Choosing an accounting framework

By Laura Hay, CPA, CAE, OSCPA executive vice president

Generally Accepted Accounting Principles (GAAP) are coming under increased scrutiny regarding the cost versus decision-usefulness of recent standards, especially for less sophisticated private businesses.

GAAP is important to financial reporting quality, providing information that is consistent and comparable, receiving public exposure and input in its development, and built by an independent standards-setting body. However, despite the introduction of some private company differences within GAAP and alternative accounting frameworks for small- and medium-sized entities, the election of GAAP departures continues to increase in use and acceptance. Is this often the best choice?

Private company differences within GAAP

In May, the Financial Accounting Foundation (FAF) closed its public comment period on a periodic review of the effectiveness of the Private Company Council (PCC). The PCC advises the Financial Accounting Standards Board (FASB) on possible differences within GAAP to meet the needs of users of private company financial statements.

In its comment letter on the draft, OSCPA noted that while early alternatives within GAAP adopted as a result of PCC initiatives were significant and important, including goodwill, intangibles and consolidations, the PCC has more recently focused on more narrow topics such as stock compensation, and the FASB has not been as open to addressing greater private company pain points such as leases, revenue recognition and credit losses.

OSCPA advocated for greater representation on the PCC from smaller and less sophisticated private entities and CPA firms who audit them, greater information collection from smaller private entities and their users earlier in the research process, and consideration of the public interest impact of private companies leaving GAAP.

GAAP departures

Many OSCPA members have commented on an increase in clients requesting GAAP departures for recent standards such as leases and revenue recognition, and increased acceptance from lenders of reports disclosing departures from GAAP. The market is very clearly saying that the information return from these standards does not exceed their implementation cost for certain entities with less-sophisticated operations.

OSCPA’s Accounting and Auditing Committee shared several considerations for CPA firm and their clients electing GAAP departures:

• Does management truly understand the implications of having the GAAP departure in the report, and what it might mean to future users of the financial statements?

• Is GAAP required by any loan covenants, contracts or outside regulators?

• Unless it can be readily determined that the departure is immaterial, remember that management and the external CPA would need to do the work to quantify the materiality of the departure. Or, if management does not sufficiently cooperate or is unable to provide the information to perform that calculation, that limitation would need to be disclosed in the report (AU-C 705.18).

• There can be some situations where the departure would be so significant to the financial statements, or where the election is made with the intention to mislead, that the CPA could not be associated with the financial statements and would be obligated to withdraw.

• Depending on the needs of any third-party users, there may be other alternatives, such as tax-basis financial statements.

Other comprehensive bases of accounting

There are a number of widely-used alternative frameworks to U.S. GAAP collectively referred to as special purpose frameworks, or other comprehensive bases of accounting (OCBOA). Examples include:

• Cash basis

• Tax basis

• Regulatory basis

• Contractual basis

• Other basis that uses a definite set of logical, reasonable criteria applied to all material items appearing in financial statements

Unlike GAAP, little authoritative guidance is available for accounting under these frameworks. To help promote consistency and answer frequent questions about best practices, in 2018, the AICPA Accounting and Review Services Committee issued a non-authoritative practice aid, Accounting and Financial Reporting Guidelines for Cash- and Tax-Basis Financial Statements.

Authoritative guidance does exist for reporting on OCBOA financial statements. A resource from the AICPA Center for Plain English Accounting, Navigating Disclosure Requirements for OCBOA Financial Statements , addresses considerations in professional standards for preparing and reporting on OCBOA financial statements. Some considerations are:

• Including a description of the special purpose framework, including a summary of significant accounting policies and how the framework differs from U.S. GAAP

• Financial statements being properly titled

• Disclosures necessary for fair presentation

• Options for substituting qualitative information for the quantitative information required by U.S. GAAP that communicates the substance of those requirements

The report notes that the assumption that OCBOA would reduce disclosure requirements may be a misconception; while there are some disclosures that are not required, there are also needs for some additional disclosures. While disclosures may be omitted in a compilation, the CPA needs to determine if the omissions would be misleading to the users and the report modified appropriately.

Advantages of OCBOA statements include greater understandability to some users and cost savings for many clients. Disadvantages include ensuring the adequacy of disclosures and following professional standards for reporting on these engagements.

Financial Reporting Framework for Smalland Medium-Sized Entities

In 2013, the AICPA issued a new option for non-GAAP financial reporting with the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). FRF for SMEs was designed to offer a more cost-effective framework that includes comprehensive accounting principles developed with public exposure. FRF for SMEs is also a special purpose framework, but with more definitive requirements.

The framework uses accrual accounting, but retains accounting treatments for items such as revenue recognition and leases traditionally used in the U.S. before the adoption of recent standards. It is separate and distinct from the International Accounting Standards Board’s IFRS for SMEs, which is another alternative for SMEs not needing GAAP financial statements.

This just got confusing.

AICPA has provided a Decision Tool for Adopting an Accounting Framework to assist owners and leaders of SMEs in selecting between U.S. GAAP and various special-purpose frameworks. Considerations include:

• The nature of the entity and the purpose of the financial statements

• Whether the entity has any reporting requirements for GAAP-based financial statements

• The entity’s plans for future expansion and financing

• Whether the entity operates in an industry that requires highly-specialized accounting guidance not available in non-GAAP frameworks

• The ability of the framework to achieve fair presentation

• The users’ ability to understand the framework and its relevance for their needs

Options are good, but increase the demands on an already-strained profession in keeping staff sufficiently trained and informed of the requirements of existing alternatives. While special-purpose frameworks may offer improved cost-effectiveness and decision-usefulness for certain stakeholders, it is crucial to balance these alternatives with financial reporting quality for the desired purpose, and to balance costs with benefit in regulation and standard-setting.

Laura Hay, CPA, CAE, is the executive vice president of The Ohio Society of CPAs and the staff liaison to the Accounting, Auditing, Professional Ethics Committee and Peer Review Committee. She can be reached at Lhay@ohiocpa.com or 614.321.2241