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FRF for SMEs: Simplifying Financial Reporting for Small to Medium-Sized Private Businesses

FRF for SMEs: Simplifying Financial Reporting for Small to Medium-Sized Private Businesses

September 19, 2024

 

What is FRF for SMEs?

In 2013, The American Institute of Certified Public Accounts (AICPA) developed a new framework called Financial Reporting Framework for Small to Medium Sized Entities (FRF for SMEs) to help create a simpler path of financial reporting for Small to Medium Sized Entities (SME) compared to other widely used frameworks such as United States Generally Accepted Accounting Principles (GAAP). FRF for SMEs draws from a combination of traditional methods of accounting such as accrual and income tax methods that may be valuable for entities which are not required to report their financials using GAAP or other frameworks.

FRF for SMEs did not gain much traction. Banks were opposed to FRF for SMEs as it was not as well-known as other frameworks and business owners did not want to learn another basis of accounting.

However, due to new, complex accounting standards such as Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842), FRF for SMEs may be worth giving a second chance. While some Private Company accounting alternative provisions were included in these new standards, the Revenue and Lease standards both introduced new, complex methods of accounting which increased costs and confusion for many privately held companies and banks. For details regarding these standards, please refer to our ASC 606 Revenue and ASC 842 Lease accounting posts for more details.

The following table summarizes the main differences and similarities between the FRF for SMEs and GAAP frameworks.

 

FRF for SMEs

GAAP with Private Company Election

Disclosures on Financial Statements

Basic financial disclosures for users to understand the accounting policies utilized.

More prescribed and required disclosures such as Leases, Revenue Recognition, and Fair Value Standards.

Fair Value Measurement

Limits the use of fair value measurements, often opting for historical cost, which simplifies valuation processes. For example, investments are usually recorded using the cost or equity method depending on level of influence by the Company on the investment.

Emphasizes fair value measurement, which can provide more current valuations but adds complexity.

Consolidation

Consolidation of controlled entities required. Variable Interest Entities are not required to be consolidated.

Potentially similar to FRF for SMEs. Variable Interest Entities (VIEs) are required to be consolidated unless the Company qualifies for the Private Company election for VIEs.

Revenue Recognition

Recognized when seller of the goods has:

1.        transferred to the buyer the significant risk and rewards of ownership of goods or service

2.        Reasonable assurance of the measurement of consideration to be received.

In cases 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 aligns the revenue recognized with the work accomplished.

Adopts a 5-step revenue recognition standard as prescribed by ASC 606, which requires detailed analysis and documentation. However, this could result in the same revenue recognition method used for FRF for SMEs depending on the details of the contract.

Goodwill and Intangible Assets

Amortizes goodwill and other intangible assets over a period no greater than 15 years (same as tax useful life), simplifying impairment testing.

GAAP also introduced a Private Company election that allows for amortization of goodwill over no greater than 10 years.

Inventory

Inventories are recognized at the lower of cost or net realizable value. Cost of inventory also includes fixed and variable production overhead incurred when converting materials into finished goods.

Inventories are also recognized at the lower of cost or net realizable value. However, cost of inventory should only include direct costs excluding the cost of indirect materials, labor, and depreciation.

Lease Accounting

Accounts for leases as operating or capital leases. Only capital leases are capitalized as an asset and liability on the balance sheet.

Requires detailed lease accounting, including the recognition of right-of-use assets and lease liabilities as required by ASC 842 for all leases (operating and finance). Practical expedient is allowed to not capitalize short-term leases. Short-term leases include terms of 1 year or less and the Company is not likely to exercise renewable lease options.

Start-up Costs

Companies can either capitalize and amortize over 15 years or expense as incurred. Policy elected must be consistently applied to all similar expenses.

Start-up costs are expensed as incurred.

Income Taxes

An entity must make an accounting policy election to account for income taxes using either

a.        the taxes payable method or

b.       the deferred income taxes method.

Companies must utilize the deferred income taxes method.

Classification of P&L

Does not prescribe how expenses should be grouped or presented on the Statement of Operations except that the statement should include Revenue, COGS, Operating expenses, other revenues and gains, and other expenses and losses.

Prescribes what costs should be included in COGS such as direct labor and direct overhead. Indirect labor and costs are specifically excluded from COGS.

 

Summary

In summary, FRF for SMEs provides a simpler framework for SMEs that are not interested in adopting more complex GAAP pronouncements. Privately held companies that are not required to report their financial statements using GAAP may want to consider using FRF for SMEs for their reporting needs. Please consult with one of our Larson accounting advisers for more information. Larson and Company has developed a suite of services specifically to serve the needs of companies of all sizes in a wide range of industries.