And in This Corner – FRF for SMEs
FRF for SMEs stands for Financial Reporting Framework for Small and Medium-Sized Entities. It’s a non-authoritative, non-GAAP, special-purpose accounting framework developed by the AICPA almost a decade ago. It stands in contrast to U.S. GAAP (“GAAP”) and other special-purpose frameworks, such as the income tax and cash basis of accounting, which have been used for many decades.
The most appealing feature of FRF for SMEs is that it has much of the traditional look and feel of GAAP but without some more complex areas.
As promoted by the AICPA, FRF for SMEs was developed for small to medium-sized entities that require reliable non-GAAP financial statements for both internal and external purposes. A good fit, according to the AICPA, would include for-profit entities that:
- Are closely held;
- Don’t have regulatory reporting requirements that would require the use of GAAP;
- Have no intention of going public;
- Have management and owners that rely on financial statements to manage their business;
- Don’t operate in an industry requiring highly specialized accounting guidance, like banking;
- Don’t engage in complicated transactions;
- And do not have significant foreign operations.
As stated above, FRF for SMEs’ calling card is that it has much of GAAP that is familiar while excluding more complicated areas that may not significantly enhance the usefulness of the financial statements. For example, as explained by the AICPA, under the FRF for SMEs framework, there are:
- No other comprehensive income
- No VIEs
- No complicated accounting for stock compensation and derivatives
- No hedge accounting
- Disclosures are targeted and not excessive.
- Goodwill amortization is consistent with federal tax, with no impairment testing.
- All intangible assets are considered to have a finite life and amortized.
- It leans toward historical cost and away from the complications of fair value accounting. There are only limited market value measurements.
- There’s no impairment of long-lived assets.
- It’s a policy decision to either consolidate subsidiaries (with subsidiaries defined as greater than 50% ownership) or use the equity method for such subsidiaries.
- ASC 606 principles are not recognized for revenue recognition.
- ASC 842 principles are not recognized for lease accounting.
- In short, the AICPA intends that the framework have a look and feel of GAAP but, for clarity, be simplified and void of many complex and less informative areas found in GAAP.
Another benefit of FRF for SMEs is that even though it is not GAAP, it looks and feels more like GAAP than other special-purpose frameworks. And in many areas of the financial statements, the results are the same.
But there is a big caveat. Decision makers interested in switching from GAAP to FRF for SMEs should consider whether it will be acceptable to their end users of the financial statements. Many bankers, for example, may not be familiar with or even heard of FRF for SMEs. This, of course, would be a significant impediment to making such a change. Also, the impact on loan covenants must be considered. Many loan agreements require financial statements prepared under GAAP.
For those interested in exploring this more, the AICPA has placed extensive tools on its website.