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“Little GAAP” vs. “FRF for SMEs”

Reading the title to this article, you may think you’ve wandered across an article about an Ultimate Fighting Championship match between two guys with really odd nicknames. But really, it’s an accounting article about a fight between two different accounting frameworks with really odd nicknames. These frameworks were both born a little over a year ago, so now that we’ve had a bit of time to see them in action, let’s report on what we know.

First, a little background… In the wake of the 1929 stock market crash, the American Institute of Accountants (now known as the American Institute of Certified Public Accountants – AICPA), the New York Stock Exchange and the government (in the form of the SEC), decided it would probably be a good thing to have some standards for financial statements. This makes sense, considering that a significant factor in the stock market crash was that no one was really able to rely on the financial reports issued by publicly traded companies. These standards, known as Generally Accepted Accounting Principles (GAAP), were determined by the AICPA until 1973. From 1932 – 1958, GAAP is fairly flexible and more “principles-based” instead of “rules-based,” allowing companies to choose from several options in order to meet their needs.

In 1959, the AICPA shifts gears to begin removing the options from GAAP, so that GAAP will be more uniform regardless of the size and circumstances of a company. At this time, also, the AICPA changes the composition of the board that is responsible for determining GAAP, shifting it toward more spots on the board being filled by CPAs from the largest CPA firms in the country along with financial executives from the publicly-traded companies themselves that would be affected by changes to GAAP. This model for establishing GAAP limped along until 1973, when, under pressure, the AICPA recommended that the responsibility for establishing GAAP would best be served by a full-time independent board. Hence, the Financial Accounting Standards Board (FASB) was established, theoretically independent from the AICPA, the SEC, the big accounting firms, and the publicly-traded companies.
Soon thereafter, the fighting began. Many in the accounting profession, including the AICPA who kind of created this mess in the first place, started saying that GAAP was getting too complex to apply to all companies on a one-size-fits-all basis. Instead, there should be Big GAAP for the publicly-traded companies and Little GAAP for the closely-held businesses. The issue was debated and studied and tabled time and again for about 30 years. Finally, about two years ago, it looked like Little GAAP was going to happen; this would be a whole different set of rules established by the FASB just for small businesses.

Instead, the FASB decided not to make a different set of rules, but rather to just create exceptions to the normal Big GAAP rules. They established the Private Company Council (PCC) to recommend exceptions for small businesses to follow, but the FASB retained control over whether those recommended exceptions would actually be implemented. What happened next? The AICPA got ticked. They called the FASB every name in the book and decided that since FASB wouldn’t write new rules for small businesses, they would do it themselves.

In June 2013, the AICPA issued the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) as a self-proclaimed alternative to GAAP. This is to be a self-contained set of standards that doesn’t over-complicate things for small businesses and is only updated once every few years. In theory, it’s a nice thing. In practice… Well, we’ve never seen it in practice yet. And we can’t see where the AICPA is touting the number of companies that are applying FRF for SMES, which you would think they would do if it were becoming widely accepted as they hoped it would. The main problem is that it just isn’t GAAP, and most lenders that want financial statements want GAAP. Instead, FRF for SMEs is what is called an Other Comprehensive Basis of Accounting (OCBOA). It is a very nice OCBOA, but OCBOAs are generally most useful for owners/managers of companies, and they aren’t going to switch from what they currently know and understand to another OCBOA just because it is shiny and new.

In the meantime, the FASB’s Private Company Council (PCC) has finalized Little GAAP exceptions for hedge accounting (a minor annoyance with very limited applicability to small businesses), goodwill accounting (an annoyance but with limited companies affected), and variable interest entities (a big problem when FASB expanded this concept about 10 years ago). Plus, they’re working on additional Little GAAP exceptions for business combinations and stock-based compensation. In other words, the PCC got right down to business, and they are making real changes for small businesses. It would be nice to see them work on Little GAAP exceptions to pension accounting and uncertain tax positions, so we’ll see what the future holds.

What does this all mean for you? A year ago, we might have told you to start pushing your lender to accept financial statements prepared using FRF for SMEs. But since we waited to see how things played out, we can confidently say that Little GAAP as created by the PCC is the way to go. IF you or your lender has any questions about how these financial reporting issues specifically affect you, we would be glad to discuss them with you.