of variable interest entities. The GAAP requirement to consolidate variable interest entities had many consequences for smaller private companies who have separate entities set up to own real estate for tax and liability purposes.

This requirement introduced many complexities into the financial reporting process and arguably reduced the quality of financial reporting by clouding up the financial results of the standalone operating company. Entities that did not consolidate variable interest entities were then subject to modified audit opinions with additional disclosure requirements.

Another simplification is that FRF for SMEs considers all intangible assets to have finite lives with goodwill being amortized over 15 years. This allows for companies to amortize these assets over a set period versus hanging them up on the balance sheet for perpetuity as required by GAAP. The framework also removes the impairment testing requirement which can be very complex and again require outside experts to provide valuations.

In conclusion, the reduction in financial reporting complexities could prove to be beneficial to entities without the need for full GAAP financial statements. The reduction in costs could also prove to enhance the quality of financial reporting by removing certain disclosure and reporting requirements that can prove to be confusing to the financial statement users. As many covenants in financing agreements require GAAP financial statements, the framework will require the backing of financial institutions, but their wide spread acceptance has yet to be seen.

Ryan Snyder, CPA, is a manager at Mengel, Metzger, Barr & Co. LLP. He can be reached at Rsnyder@mmb-co.com.