Dallas CPA SocietyConvergence 2014

May 8, 2014Financial Reporting Framework for Small- and Medium Sized-Entities

James A. Smith, CPAManaging Director

Smith, Jackson, Boyer & Bovard, PLLC

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Financial Reporting Framework for Small- and Medium Sized Entities

“FRF for SMEs”• On June 10, 2013 the AICPA released the Financial

Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs for short).

• The exposure draft of FRF for SMEs was issued in the Fall 0f 2012 in response to a perceived need by all stakeholders of non-public, for-profit businesses for a financial reporting framework that was simpler than GAAP, yet still meaningful .

• Because use of the framework is optional, there is no effective date for its implementation.

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FRF for SMEs• FRF for SMEs is not GAAP and is not designed for

entities which have to report under GAAP.• It is a self-contained financial reporting framework not

based on U.S. GAAP. Special purpose frameworks, with the exception of the contractual basis of accounting, are commonly referred to as other comprehensive bases of accounting or OCBOA. Special purpose frameworks include cash basis, modified cash basis, tax basis, regulatory basis, contractual basis, and other non-GAAP bases of accounting that utilize a definite set of logical, reasonable criteria that is applied to all material items appearing in the financial statements.

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FRF for SMEs

• FRF for SMEs draws upon a blend of traditional accounting principles and accrual income tax methods of accounting, using historical cost as its primary measurement basis.

• FRF for SMEs is a cost-beneficial reporting option for management, owners, and others who require financial statements prepared in a consistent and reliable manner in accordance with a non GAAP framework that has undergone public comment and professional scrutiny.

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FRF for SMEsFRF for SMEs is designed to have the following

attributes:• Objectivity. The framework is free from bias. • Measurability. The framework permits reasonably

consistent measurements. • Completeness. The framework is sufficiently complete so

that those relevant factors that would alter a conclusion about the financial statements are not omitted.

• Relevance. The framework is relevant to financial statement users.

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FRF for SMEs• A standard definition of small- and medium-sized

entities does not exist in the United States.• Following are characteristics of typical entities that may

utilize the framework. These characteristics are not all-inclusive and are not presented as a list of required characteristics an entity must possess in order to utilize the framework. The AICPA has no authority to prevent or require the use of a special purpose framework like the FRF for SMEs accounting framework. Ultimately, the decision regarding which accounting framework best meets an entity’s financial reporting needs rests with management.

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FRF for SMEs• The entity does not have regulatory reporting requirements

that essentially require it to use GAAP-based financial statements.

• A majority of the owners and management of the entity have no intention of going public.

• The entity is for-profit.• The entity may be owner-managed, which is a closely held

company in which the people who own a controlling interest in the entity are substantially the same set of people who run the company.

• Management and owners of the entity rely on a set of financial statements to confirm their assessments of performance, cash flows, and of what they own and what they owe.

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FRF for SMEs• The entity does not operate in an industry requiring highly-

specialized accounting guidance, such as financial institutions and governmental entities.

• The entity does not engage in overly complicated transactions.• The entity does not have significant foreign operations.• Key users of the entity’s financial statements have direct

access to the entity’s management.• Users of the entity’s financial statements may have greater

interest in cash flows, liquidity, statement of financial position strength, and interest coverage.

• The entity’s financial statements support applications for bank financing when the banker does not base a lending decision solely on the financial statements but also on available collateral or other evaluation mechanisms not directly related to the financial statements.

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FRF for SMEsTable of Contents• Chapter 1: Financial Statement Concepts• 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 • 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

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FRF for SMEsTable of Contents (continued)• 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 • Chapter 18: Equity • Chapter 19: Revenue • Chapter 20: Retirement and Other Postemployment

Benefits

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FRF for SMEsTable of Contents (continued)• Chapter 21: Income Taxes • Chapter 22: Subsidiaries • Chapter 23: Consolidated Financial Statements and

Non-controlling 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 • Chapter 31: Foreign Currency Translation

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FRF for SMEs• Financial statements include the statement of financial

position, statement of operations, statement of changes in equity (changes in equity may be disclosed in the notes to the financial statements or as part of another financial statement), and statement of cash flows. The selection of specific financial statement titles is a matter of judgment, and the preceding titles are not the only acceptable titles (for example, the statement of financial position may be titled the statement of assets, liabilities, and equity, and the statement of operations may be titled the statement of revenue and expenses.) Notes to financial statements, and supporting schedules to which the financial statements are cross-referenced, are an integral part of such statements.

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FRF for SMEs• Supplementary information set out in other material

attached to, or submitted with, financial statements are not an integral part of the financial statements.

• Nothing in the FRF for SMEs accounting framework precludes management from using it to prepare a single financial statement, rather than a complete set of financial statements.

• Accounting treatments that are not in accordance with the FRF for SMEs accounting framework are not rectified either by disclosure of the accounting policies used or by information provided in notes or supporting schedules.

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FRF for SMEs• An entity that prepares its financial statements in

accordance with the FRF for SMEs accounting framework should state this basis of presentation prominently in the notes to its financial statements. Because some reporting standards (for example AU-C section 800, Special Considerations—Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks [AICPA, Professional Standards]) also require an auditor or practitioner to evaluate whether the financial statements adequately describe how the special purpose framework differs from accounting principles generally accepted in the United States of America, an entity may want to include a brief description of those primary differences.

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FRF for SMEs• The disclosure of a summary of accounting policies

should generally be the first note to the financial statements. Suitable titles include “Summary of Significant Accounting Policies” or “Accounting Policies.”

• FRF for SMEs should be used only by an entity that is a going concern. An entity that is not a going concern should prepare its financial statements on the liquidation basis of accounting.

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FRF for SMEsConversion/Transition to FRF for SMEs• As of the date of conversion to FRF for SMEs, the

converting entity should prepare an opening statement of financial position in accordance with the framework, recognizing, with three exception options, only assets and liabilities permitted under the framework and reclassifying components of assets, liabilities and equity to the extent their classification would be different under the framework.

• Management may elect to use exemptions related to one or more of the following:a. Business combinationsb. Financial assets and liabilitiesc. Asset retirement obligations

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FRF for SMEs• In conversion to the framework, FRF for SMEs prohibits

(with limited exceptions) retrospective application of some aspects of other principles relating toa. de-recognition of financial assets and liabilities;b. estimates; andc. non controlling interests.

• A entity should disclose the amount of each charge or credit to equity at the date of transition to the FRF for SMEs accounting framework resulting from the adoption of these principles and the reasons therefore. If the date of transition is earlier than the current period so that prior period financial statements can be presented, those prior year financial statements need to be restated to conform to the framework.

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FRF for SMEs• The Statement of Financial Position (Balance Sheet)

1. Follows the traditional format and categories of assets, liabilities and equity.2. In a classified balance sheet, current and long term assets and liabilities are segregated and subtotaled, with the traditional 12 month or operating cycle criteria used for classification.3. Excluding derivatives, financial assets are recorded when the entity becomes a party to a contract and measured by the transaction amount adjusted by financing fees and transaction costs that are directly attributable to its origination, acquisition, issuance, or assumption.

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FRF for SMEs• The Statement of Financial Position (continued)

4. Derivatives are accounted for by recognizing the net cash paid or received at settlement.5. A financial instrument, or its component parts, should be classified as a liability or as equity in accordance with the substance of the contractual arrangement on initial recognition.6. Accounts and notes receivable should be segregated to show separately trade accounts, amounts owing by related parties, and other unusual items of significant amount. The amounts, and, when practicable, maturity dates of accounts maturing beyond one year should be disclosed separately.

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FRF for SMEs• The Statement of Financial Position (continued)

7. The balance sheet disclosures are very similar to what have existed under GAAP, except where FRF for SMEs establishes reporting differences.8. For derivatives, an entity should disclose the following:a. The face or contract amount (or notional principal amount, if there is no face or contract amount);b. The nature and terms, including a discussion of the credit and market risk and the cash requirements of those derivatives;c. A description of the entity’s objectives for holding the derivatives; andd. The net settlement amount of the derivative at the statement of financial position date.

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FRF for SMEs• The Statement of Financial Position (continued)

9. An entity should disclose the following items of income, expense, gains, or losses either on the face of the statements or in the notes to the financial statements:a. Net gains or net losses recognized on financial assets and liabilities;b. Total interest income; andc. Total interest expense, separately identifying amortization of premiums, discounts, transaction costs, and financing fees.

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FRF for SMEs• Statement of Operations (Income Statement)• Following is a list of typical items that are distinguished in the

statement of operations. Some may be set out more readily in notes to the financial statements or attached schedules. a. Revenue recognized.b. Income from investments, disclosing income from

i. nonconsolidated subsidiaries and non proportionately consolidated joint venturesii. all other investments showing separately (1) investments measured using the cost method (2) investments measured using the equity method (3) investments measured at market value

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FRF for SMEs• Statement of Operations (continued)

c. The amount charged for depreciation of property, plant, and equipment. d. The amount charged for amortization of intangible assets. e. The amount of exchange gain or loss included in net income. f. Revenue, expenses, gains, or losses resulting from transactions or events that are not expected to occur frequently over several years or do not typify normal business activities of the entity.g. Income taxes. Income tax expense or benefit included in the determination of income or loss before discontinued operations should be presented separately in the statement of operations.

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FRF for SMEs• Statement of Cash Flows

1. A statement of cash flows that classifies cash flows during the period arising from operating, investing, and financing activities is required as an integral part of a complete set of financial statements for each period for which financial statements are presented.2. Either the direct or indirect method of reporting cash flows from operations is permissible.3. Investing and financing transactions that do not require the use of cash or cash equivalents should be excluded from a statement of cash flows but should be disclosed on the face of the statement of cash flows as “noncash investing or financing activities” or disclosed in the notes to the financial statements in a way that provides all the relevant information about these investing and financing activities.

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FRF for SMEs• Statement of Cash Flows (continued)

4. An entity should disclose, in aggregate, in respect of both business combinations and disposals of business units during the period a. the total purchase or disposal consideration; b. the portion of the purchase or disposal consideration composed of cash and cash equivalents;c. the amount of cash and cash equivalents acquired or disposed of; andd. the total assets, other than cash or cash equivalents, and total liabilities acquired or disposed of.

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FRF for SMEs• Intangible Assets

1. The definition of an intangible asset requires an intangible asset to be identifiable to distinguish it from goodwill. 2. Goodwill acquired in a business combination represents a payment made by the acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognized.3. An intangible asset should be recognized if, and only ifa. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity;b. the cost of the asset can be measured reliably; andc. the useful life of the asset can be estimated.4. An intangible asset should be measured initially at cost.

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FRF for SMEs• Intangible Assets (continued)5. A recognized intangible asset should be amortized over its

useful life. For purposes of the framework, all intangible assets should be considered to have a finite useful life. The useful life of an intangible asset arising from contractual or other legal rights should not exceed the period of those rights but may be shorter depending on the period over which the entity expects to use the asset. If the contractual or other legal rights are conveyed for a limited term that can be renewed, the useful life of the intangible asset should include the renewal period(s) only if there is evidence to support renewal by the entity without significant cost.6. Goodwill should be amortized generally over the same period as that used for federal income tax purposes or, if not amortized for federal income tax purposes, then a period of 15 years.

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FRF for SMEs

7. The financial statements should disclose the following information:a. The carrying amount in total and by major intangible asset class;b. The aggregate amortization expense for the period;c. The amortization method used, including the amortization period or rate by major intangible asset class; andd. The accounting policy for internally-generated intangible assets, including the treatment of development costs, whether expensed or capitalized.

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FRF for SMEs• Property, Plant & Equipment

1. Property, plant, and equipment should be recorded at cost.2. The cost of an item of property, plant, and equipment made up of significant separable component parts is allocated to the component parts when practicable and when estimates can be made of the lives of the separate components. 3. Depreciation should be recognized over the useful life of the asset in a rational and systematic manner appropriate to the nature of an item of property, plant, and equipment with a limited life and its use by the entity. Depreciation expense is calculated on the cost less any expected residual value.4. For each major category of property, plant, and equipment, the cost and the depreciation method used, including the depreciation period or rate, should be disclosed.

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FRF for SMEsEquity• An entity should present separately changes in equity for

the period arising from each of the following:a. Net income, showing separately the total amounts attributable to owners of the parent and non-controlling interests;b. Other changes in retained earnings;c. Changes in additional paid-in capital;d. Changes in capital stock; ande. Other changes in equity.

• Capital transactions should be excluded from the determination of net income and shown separately in the statement to which they relate (at least for the year in which the transactions occur).

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FRF for SMEsEquity (continued)• As applicable, an entity should present separately the

following components of equity either in the body of the financial statements or in the accompanying notes:a. Retained earnings;b. Additional paid-in capital;c. Capital stock;d. Non-controlling interests; ande. Other components of equity

• The financial statements of unincorporated businesses and partnerships should include a statement detailing the changes in the owners’ equity during the period, and this statement should detail separately contributions of capital, income or losses, and withdrawals.

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FRF for SMEsEquity (continued)• Disclosure should be made of authorized and issued capital

stock, including:a. the number of shares issued and outstanding for each class, giving a brief description and the par value, if any;b. dividend rates on preference shares and whether or not they are cumulative;c. the redemption price of redeemable shares;d. the existence and details of conversion provisions;e. the number of shares and the amount received or receivable that is attributable to capital for each class (when any shares have not been fully paid, disclosure should be made of the amounts that have not been called and the unpaid amounts that have been called or are otherwise due, as well as the number of shares in each of these categories); andf. arrears of dividends for cumulative preference shares.

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FRF for SMEsRevenue• Revenue from sales and service transactions should be

recognized when the following conditions have been fulfilled:a. The seller of the goods has transferred to the buyer the significant risks and rewards of ownership in that all significant acts have been completed, and the seller retains no continuing managerial involvement in, or effective control of, the goods transferred to a degree usually associated with ownership.b. Reasonable assurance exists regarding the measurement of the consideration that will be derived from the sale of goods and the extent to which goods may be returned.

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FRF for SMEsRevenue (continued)• In the case of rendering of services and long-term contracts and

modifications to those contracts, performance should be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished.

• The percentage of completion method is used when performance consists of the execution of more than one act, and revenue would be recognized proportionately by reference to the performance of each act. Revenue recognized under this method should be determined on a rational and consistent basis, such as on the basis of sales value, associated costs, extent of progress, or number of acts.

• When services are provided by an indeterminate number of acts over a specific period of time, revenue should be recognized on a straight-line basis over the period, unless there is evidence that some other method better reflects the pattern of performance.

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FRF for SMEsRevenue (continued)• The completed contract method is used when the entity

cannot reasonably estimate the extent of progress toward completion. The completed contract method may also be used if both of the following conditions are met:a. The completed contract method is used for income tax reporting purposes.b. The financial position and results of operations of the entity would not vary materially from those resulting from the use of the percentage of completion method (for example, in circumstances in which an entity has primarily short-term contracts).

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FRF for SMEsIncome Taxes• An entity should make an accounting policy choice to account

for income taxes using either:a. the taxes payable method, under which only current income tax assets and liabilities are recognized orb. the deferred income taxes method, under which an entity recognizes a deferred income tax liability whenever recovery or settlement of the carrying amount of an asset or liability would result in deferred income tax outflows and recognizes a deferred income tax asset whenever recovery or settlement of the carrying amount of an asset or liability would generate deferred income tax reductions.

• No provision for income taxes should be made in the financial statements of businesses for which income is taxed directly to the owners.

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FRF for SMEsAccounting for Subsidiaries• An entity should make an accounting policy choice to either

a. consolidate its subsidiaries orb. account for its subsidiaries using the equity method.

• All subsidiaries should be accounted for using the same method. A material difference in the basis of accounting between a parent and a subsidiary precludes the preparation of consolidated financial statements and the use of the equity method.

• Combined financial statements (as distinguished from consolidated financial statements) may be useful when one individual, or a group of individuals, owns a controlling interest in several entities, although they are not a substitute for consolidated financial statements.

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FRF for SMEs• Joint Venture Accounting• A venturer should make an accounting policy choice to

account for its interests in joint ventures usinga. the equity method; orb. the proportionate consolidation method, only applicable to unincorporated entities when it is an established industry practice.

• All interests in joint ventures should be accounted for using the same method. Equity method investees normally should follow the same basis of accounting (that is, the FRF for SMEs accounting framework) as the investor.

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FRF for SMEsLease Accounting• FRF for SMEs classifies leases as follows:

a. From the point of view of the lessee—capital and operating leases;b. From the point of view of the lessor—sales-type, direct financing, and operating leases.

• A capital lease should be accounted for by the lessee as an acquisition of an asset and an assumption of an obligation, both presented separately in the financials.

• Contingent rentals should be charged to expense as incurred.• Operating lease rentals should generally be charged to

expense on a straight-line basis over the lease term, even if not payable in such a manner, unless circumstances indicate that another basis may be more appropriate.

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FRF for SMEsBusiness Combinations• Management should account for each business combination

by applying the acquisition method, which requires:a. identifying the acquirer;b. determining the acquisition date;c. recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree; andd. recognizing and measuring goodwill or a gain from a bargain purchase.

• The acquirer should account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception: the costs to issue equity securities.

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Commitments

• Material commitments must be disclosed. The following are examples:

• a. facilities purchase or construction;• b. debt reduction commitments;• c. working capital requirements; and• d. purchase commitments.

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ContingenciesContingencies include, but are not limited to:

a. pending or threatened litigation;b. threat of expropriation of assets;c. guarantees of indebtedness or performance of

others; andd. discounted bills of exchange or promissory

notes.• Contingencies do not include allowances for

uncollectible accounts, vendor rebates or warranties.

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Contingencies (Cont.)The accounting treatment is determined by the 3 predictive factors we have used in the past:

Probable - likely to occur;Remote - slightly likely to occur;Reasonably possible – more than slightly but less

than likelyWhether the contingency is reflected in the financial statements or disclosed in the footnotes is dependent on the probability and measurability of the matter.

Contingent gains are usually not accrued, but, if probable, should be disclosed as to nature and estimate (if measurable).

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Accounting for Equity Compensation

• No compensation expense is recognized when equity is issued in lieu of cash compensation.

• Disclosure should be made of the general terms of the various equity based compensation plans, including the vesting requirements and the maximum term of options granted.

• Acquisition of goods and services from non-employees should be recognized when the goods or services are delivered, based on the most measureable side of the transaction.

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Retirement and Post Retirement Benefits

• Defined contribution cost should be recognized as a period cost, and the name, description, and amount of cost for the period should be disclosed.

• Deferred compensation cost related to current and future employment should only be accrued to the extent of the amount related to current employment.

• Defined benefit plans may choose to use the current contribution method or the accrued benefit method.

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Related Party Transactions• Related parties are defined in FRF for SMEs, but

are comparable to the traditional definitions.• Measurement is in accordance with traditional

arms-length valuations, unless the transaction is outside the normal course of business is either measured at carrying amount or third-party value, if supportable.

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Related Party Transactions (cont.)

• The disclosures are also traditional: a. nature of relationship;b. description of the transaction, including those

for which no amount has been recognized;c. the recognized amount of the transaction;d. the measurement basis for the transaction;e. the amounts due to and from the related

parties; andf. any commitments or contingencies involving

the related parties.

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Subsequent Events

• The treatment of subsequent events is similar to the traditional accounting.

• Events providing evidence of conditions existing at the date of the financial statement which are discovered before the financial statements are issued should be reflected in those statement.

• Events occurring after the financial statement date but before the financial statements are issued should be disclosed.

• The date through which subsequent events have been evaluated should be disclosed.

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