AICPA’s Special-Purpose Framework Proves Controversial

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The AICPA wrote another important chapter in the history of the search for simpler accounting practices when it issued an exposure draft of a proposed special-purpose framework in November 2012. But this won’t likely be the final chapter, since some aspects of the framework have proven controversial. Although the comment letters expressed widespread support for the notion of simpler accounting practices for smaller companies, the details are likely to continue to evolve in response to the many concerns raised about the proposed approach. This approach calls for the AICPA to issue and maintain a non-authoritative, non-GAAP framework for use in special-purpose financial statements starting in late Spring 2013. The volume of questions raised and the tone of the views expressed clearly show this approach is considerably more controversial among accounting practitioners than initially expected.

This Messenger summarizes the basic approach and the reasons for the controversy.

The AICPA’s concept

Basically, the proposed framework is a document of about 250 pages. Its full title is “Proposed Financial Reporting Framework for Small- and Medium-Sized Entities.” Supplemental materials released by the

March 2013

AICPA’s Special-Purpose Framework Proves Controversial

AICPA describe the document as a “set of criteria” that can be used to determine the measurement, recognition, presentation, and disclosure of all material items in financial statements that are not required to be prepared according to US generally accepted accounting principles (US GAAP).

The differences between statements prepared according to GAAP and statements prepared using the proposed framework can be summarized as follows:

•GAAP. Generally accepted accounting principles are suitable for preparing general-purpose financial statements. They include US GAAP issued by the FASB, IFRS issued by the IASB, and IFRS for Small and Medium-Sized Entities issued by the IASB. Typically, GAAP is the required basis for financial statements prepared for use by external users who lack the ability to prescribe the financial information they receive from the company.

• Proposed framework. In contrast, the AICPA’s framework would be considered one of a number of other comprehensive bases of accounting (OCBOA) available to US companies for special-purpose financial statements. Currently, companies typically prepare special-purpose OCBOA statements using a cash basis or using the same principles used for income tax returns.

In addition to the framework, the AICPA plans to issue implementation guidance containing examples, illustrative financial statements, a disclosure checklist and similar materials, as well as toolkits to help CPA firms introduce and explain the framework to clients and financial statement users. The AICPA has not


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yet decided whether the final framework and/or the accompanying implementation guides and toolkits will be made available at no cost or for a fee.

Reasons for the controversy

The AICPA describes its proposed framework as one that is suitable for smaller- to medium-sized owner-managed, for-profit entities that need reliable financial statements for times when users have direct access to the owner-manager and GAAP financial statements are not required. The goal was to develop a framework based on a “blend of traditional accounting methods and accrual income tax methods.” To accomplish this goal, the framework makes a number of assumptions about the needs of users and the desirability of key features. The controversy arises because there are different views about the validity of these assumptions and how best to mitigate any adverse effects.

Following are highlights of the four most controversial issues.

1. Does an OCBOA framework respond effectively to marketplace demands?

The AICPA’s stated intent in developing the proposed OCBOA framework is to respond to marketplace demands. Below are the major assumptions, concerns and suggestions.

• Assumptions: The AICPA’s research indicates the marketplace is demanding a financial reporting framework that is more cost-effective than GAAP. The Institute feels its framework will meet the needs of two types of users:

• Privately-owned small and medium-sized entities that are looking for a more relevant, less complicated and cost-beneficial framework for their financial reporting needs.

• Bankers and other financial statement users

who need easier-to-understand, useful financial statements that are based on a reliable, principles-based framework.

• Concerns: Some accounting practitioners and state societies of CPAs feel the AICPA is misinterpreting the market demands and its approach will cause confusion. Their views:

• The demand is for a single set of authoritative standards. A non-authoritative framework like the one proposed by the AICPA would cause unnecessary confusion among practitioners and preparers.

• The Financial Accounting Foundation’s recently-formed Private Company Council (PCC) is better positioned to meet market-based demands by developing suitable modifications and exceptions to authoritative GAAP.

• Suggestions: To help mitigate the concerns about confusion, many practitioners suggested different names for the framework, and one firm suggested different titles for financial statements because terms like “statement of financial position” are indicative of financial statements prepared in accordance with GAAP. The concerns about marketplace needs are more difficult to mitigate. The National Association of State Boards of Accountancy took a strong position on this issue by urging the AICPA to table or withdraw its proposed framework so the PCC can carry out its mission alone and without confusion.

2. Does a principles-based OCBOA framework provide a cost-effective solution?

The AICPA has proposed the use of a principles-based framework as a practical compromise between GAAP and the unmet needs of some financial statement users. The appendix highlights a number of areas in which the OCBOA framework would depart from or be

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less prescriptive than US GAAP. Below are the major assumptions, concerns and suggestions regarding this approach.

• Assumptions: The use of a principles-based framework is seen as a cost-effective solution because:

• It is simpler, easier to learn, and less prescriptive than US GAAP. In effect, this means the framework permits more options, requires fewer disclosures and involves more judgment.

• It provides more benefits than tax-basis or cash-basis statements because it is more robust than the existing OCBOA frameworks.

• Concerns: Some accounting practitioners and state societies of CPAs have a different view of the costs and benefits. Their thoughts:

• The accounting policy elections and gaps in the framework will reduce the benefits by creating diversity in practice and impairing the credibility of the financial statements. They will also add to the costs because significant transactions will fall outside the scope of the framework, and preparers, users and practitioners will likely need to devote additional time to effectively address the accounting for the outlying transactions.

• The costs associated with learning time will likely be significant. Practitioners find it time-consuming to review the proposed materials and respond to exposure drafts, and the new framework would add another layer to accounting firms’ training and quality control efforts. Some firms feel the added efforts will also have an opportunity cost because they will detract from time spent on keeping up with changes in GAAP and the activities of the PCC.

• The costs associated with educating users will also likely be significant because the AICPA’s framework is based partly on GAAP and partly on income tax reporting. The former is designed to faithfully portray the economics of transactions while the latter has very different objectives, and the resulting differences may not be readily apparent to some users without significant education and training.

• Suggestions: To temper these practical concerns with respect for the AICPA and its good intentions, practitioners made a number of suggestions, including the following:

• The AICPA should reconsider some policy elections and issue guidance on how to handle areas that are missing from the framework, such as “follow GAAP as closely as possible.”

• More research and information are needed to evaluate the costs and benefits for all the participants in the financial reporting process. To help firms with this analysis, the AICPA should provide additional information for public comment, including a comparison with US GAAP and/or IFRS for SMEs and a draft of the implementation guidance.

3. Should the framework be driven by CPA firms and be available to all companies?

The proposal calls for CPA firms to play a major role in gaining acceptance for the framework by explaining it to the entities and users for whom it would be beneficial. Below are the related assumptions, concerns, and suggestions regarding this approach.

• Assumptions: The framework will work best by leveraging the expertise of CPA practitioners and allowing them to determine which companies will benefit from the use of the framework.


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• The AICPA plans to call upon CPA firms to take the lead in persuading suitable companies and lenders to use this framework, and it plans to issue toolkits to help them do so after the framework is finalized.

• No entities would be precluded from using the framework. But the framework will contain language cautioning readers that it is not appropriate for some companies, including those that hope to go public, and it is not recommended for use by not-for-profit organizations When evaluating potential use by lenders, the Institute made the assumption that the framework would be useful in supporting applications by smaller entities for bank financing when the banker does not base a lending decision solely on the financial statements.

• Concerns: Both practitioners and users of financial statements expressed concerns that the framework does not contain language that severely restricts its use. Their letters explained that the framework will not provide a benefit over GAAP in many cases, especially to lenders and others who wish to compare the financial statements of private companies. Their thoughts:

• Many clients of CPA firms will not benefit from a non-GAAP framework because they are small businesses whose owners often pursue exit strategies that involve going public or being purchased by a public company.

• Lenders and surety bond underwriters will get little benefit from a non-GAAP framework. A survey by a construction industry association found most surety bond underwriters are aware of the proposed framework but generally prefer GAAP financial statements. One surety company said use of the AICPA’s framework would likely result in increased costs due to

additional training and changes to underwriting systems, and these costs would likely be passed along to companies preparing OCBOA statements. Another surety company said the usefulness of the framework would be limited to certain entities that are on the low end of the risk spectrum where extensive disclosures are not necessary; others would need to provide GAAP statements or make disclosures that are not required by the framework.

• Suggestions: Some practitioners suggested the AICPA should conduct more research into the types of companies that would benefit from the framework and issue more restrictive guidance. For example, this type of OCBOA might be limited to statements used only by management.

4. Should the framework be rolled out quickly and revisited in three or four years?

The AICPA has designed the model to be helpful to small companies and practitioners who do not have time to keep up with a rapid level of change in accounting standards. Here are the major assumptions, concerns, and suggestions in this regard.

• Assumptions: The framework needs to be developed quickly and changed infrequently.

• The framework can best be developed quickly by modeling it after the approach taken by the International Accounting Standards Board when it issued International Financial Reporting Standards for Small and Medium-sized Entities (IFRS for SMEs).

• Small companies and practitioners will spend less time keeping up with changes in accounting standards because the framework will not change much for the next 3 to 4 years.

• Concerns: Some practitioners feel the quick roll-


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TheinformationinthisMHMMessengerisabriefsummaryandmaynotincludeallthedetailsrelevanttoyoursituation.PleasecontactyourMHMserviceprovidertofurtherdiscusstheimpactonyourfinancialstatements.

out and lack of updating could be weaknesses rather than strengths. Their views:

• The framework leaves many questions unanswered because it was developed by an AICPA Task Force based on input and assumptions that are not transparent to others.

• Although the OCBOA framework is intended to be updated only every three or four years, GAAP will change more frequently, and updated comparisons of the AICPA’s framework with GAAP will be important for preparers, users, and practitioners.

• Suggestions: Many practitioners suggested the framework should be updated more often and a more robust “due process” should be put in place to develop and maintain the framework.

• The process should include an extension of time to review and comment on the initial proposal, as well as the implementation guidance and toolkits.

• More information should be made available about the level of outreach already conducted by the Task Force in developing the framework.

• The AICPA should consider establishing a more rigorous “due process” that would include such techniques as publication of comprehensive rules of procedures and processes, holding public hearings, commissioning “fatal flaw” reviews, establishing future funding and staffing plans, making the guidance available to the public free of charge, and establishing oversight by an appropriate AICPA Committee, such as the Technical Issues Committee.

Next Steps

The AICPA will need to consider the concerns expressed in the letters. In summary, the common themes are that a non-authoritative, non-GAAP framework is not the best way to meet the demands of today’s marketplace and that the OCBOA framework proposed by the AICPA would cause confusion, be inappropriate for many smaller companies and unacceptable to many lenders, and result in greater costs and fewer benefits than initially contemplated. Many suggestions were made to help the AICPA revise the model, and further outreach may be forthcoming before the AICPA makes a final decision about how to proceed with the framework. If not, then the AICPA may go ahead with its original timeline which calls for issuance of the final framework in the first half of 2013, concurrently with a turnkey toolkit (to help CPA firms explain the framework to clients and users) and an implementation volume with illustrative financial statements, checklists, and application examples.

In the meantime, the ED and webcast are available on the AICPA’s website at http://apps.aicpa.org/pcfr/.

For more information

MHM’s Professional Standards Group will monitor progress on the AICPA’s OCBOA framework. We provided our input to the AICPA in our comment letter.

If you have any specific questions, comments or concerns, please share them with Ernie Baugh or Keith Peterka of MHM’s Professional Standards Group or your MHM service professional. You can reach Ernie at [email protected] or 423-870-0511, and you can reach Keith at [email protected] or 610-862-2744.

http://apps.aicpa.org/pcfr/

[email protected]

mailto:[email protected]

MHM Messenger 6-13 Appendix: Significant Differences with US GAAP

Below are some areas in which the criteria prescribed in the framework differ from current US GAAP.

Measurement basis. Historical cost is the primary measurement criteria. Only held-for-sale equity securities are measured at fair value.

Inventories. Inventories are measured at the lower of cost or market, with market defined as net realizable value. The cost of inventories is calculated using the first-in, first-out (FIFO), last-in, first-out (LIFO), or weighted average cost formula.

Property, plant and equipment. Permitted depreciation methods include a straight-line method, a variable charge method that reflects service as a function of usage, and other methods that may be appropriate in certain situations. The amount of depreciation that should be charged to income is the greater of (a) the cost, less salvage value over the life of the asset, or (b) the cost, less residual value over the useful life of the asset.

Goodwill. Goodwill is amortized. The period of amortization is generally the same period as that used for federal income tax purposes, or a period of ten years if the goodwill is not amortized for federal income tax purposes.

Revenue. For services and long-term contracts, performance is determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished.

Leases. Lease accounting for financial reporting is aligned with lease accounting for federal income tax purposes. The criteria for capitalizing a lease are the same for book and tax purposes.

Accounting for income taxes. Companies would have the flexibility to make an accounting policy election to use either: (a) the taxes payable method, or (b) the deferred income taxes method. Under the taxes payable method, only current income tax assets and liabilities are recognized. If a portion of current income taxes is unpaid, it is recognized as a liability; if a portion is refundable, it is recognized as an asset. The liability for current income taxes on the balance sheet is the cost or benefit of current income taxes for current and prior periods less amounts already paid for these income taxes.

Subsidiaries and consolidation: The OCBOA framework would not use the concept of variable interest entities. Instead, the framework would spell out that consolidation is not appropriate when an entity has a limited right and ability to determine or influence the strategic policies of another entity but does not control it. A holding of an interest in an entity that is not a subsidiary would qualify as an investment. Companies would have the flexibility to make an accounting policy election to either: (a) consolidate their subsidiaries, or (b) account for their subsidiaries using the equity method.


AICPA’s Special-Purpose Framework Proves Controversial

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