By David D. Wagaman, CPA

In May 2012, the Financial Accounting Foundation (FAF) released Final Report: The Establishment of the Private Company Council. The Private Company Council (PCC) was charged with determining whether exceptions or modifications (carve-outs) to existing nongovernmental U.S. generally accepted accounting principles (GAAP) are necessary. In addition, the PCC serves as the primary advisory body to the Financial Accounting Standards Board (FASB) on the appropriate treatment for private companies for items under consideration on the FASB’s technical agenda. From the start, the PCC’s domain was assumed to be larger private companies that are required by third parties to prepare financial statements conforming to GAAP. In 2012, the FAF also supported the AICPA’s effort to provide expanded guidance on OCBOA (other comprehensive basis of accounting) for smaller private businesses. The result was the Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs, or “the framework”), which was released in June 2013.

So, five years later, what impact has FRF for SMEs had? The framework promised a cost-effective but more robust alternative than the options under traditional OCBOA. This question is perhaps even more relevant for private businesses whose third-party financial report users (usually lenders) require GAAP-based financial statements. Also, in the next two years such businesses may be burdened by the implementation of ASC 606 (Revenue Recognition) and ASC 842 (Leases). A positive note can be found in a 2017 study that said FRF for SMEs was a viable alternative to GAAP when the credit risk of the borrower was low.¹ On the other hand, another 2017 report indicated FRF for SMEs has seen only limited adoption.²

To get more insight on the use of FRF for SMEs (or lack thereof), I sought the input of several alumni and friends of the accounting program at Kutztown University who work for accounting firms that have a sizable small-business clientele. Ten responses were received. I also received input from some commercial lenders in regional banks. These individuals were asked two questions:

• How many of your clients who are eligible to use the framework do so?
• What has been the typical reaction by lenders to the framework, especially in comparison to the tax basis under OCBOA?

Except for one respondent, none of the accounting firms had clients who were preparing financial statements in accordance with FRF for SMEs. The one affirmative response, from a senior manager specializing in small business for a top 20 accounting firm, reported a very small portion of his client base used the framework. Lenders prefer that private entities prepare financial statements that conform to GAAP, typically requiring its use for larger businesses. For small businesses, the tax basis (OCBOA) is the most common alternative to GAAP.

Does this mean that lenders were not receptive to the framework? One lender indicated that more than 90 percent of commercial loan applications were supported by GAAP-based financials. That lender said they would accept FRF for SMEs; however, in his branch there had only been one borrower who provided financial statements using the framework.

CPAs’ reactions to that question were mixed. Several suggested that lenders were not receptive, and one indicated that a bank recently pushed for GAAP financials from a client rather than the tax-basis, which had previously been used. By contrast, another CPA indicated that banks, for the most part, were on board with the framework. One related that when his firm presented the FRF for SMEs to bankers during seminars in early 2014, they seemed to be receptive to it. Based on the framework’s limited use, this individual wondered whether it would take more time for the framework to gain traction. However, he also was concerned that lenders may not believe there is enough of a benefit for them to direct customers toward FRF for SMEs.

There were other noteworthy comments that should be considered. One CPA said that FRF for SMEs accomplishes very little in alleviating the disclosure and accounting burdens for smaller enterprises that prepare GAAP-based reports. This individual also expressed the need for small-business exemptions to GAAP, and that a new framework only causes user confusion. That would suggest more carve-outs from GAAP by the PCC. Indeed, a respondent indicated that the PCC’s modifications for variable interest entities and goodwill may have minimized some of the benefits of FRF for SMEs.

Since its inception, the PCC has only had four projects that have modified GAAP for private companies. In addition, there is evidence that these exceptions to GAAP have not been widely adopted.³ The FAF has indicated that, in the future, the PCC should be increasingly focused on providing private business perspectives on the FASB’s active technical agenda items. Interestingly, other than delayed effective dates for nonpublic entities, there are no exemptions from the complex provisions of the revenue recognition and lease standards.

What does this mean going forward? Perhaps the 2012-2013 changes just need more time to gain a foothold. Others might say there has been much ado about nothing, since GAAP is widely required for private businesses, and when it is not required the tax basis (or some other OCBOA) is sufficient. However, consider the following comment by a CPA: “We have clients with 30-plus page financial statements with footnotes only an accountant could possibly understand. These are privately held companies, so, without shareholders, what is the value of elaborate disclosures to management? The burden on small business to comply with standards today is overwhelming.” If this is a widely held belief, it may be time to revisit this issue.

¹ F. Todd DeZoort, Anne Wilkins, and Scott E. Justice, “The Effect of SME Reporting Framework and Credit Risk on Lenders’ Judgments and Decisions,” Journal of Accounting & Public Policy, Vol. 36, Issue 4 (July 2017), pp. 302-15.
² Nicholas J. Mastracchio Jr. and Heather M. Lively, “Private Company Accounting Standards: Survey of New York CPAs Finds Adoption Slow,” The CPA Journal (December 2017), pp. 50-53
³ Ibid., p. 52.

David D. Wagaman, CPA, is an associate professor and coordinator of the accounting program at Kutztown University of Pennsylvania in Kutztown, Pa. He can be reached at dwagaman@kutztown.edu.