100.4 In addition, the authors believe converting from the cash, modified cash, or tax basis of

Transcription

1 Checkpoint Contents Accounting, Audit & Corporate Finance Library Editorial Materials Accounting and Financial Statements (US GAAP) Financial Reporting Framework for SMEs Chapter 1 Introduction and Overview 100 Introduction 100 Introduction Preparers and users of financial statements of small- and medium-sized entities generally agree that the financial reporting needs of those entities are unique. While the notion of generally accepted accounting principles is appealing, there is considerable frustration with the application of current authoritative accounting literature GAAP to small- and medium-sized entities. Recent accounting pronouncements have heightened that frustration. Their scope has been broad, without clearly distinguishing between the plain vanilla transactions of small- and medium-sized entities and the complex transactions of large entities. In addition, the standards have been written in such a way that understanding how to apply them to small- and medium-sized entities can be difficult On June 10, 2013, the AICPA issued a new, optional financial reporting framework, referred to as the Financial Reporting Framework for Small- and Medium-Sized Entities, to provide a GAAPalternative for those entities. (The AICPA refers to the new framework as FRF for SMEs while the authors also refer to it as the Framework. ) Although this new simplified Framework provides another tool in the CPA's arsenal for meeting the needs of small- and medium-sized clients and their financial statement users, like most things new, it may take time to achieve acceptance. The Framework has been somewhat controversial since its release, with some welcoming it while others warn against it. This Guide is intended to familiarize practitioners with the new Framework so that they can provide appropriate information to their clients to make decisions about whether to implement it. If the decision to implement is made, this Guide provides detailed guidance on converting from GAAP to the FRF for SMEs This Chapter provides an introduction to and overview of the new Framework, discusses the conversion process, and outlines the steps in the implementation process. The remainder of this Guide provides a detailed discussion of differences between the FRF for SMEs and traditional U.S. GAAP, along with related conversion guidance and examples, by financial statement area. The authors assume that users of this Guide are familiar with GAAP. Therefore, financial statement areas for which the FRF for SMEs is the same as GAAP are not addressed. For guidance on traditional GAAP in those areas, users can refer to PPC's Guide to Preparing Financial Statements or PPC's Guide to GAAP In addition, the authors believe converting from the cash, modified cash, or tax basis of 1/40

2 accounting to the FRF for SMEs will not be common because, if financial statement users already accept statements prepared on a comprehensive basis of accounting other than GAAP, then converting to the new Framework is not likely to be beneficial and may be more costly. For example, an entity converting from the tax basis of accounting would be required to keep two sets of books one for tax and another for financial reporting. Therefore, this Guide does not address differences between FRF for SMEs and the cash, modified cash, or tax basis of accounting or converting from those bases. For guidance on the cash, modified cash, and tax bases of accounting, users can refer to PPC's Guide to Cash, Tax, and Other Bases of Accounting Thomson Reuters/PPC. All rights reserved. 2/40

3 END OF DOCUMENT Thomson Reuters/Tax & Accounting. All Rights Reserved. 3/40

4 Checkpoint Contents Accounting, Audit & Corporate Finance Library Editorial Materials Accounting and Financial Statements (US GAAP) Financial Reporting Framework for SMEs Chapter 1 Introduction and Overview 101 Background of the FRF for SMEs 101 Background of the FRF for SMEs There are two ways for preparers and users of financial statements of small- and mediumsized entities to address the frustrations involved in applying GAAP. One is for the authoritative accounting literature to be changed so it can be applied differently depending on the needs of those entities, which was recommended by the Blue-Ribbon Panel on Standard Setting for Private Companies in January Another is for the entity to prepare its financial statements using an 1 accounting framework other than GAAP Activity is currently underway on both fronts. The Private Company Council is working with the Financial Accounting Standards Board (FASB) to develop exceptions and modifications to existing GAAP where needed to address the needs of private company financial statement users. Then, the AICPA has developed its new, optional reporting framework that provides another GAAP-alternative for small- and medium-sized entities. This section provides an overview of that activity, including the following: Activities of the Private Company Council. Development of the FRF for SMEs. Initial reaction to the FRF for SMEs. Activities of the Private Company Council In May 2012, the Financial Accounting Foundation (FAF), which oversees FASB, established the Private Company Council (PCC). The PCC was asked to determine whether exceptions or modifications to existing GAAP are needed to address the needs of private company financial 4/40

5 statement users and to function as the primary advisory body to the FASB as they consider modifications of existing projects for private company concerns Through April 2014, the FASB released for public comment the following four alternatives within U.S. GAAP proposed by the PCC to address concerns of private company stakeholders: Proposed Accounting Standards Update, Intangibles Goodwill and Other (Topic 350): Accounting for Goodwill (a proposal of the Private Company Council). This proposal would allow private companies to amortize goodwill over a period of time not to exceed 10 years and provide a more simplified goodwill impairment model, instead of requiring an annual assessment of whether goodwill has been impaired. Proposed Accounting Standards Update, Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable Pay-Fixed Interest Rate Swaps (a proposal of the Private Company Council). This proposal would allow private companies to use a simpler approach to accounting for receive-variable, pay-fixed interest rate swaps, often referred to as plain vanilla interest rate swaps. Proposed Accounting Standards Update, Consolidation (Topic 810): Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements (a proposal of the Private Company Council). This proposal would permit a private company to elect not to apply variable interest entity guidance for assessing whether it should consolidate a lessor entity when certain criteria are met. Proposed Accounting Standards Update, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (a proposal of the Private Company Council). This proposal would allow private companies to not separately recognize certain intangible assets (such as customer relationship intangibles) acquired in a business combination In the first quarter of 2014, the first three proposed ASUs discussed in the preceding paragraph were issued as final ASUs: ASU , Accounting for Goodwill, provides an accounting alternative for goodwill by allowing nonpublic entities to elect to amortize goodwill using straight-line amortization over 10 years or less than 10 years if the entity determines that a shorter period is more appropriate. This accounting alternative, if elected, should be applied prospectively to goodwill existing as of the beginning of the period of adoption and new goodwill recognized in annual periods beginning after December 15, However, early application is permitted, including application to any 5/40

6 period for which the entity's annual or interim financial statements have not yet been made available for issuance. ASU , Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps Simplified Hedge Accounting Approach, provides a simplified hedge accounting approach for private companies that enter into certain plain vanilla interest rate swaps solely to convert variable-rate debt to a fixed rate. The ASU allows these swaps to be measured at settlement value rather than fair value, and the hedge documentation can be completed up to the date that the first annual financial statements are available to be issued. ASU is effective for annual periods beginning after December 15, 2014, with early adoption permitted. ASU , Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements, provides an option for a private company lessee to elect to not apply the VIE guidance in GAAP to a lessor entity if certain criteria are met. In that case, the reporting entity would not have to consolidate the lessor entity. This alternative is effective for annual periods beginning after December 15, 2014, with early adoption permitted. Development of the FRF for SMEs The notion of financial reporting frameworks other than GAAP is certainly not new, but their use by small- and medium-sized entities has increased dramatically. That likely is in response to frustration with changes in GAAP. GAAP is designed to account for transactions according to their economic substance. The three other financial reporting frameworks used most often by small- and medium-sized entities the income tax basis, the pure cash basis, and the modified cash basis have different objectives. a. The income tax basis is designed to account for transactions according to positions taken for filing with taxing authorities, which are not always designed to account for their economic substance. For example, rather than depreciating the cost of equipment over its estimated useful life in a systematic and rational manner, depreciation may be accelerated under economic incentives such as bonus depreciation and expanded Section 179 deductions. The tax basis of accounting is useful for entities whose financial statement users are interested primarily in the tax aspects of their relationship with the entity, for example, investors in tax-driven partnerships. b. The pure cash basis is designed to account for transactions based only on when they affect cash. The pure cash basis of accounting may be appropriate when the entity is interested primarily in understanding cash flow, has a limited number of financial statement users, relatively 6/40

7 simple operations engaged in one primary activity, and insignificant amounts of debt, fixed assets, or other items that would be recognized under the accrual basis. Examples of typical entities using this method include estates, trusts, political and civic organizations, and professional service entities. c. Even though modifications of the pure cash basis are made to conform to GAAP, the modified cash basis is designed primarily to account for transactions according to when they affect cash In an effort to propose a solution to the issue of differing objectives, the AICPA decided to provide small- and medium-sized entities another alternative to GAAP. On June 10, 2013, the AICPA released its Financial Reporting Framework for Small- and Medium-Sized Entities. A stated objective of the Framework is to account for transactions according to their economic substance, the same objective as GAAP The AICPA's new Framework is different from the actions being taken by the PCC, as the PCC's efforts, as approved by the FASB, actually amend GAAP. The FRF for SMEs is another alternative when GAAP is not required, but it does not modify existing GAAP. Reaction to the FRF for SMEs The new Framework has been met with mixed reactions. In fact, some constituents have been highly critical of the new Framework. Several of the 76 comment letters that the AICPA received on the exposure draft of the FRF for SMEs expressed dissatisfaction with the process and/or the result of the AICPA's efforts. Many respondents to the Exposure Draft expressed their support for GAAP financial statements, especially given the progress the PCC is making to modify GAAP for private companies. Other critics of the Framework have voiced concern that another special purpose framework will only add confusion to the marketplace due to the number of options available. In addition, the Institute of Management Accountants expressed concerns about the use of the new Framework, and FAF clarified its May 2012 support of the Framework project to make it clear that it has not taken a position on the substance of the Framework and now has concerns about the possibility that some may confuse the Framework with GAAP In the fall of 2013, the Tax & Accounting business of Thomson Reuters conducted a survey about the new Framework. Forty-six percent of the 213 respondents to the survey were familiar with the Framework. Those who were familiar with the Framework were asked what they expect the biggest challenge to be for acceptance of the Framework. Forty percent believe that acceptance by lenders will be the biggest challenge, while 31% think it will be acceptance and understanding by the firm, and 29% believe it will be acceptance by clients. Finally, 56% of respondents said they expect that one or more of their clients will consider using the FRF for SMEs, 10% said they do not expect their clients to use the Framework, and 34% were unsure While there have been a number of critics, many practitioners who deal with the challenges of 7/40

8 complexity on a daily basis have expressed support for the new Framework and have applauded the AICPA's efforts to provide a more comprehensive alternative to GAAP. The authors have spoken with a number of practitioners who intend to further evaluate using the new Framework. This Guide is intended for those practitioners. 1 GAAP encompasses U.S. GAAP, International Financial Reporting Standards (IFRS), and IFRS for SMEs. IFRS for SMEs was developed by the International Accounting Standards Board as a simplified, cost-effective financial reporting framework for small- and medium-sized entities that is more targeted and less prescriptive than IFRS. IFRS for SMEs is outside the scope of this Guide Thomson Reuters/PPC. All rights reserved. 8/40

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10 Checkpoint Contents Accounting, Audit & Corporate Finance Library Editorial Materials Accounting and Financial Statements (US GAAP) Financial Reporting Framework for SMEs Chapter 1 Introduction and Overview 102 Overview of the FRF for SMEs 102 Overview of the FRF for SMEs So what exactly is this new Framework? The AICPA explains that the FRF for SMEs is a selfcontained framework that was created to help owner-managed businesses provide relevant, streamlined reporting for users of their financial statements. As with GAAP, historical cost is the primary measurement basis. However, while recurring and nonrecurring adjustments for unrealized changes in value are required in certain circumstances, those circumstances are more limited than the circumstances requiring adjustments in GAAP. There are also several similarities to the accrual income tax basis. For some accounting policies, the Framework allows alternatives so that smalland medium-sized entities can select the policy they believe best meets the needs of the users of their financial statements The Framework is also more principles based, so entities using the Framework should expect to encounter situations where professional judgment is necessary to select among measurement or disclosure alternatives. Generally, the Framework was developed to address transactions typically encountered by private, for-profit, small- and medium-sized entities. If a transaction, or other condition or event is not addressed in the Framework, then professional judgment needs to be used to apply the general principles, concepts, and criteria contained in the Framework. As a result, two entities that enter into the same transaction may choose to measure or disclose the transaction differently depending on their judgment, and both treatments may be considered appropriate for the transaction. The Framework does not include industry-specific guidance Practitioners have historically requested that more specific guidelines and examples be included in the accounting literature, so a framework that is more principles based will require a change in mindset as practitioners encounter issues and transactions that are not specifically addressed in the Framework. To assist with that issue, the Framework includes guidance on applying its principles and concepts. The entity's development and application of accounting policies should result in financial information that is consistent with the financial statement concepts described in Chapter 1 of the FRF for SMEs. That guidance is discussed in Chapter 2 of this Guide This section provides an overview of the FRF for SMEs, including the following: 10/40

11 Structure and content of the FRF for SMEs. Definition of an SME. Key differences from GAAP. Presentation and disclosure requirements. Frequency of making changes to the Framework. Structure and Content of the FRF for SMEs The FRF for SMEs is a 206-page document that outlines the principles and specific requirements for applying the Framework. It is divided into 31 chapters and a glossary. The first three chapters address general requirements and principles, including transition guidance. Subsequent chapters provide guidance on specific financial statement elements. Chapter topics, which are somewhat similar to the Financial Accounting Standards Codification, are listed in Exhibit 1-1. Chapter 1: Financial Statement Concepts Exhibit 1-1 Contents of the FRF for SMEs Chapter 2: General Principles of Financial Statement Presentation and Accounting Policies Chapter 3: Transition Chapter 4: Statement of Financial Position Chapter 5: Current Assets and Current Liabilities 11/40

12 Chapter 6: Special Accounting Considerations for Certain Financial Assets and Liabilities Chapter 7: Statement of Operations Chapter 8: Statement of Cash Flows Chapter 9: Accounting Changes, Changes in Accounting Estimates, and Correction of Errors Chapter 10: Risks and Uncertainties Chapter 11: Equity, Debt, and Other Investments Chapter 12: Inventories Chapter 13: Intangible Assets Chapter 14: Property, Plant, and Equipment Chapter 15: Disposal of Long-Lived Assets and Discontinued Operations Chapter 16: Commitments Chapter 17: Contingencies 12/40

13 Chapter 18: Equity Chapter 19: Revenue Chapter 20: Retirement and Other Postemployment Benefits Chapter 21: Income Taxes Chapter 22: Subsidiaries Chapter 23: Consolidated Financial Statements and Noncontrolling Interests Chapter 24: Interests in Joint Ventures Chapter 25: Leases Chapter 26: Related Party Transactions Chapter 27: Subsequent Events Chapter 28: Business Combinations Chapter 29: New Basis (Push-Down) Accounting Chapter 30: Nonmonetary Transactions 13/40

14 Chapter 31: Foreign Currency Translation Glossary Chapters within the Framework are further divided into subtopics, with guidance on purpose and scope, recognition, measurement, and disclosure. This Guide provides references to specific chapters and paragraphs within the Framework using the format FRF SME #.##. For those customers that also purchase access to the Framework on Checkpoint, links exist between this Guide and the Framework. What Is the Definition of an SME? An entity may choose whether to adopt the Framework. When evaluating that option, the entity might question whether it meets the definition of an SME. However, the Framework does not define a small- and medium-sized entity, and there are no size thresholds to meet for an entity to be an SME. The Framework indicates that an entity may be incorporated or unincorporated, and it should also be a going concern. Exhibit 1-2 provides some other characteristics included in the Framework of entities that would be considered SMEs, although this list is not all-inclusive and the criteria are not required to be met. Exhibit 1-2 Characteristics of Small- and Medium-Sized Entities The entity is not required to prepare GAAP-based financial statements. The entity has no plans to go public in the foreseeable future. The entity is a for-profit entity. The owner(s) of the entity is (are) also the person(s) who runs the entity. There is no highly-specialized accounting guidance for the industry in which the entity operates. 14/40

15 (For example, financial institutions and governments have highly-specialized accounting guidance and would not meet that criterion.) There are no overly complicated transactions. There are no significant foreign operations. The financial statement users have direct access to management. The financial statement users are normally interested in the entity's cash flows, liquidity, interest coverage, and balance sheet strength It is important to note that not all of these criteria are required to be met for an entity to choose to use the Framework. For example, some not-for-profit entities may choose to adopt the FRF for SMEs even though the criteria say that the entity should be a for-profit entity. However, specific guidance for not-for-profit entities is not included in the FRF for SMEs. The authors believe there may be some not-for-profit entities that could use the FRF for SMEs. For example, not-for-profit entities that are not impacted by specialized accounting guidance on contributions and net asset classifications may find this to be an appropriate framework. That could include organizations such as country clubs or trade associations. Nevertheless, the authors believe state regulatory agencies and watchdog groups are not likely to be familiar with the FRF for SMEs and would likely not accept financial statements of not-for-profit entities prepared using the FRF for SMEs. What Are the Key Differences From GAAP? Much of the guidance in the FRF for SMEs is very similar to the requirements contained in GAAP. However, there are several important differences that may make it easier to prepare financial statements using the new Framework. For example, the differences in the requirements for recognizing changes in fair value is expected to be one of the most significant cost-saving features of the Framework, as fair value estimates are often time-consuming and costly to prepare. The table in Exhibit 1-3 presents the differences between GAAP and the FRF for SMEs that the authors consider to be most significant. Those differences are discussed in detail in subsequent chapters of this Guide. Exhibit /40

16 Significant Differences between GAAP and the FRF for SMEs Accounting Area FRF for SMEs Treatment GAAP Treatment Accounting for income taxes Entities subject to income taxes are allowed to elect whether to use the taxes payable method or the deferred income taxes method. The taxes payable method only recognizes current income tax assets and liabilities (i.e., the amount that would be payable or receivable as reflected on the income tax return). Uncertainty in income taxes cannot be considered in accounting for income taxes. The deferred income tax method must be used, and uncertainty in income taxes must be considered in accounting for income taxes. Accounting for intangible assets acquired in a business combination Amortization of goodwill Reporting of subsidiaries Accounting for and reporting of variable interest entities (VIEs) Entities may choose whether they will separately recognize identifiable intangible assets or not separately recognize them but rather account for them as goodwill. Entities are required to amortize goodwill over a period consistent with that used for federal income tax purposes, or over a period of 15 years if goodwill is not amortized for federal income tax purposes. A parent entity may choose whether to consolidate or use the equity method to account for its subsidiaries. However, the same method of reporting must be applied to all subsidiaries. That guidance essentially allows parent-only financial statements. The concept of VIEs is not included. Therefore, a reporting entity that is the Identifiable intangible assets acquired in a business combination must be separately recognized at the acquisition date. After the issuance of ASU , Accounting for Goodwill, entities may elect to amortize goodwill over a period of up to 10 years, or use the existing method of not amortizing but instead assessing for impairment on an annual basis, although the assessment may be qualitative. All subsidiaries must be consolidated if the parent exhibits control over the entities. GAAP allows parent-only financial statements to be presented only when the entity also presents related consolidated financial statements. A reporting entity that is the primary beneficiary of a VIE is required to consolidate the VIE, 16/40

17 Accounting for leases primary beneficiary of a VIE is not required or allowed to consolidate the VIE. Accounting for leases by both lessees and lessors is similar to how an entity would account for its leases for tax purposes. Basically, the Framework provides that if a lease transfers substantially all of the benefits and risks of ownership to the lessee, the lease is a capital lease; if not, it is an operating lease. unless the criteria under ASU are met and that guidance is applied. More stringent tests are required to determine the proper classification of a lease. Accounting for stock-based compensation Accounting for defined benefit plans Impairment of assets Compensation expense should not be recognized when stock is issued to employees in lieu of cash compensation, but certain disclosures are required. Entities with defined benefit plans are allowed to elect whether to use the current contributions payable method or one of the accrued benefit obligation methods. The current contributions payable method would only reflect expense for the current year's contribution. A reduction of the carrying amount of inventories for impairment is required, if applicable. However, the need to adjust the carrying amounts of other assets for subsequent impairment is not addressed. It is, therefore, not clear whether the need for those adjustments should be considered. (As an observation, the exposure draft of the FRF for SMEs required impairment adjustments that were generally the same as those required by GAAP.) Compensation expense should be recognized at the grant-date fair value of the securities, less any amount paid or to be paid by the employee, and certain disclosures are also required. The net periodic pension cost, comprised of several different components, is required to be recognized each year with the overfunded or underfunded status of the plan being recognized on the balance sheet. Impairment adjustments are required for loans and accounts receivable, inventories, and intangible and other long-lived assets. 17/40

18 Recurring adjustments for changes in the value of debt and equity investments Recurring adjustments are required of the carrying amount of debt and equity investments that management is currently attempting to sell for changes in their market 2 value. Those changes in market value during each period are recognized in net income. If the securities are not held for sale, they are recorded at historical cost. Recurring adjustments are required of the carrying amount of marketable debt and equity securities for changes in their fair value. Changes in fair value for marketable securities classified as available for sale are reported in other comprehensive income rather than net income. Presentation and Disclosure The FRF for SMEs is a fair presentation framework. That means the financial statements, including the notes to the financial statements and any supporting schedules, should include all of the information necessary for a fair presentation of the financial position, results of operations, and cash flows of the entity in accordance with the Framework. Fair presentation involves faithfully representing the substance of transactions and other events underlying the financial statements The following are done to achieve fair presentation in accordance with the Framework: Apply the Framework. Exercise professional judgment to provide sufficient information about transactions or events affecting the entity's financial position, results of operations, and cash flows for the periods presented that are of a size, nature, and incidence that disclosure is necessary to understand their effects. Provide information that is clear and understandable. The following paragraphs discuss the general requirements for presentation and disclosure under the Framework. A disclosure checklist is provided at Appendix 4A Presentation Both GAAP and the new Framework state that financial statements normally include a statement of 18/40 3

19 3 financial position, a statement of operations, a statement of changes in equity, and a statement of cash flows, although the titles of the statements may be slightly different. For example, the statement of financial position may be titled the statement of assets, liabilities, and equity, and the statement of 4 operations may be titled the statement of revenue and expenses. It is acceptable to present an individual financial statement, but if a statement of financial position and statement of operations are presented, then a statement of cash flows must also be presented. However, a difference is that GAAP also includes a statement of comprehensive income, when applicable, and the new Framework does not include the concept of comprehensive income Financial statements may be presented on a comparative basis. However, comparative information may not be meaningful in certain circumstances, such as when the entity's financial structure has changed significantly or when assets and liabilities have been revalued following a business combination to establish a new cost basis Much like GAAP, the classification of items in the financial statements should enhance their understandability. If the classification of an item in current period financial statements differs from its classification in prior periods, for example, as a result of a change in the allocation or grouping of items within or among categories, the item should be reclassified in the financial statements of the prior period to conform to the new presentation. Such a change in classification is a matter of presentation and is not by itself a change in accounting policy. Items not significant by themselves may be grouped with other items closest to their nature Disclosure Notes to financial statements, and supporting schedules to which the financial statements are crossreferenced, are used to clarify or further explain the items in the financial statements. The FRF for SMEs indicates that information in the financial statements should clearly convey the nature, extent, and significant terms and conditions of the related transactions or events, as well as their financial effects on the periods presented. The terminology used should be easily understandable. Generally, disclosures required by the Framework are streamlined to avoid excess detail, complexity, and irrelevant information Notes and supporting schedules cross-referenced to the financial statements have the same significance as information or explanations set out directly in the body of the financial statements. As with GAAP, they are considered an integral part of the financial statements. The information conveyed by every note or supporting schedule should be consistent with the accounting treatment given to the specific item to which it relates. However, disclosure is not an appropriate substitute for proper accounting treatment Practitioners often cite disclosure overload as a major contributing factor to the complexity of preparing financial statements. Many of the disclosures required by traditional GAAP are not considered by some to be relevant to users of the financial statements of small- and medium-sized entities. They believe the disclosures for those entities need to be more targeted based on the presumption that financial statement users are familiar with and knowledgeable of the entity and have 19/40

20 direct access to management. Therefore, financial statement disclosures serve primarily to confirm and supplement users' existing knowledge and expectations about the business Although disclosure requirements under the FRF for SMEs are significantly less than disclosure requirements in traditional GAAP, this reduction in disclosures is not due to an arbitrary elimination of disclosure requirements by the developers of the FRF for SMEs. Rather, it stems primarily from the simplified accounting provided in the Framework. For example, because the Framework does not include the concept of VIEs, there are no specific disclosure requirements related to those entities. However, some disclosure may still be necessary to achieve fair presentation under the Framework and meet user needs. As previously stated, an overriding principle of the FRF for SMEs is that financial statements should include all of the information necessary to achieve fair presentation under the Framework. Absent specific disclosure requirements, the accountant uses professional judgment to determine the extent of information that is necessary. In many cases, the authors believe that information can be provided by describing significant transactions in narrative form The Framework discusses throughout the document the most important disclosures that are 5 needed by financial statement users of small- and medium-sized entities. If practitioners are reporting on financial statements prepared in accordance with this new Framework, the compilation, review, and auditing literature provides further guidance on the adequacy of disclosures needed in special purpose framework financial statements. That literature requires disclosure of the differences between the special purpose framework and GAAP. That literature also requires that when special purpose financial statements include items that are the same as or similar to those in financial statements prepared under GAAP, the practitioner should evaluate whether the special purpose financial statements include informative disclosures similar to those required by GAAP. Also, the auditing literature requires the auditor to evaluate whether additional disclosures, beyond those specifically required by the framework, that are related to matters not specifically identified on the face of the financial statements, or other disclosures, are necessary for the financial statements to achieve fair presentation. This topic is discussed in greater depth in chapter Disclosing Differences from GAAP. The Framework requires the notes to the financial statements to prominently state the basis of accounting used to prepare the financial statements. It also notes that entities may want to describe in the notes how the basis differs from GAAP since some reporting standards (such as AU-C 800) require practitioners to evaluate whether the disclosures adequately describe those differences. The Framework provides further guidance on the tailoring of those disclosures if the differences are described Since the compilation, review, and auditing literature all require disclosure of the differences between the special purpose framework and GAAP, the authors believe the wording used in the new Framework could create confusion among practitioners about what is required to be disclosed. Accordingly, practitioners who are reporting on financial statements prepared under the new Framework should ensure that those statements adequately disclose the differences from GAAP. 20/40

21 How Frequently Will Changes Be Made to the Framework? One of the difficulties in using GAAP is staying current with the changes the FASB makes to the FASB Codification through Accounting Standards Updates (ASUs). For example, in 2013 the FASB issued 12 ASUs. The AICPA's plan is to have fewer, less frequent updates of the Framework. The AICPA may provide revisions to address input received during the implementation of the Framework. After that time, their plan is to make updates/revisions every three to four years. That planned schedule will make it easier on small and medium-sized entities and their accountants and auditors to keep up with changes. 2 The FRF for SMEs uses the term market value rather than the term fair value that is used in GAAP. Although the definitions of the two terms might appear to be very similar, the authors believe entities are not required to use the guidelines for measuring fair value found in FASB ASC when determining the market value of investments held for sale. See Chapter 3 for further discussion. 3 Changes in equity may be disclosed in the notes to the financial statements or as part of another financial statement. 4 Judgment is required when selecting specific financial statement titles. The guidance in AU-C and.a17 indicates that titles of OCBOA financial statements should differ from those for similar statements prepared in accordance with GAAP so that there is no implication that the statements are presented in conformity with GAAP. Accordingly, the authors believe that financial statements prepared under the new Framework should not use GAAP titles to avoid confusing users of the financial statements about the basis on which they are prepared. See further details in Chapter 4. 5 Depending on the industry, other users may request additional information to be included as part of the basic financial statements or as supplementary information. For example, bonding agencies may request a schedule of contracts in progress Thomson Reuters/PPC. All rights reserved. 21/40

22 END OF DOCUMENT Thomson Reuters/Tax & Accounting. All Rights Reserved. 22/40

23 Checkpoint Contents Accounting, Audit & Corporate Finance Library Editorial Materials Accounting and Financial Statements (US GAAP) Financial Reporting Framework for SMEs Chapter 1 Introduction and Overview 103 Converting to FRF for SMEs 103 Converting to FRF for SMEs Small- and medium-sized entities can choose to adopt the Framework at any time now that it has been released; that is, there is no effective date. However, several issues need to be considered before making the decision to convert. Once a decision has been made to convert to the FRF for SMEs, the remaining steps in the conversion process include the following: Deciding when to convert. Performing the conversion. The remainder of this section discusses the issues the authors believe are most important when deciding whether to convert, and the process of transitioning to the new Framework once a conversion decision is made. Section 104 discusses other steps in the implementation process, including training staff and educating and informing clients and financial statement users. Deciding Whether to Convert The AICPA has no authority to prevent or require the use of a special purpose framework, such as the FRF for SMEs. Thus, its use is entirely optional. Ultimately, the decision about whether to convert to the FRF for SMEs in the preparation of financial statements rests with management. Making that decision primarily involves consideration of the following matters: Whether financial statement users will accept financial statements prepared under the new Framework. Whether the entity is a viable candidate for conversion. 23/40

24 103.3 Acceptance of the Framework by Financial Statement Users The financial statements of small- and medium-sized entities are typically used in the following ways: Management and owners of the entity use the financial statements to confirm their understanding of the entity's performance, its cash flows, and what the entity owns and owes. External users of the entity's financial statements generally focus their attention on cash flows, liquidity, statement of financial position strength, and interest coverage. The entity's financial statements are often used to support an application for bank financing when the banker does not rely solely on the financial statements to make the lending decision. He or she also considers available collateral or makes other evaluations outside the financial statements The biggest question that currently looms over the Framework is whether financial statements prepared under the Framework will be accepted by financial statement users, primarily banks and other financing sources. The Framework is not intended to be a substitute for GAAP when users require GAAP-based financial statements. For example, many banks have historically included provisions in loan covenants requiring entities to provide financial statements prepared in accordance with GAAP, so many small- and medium-sized entities had no choice. For those entities to be in a position to consider adopting the FRF for SMEs, their banks must be willing to accept financial statements prepared on that basis. For some entities, the financial statement users include others in addition to bankers, such as sureties for some construction contractors. Thus, consideration of whether financial statement users will accept financial statements prepared under the new Framework is of paramount importance. That determination needs to be made before significant effort is spent on the conversion process. Practitioners may consider the following questions: Do legal or regulatory reporting requirements mandate the use of GAAP-based financial statements? Do loan covenants or other agreements currently allow for financial statements prepared on a basis of accounting other than GAAP or can they be amended to allow that alternative? Are the financial statements currently prepared on an OCBOA (such as the tax basis) and 24/40

25 would the Framework better meet the needs of the users? Are topics contained in GAAP and omitted from the Framework, such as fair value accounting, deferred income tax accounting, or other comprehensive income, particularly relevant to the entity and its financial statement users? Section 104 discusses steps that might be taken to inform or educate financial statement users about the new Framework as part of gaining acceptance Identifying Candidates for Conversion Assuming financial statement users would accept or permit financial statements prepared on a basis of accounting other than GAAP, another important consideration when making the decision to convert is whether the entity is a viable candidate for conversion. The Framework may be appropriate for small- and medium-sized entities in many industry groups and may be used by unincorporated, as well as incorporated, entities. The Framework should be used only by an entity that is a going 6 concern Developers of the Framework intentionally did not provide quantified size criteria for determining what constitutes a small- and medium-sized entity. They concluded that a quantified size test was not feasible and not an effective way of describing the kinds of entities for which the Framework is intended. Although the Framework does not define an SME, it outlines certain characteristics of those entities. Paragraph discusses the characteristics of small- and medium-sized entities considered potential candidates for conversion. As stated previously, those characteristics are not all-inclusive and not presented as a list of required characteristics. Exhibit 1-4 provides a decision tree based on those characteristics that may be helpful when deciding whether the entity is a potential conversion candidate. Exhibit 1-4 Decision Tree for Identifying Candidates for Conversion to FRF for SMEs 25/40

26 Deciding When to Convert Because the Framework is not authoritative, it has not been acted upon, approved, or disapproved by any senior technical committee of the AICPA or FASB. As such, it has no effective date and the AICPA cannot mandate its use. But, as previously mentioned, small- and medium-sized entities can choose to adopt it at any time now that it has been released. In addition, accountants and 26/40

27 auditors can report on compiled, reviewed, or audited financial statements prepared using the Framework since it meets the criteria found in AU-C 800 Special Considerations Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks, and AR 60 Framework for Performing and Reporting on Compilation and Review Engagements, for a special purpose framework Deciding when to convert involves choosing a date of transition. The Framework defines the date of transition to the FRF for SMEs accounting framework as the beginning of the earliest period for which an entity presents financial statements under the FRF for SMEs accounting framework. The Framework does not prohibit the earliest period presented from being a prior period. For example, as of December 31, 2013, an entity decides to convert to the FRF for SMEs. The entity may choose January 1, 2012 as the date of transition to the Framework so that a complete set of comparative financial statements can be presented under the Framework. However, the Framework also does not prohibit presenting financial statements for only the current year. Thus, the entity could select January 1, 2013, as the date of transition and present only single period financial statements under the Framework. Therefore, the selection of a transition date includes consideration of whether the entity desires to present comparative or only single period financial statements The Framework (FRF SME 3.01) indicates that financial statements should contain comparable information for all periods presented. Therefore, it is not appropriate to present financial statements under the Framework in comparative form with prior period financial statements prepared under GAAP or another basis of accounting. Performing the Conversion After the decision has been made to convert and a transition date selected as discussed in the previous paragraphs, the following steps are performed to make the conversion: a. Establish accounting policies to be used under the Framework. b. Prepare the opening statement of financial position. c. Prepare and present financial statements under the Framework, including appropriate transition disclosures. Comprehensive conversion illustrations are included at Appendix 5A and Appendix 5B Accounting Policies An entity selects accounting policies to be used in preparing its opening statement of financial position and throughout all periods presented in its first set of financial statements under the 27/40