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U.S. comment letter on AICPA's proposed framework for SMEs

Published on: Feb 01, 2013

An excerpt from the comment letter is shown below:

We support efforts to address the financial reporting needs of small and medium-sized entities that are not required to prepare financial statements in accordance with U.S. GAAP as well as the needs of their financial statement users. However, while we support these objectives, we have several significant concerns that we believe should be addressed before the Framework is finalized.

We are concerned that the Framework may create the potential for (1) competition between the FRF for SMEs and modifications to U.S. GAAP by the Private Company Council and (2) confusion in the lending and equity investing markets for private entities. Thus, the AICPA should clearly indicate that the FRF for SMEs is not an alternative GAAP but rather a framework for entities that choose to prepare financial reports on a basis other than GAAP. In addition, the AICPA should indicate what information entities should consider in determining whether to use the FRF for SMEs to prepare their financial statements.

The AICPA has touted the FRF for SMEs as a “financial reporting solution that addresses marketplace demands.” However, it is not clear what marketplace demands were identified and what role marketplace participants have played in its development. We believe that the Framework has the potential to meet marketplace demands if the FRF for SMEs Task Force (the TF) makes decisions, and considers input from financial statement users and preparers, transparently. Such transparency would also help the FRF for SMEs gain wider acceptance among financial statement users and preparers. Thus, we recommend that the TF and the AICPA improve their due process as they continue to develop the Framework.

In addition, to ensure that the Framework is viewed as a set of criteria with substantial support underlying the preparation of financial statements (i.e., an other comprehensive basis of accounting), the TF should identify the set of concepts on which the FRF for SMEs is based. The TF should link these concepts to the needs of SME financial statement users, and apply them consistently throughout the Framework.

We elaborate on these observations and recommendations below.

Confusion in Lending and Equity Investing Markets for Private Entities

The objective of the FRF for SMEs is not the same as that of the Private Company Council (PCC), which was created by the Financial Accounting Foundation in May 2012. The PCC is working to determine whether exceptions or modifications to existing nongovernmental U.S. GAAP would benefit end users of private-company financial statements and to advise the FASB on how to treat private-company accounting matters on the Board’s technical agenda. These efforts are not intended to create a private-company financial reporting framework that is separate from U.S. GAAP. The FRF for SMEs, however, is a nonauthoritative framework, separate from U.S. GAAP, that is intended for use by entities that are not required to prepare financial statements in accordance with U.S. GAAP. We are concerned that these two initiatives will compete for acceptance among private-entity financial statement preparers and users and will lead to confusion in the lending and equity investing markets for private entities.

An entity’s owners, management, or owner-managers (collectively, “management”) will decide whether to use the FRF for SMEs; however, we are concerned that they will not have the tools and information they need to make a well-informed decision. We understand that the AICPA intends to offer toolkits that will help CPAs explain the FRF for SMEs and its advantages. We recommend that these toolkits, or other materials, include a clear and comprehensive discussion of the types of entities for which the FRF for SMEs was designed. Such discussion should explain (1) relevant differences between the FRF for SMEs and U.S. GAAP, (2) potential disadvantages (and advantages) of using the FRF for SMEs, and (3) other relevant considerations that could inform management’s decision. Considerations may include whether U.S. GAAP financial statements would be needed by a parent applying U.S. GAAP or an equity-method investor now or in the future, the size and complexity of entities contemplated by the TF when developing the FRF for SMEs, and the information that would be needed to reconcile financial statements prepared in accordance with the FRF for SMEs with those prepared under U.S. GAAP.

Information that may help a management team decide whether to apply the FRF for SMEs will change and evolve over time. The PCC held its first meeting in December 2012 and will propose exceptions and modifications to U.S. GAAP through a deliberative process that will take time. We therefore recommend that the TF coordinate regularly with the FASB and the PCC and update its toolkits or other materials comparing the FRF for SMEs and U.S. GAAP as modified for private entities. A collaborative relationship between the TF and the PCC may also enhance the PCC’s efforts as it addresses concerns related to private-entity accounting.

Due Process

Although the TF is now seeking public comment on its proposals, we are concerned about the lack of transparency into the TF’s due process for developing the Framework to date. Stakeholders are not able to ascertain the nature and degree of outreach conducted by the TF in developing its proposals. Input from a broad group of financial statement preparers, users, auditors, and other stakeholders is generally a necessary step in creating accounting guidance on preparing decision-useful financial statements. By gathering such input and incorporating it into the FRF for SMEs, the TF might also increase the likelihood that the FRF for SMEs becomes a broadly accepted financial reporting framework. In addition, the public must have confidence that the TF is acting in the best interests of financial statement users and is free from undue influence. Accordingly, to ensure the TF operates with transparency and objectivity, the AICPA should consider (1) publishing comprehensive rules of procedure and processes, (2) holding public meetings, and (3) subjecting the TF to independent oversight by, for example, an existing or new senior technical accounting committee of the AICPA (such as the Technical Issues Committee).

To maintain a relatively stable financial reporting environment for the Framework’s intended constituents, the TF has proposed to update the FRF for SMEs every three or four years. However, more frequent updates might increase the likelihood of broad acceptance and help ensure that preparer and user concerns are addressed. Especially in the first years of adoption, but also in subsequent years, SMEs preparing financial statements in accordance with the FRF for SMEs are likely to have questions about how to apply certain aspects of the Framework, and financial statement users may find that the proposed accounting is inconsistent with their needs. As a result, more frequent amendments to the Framework or additional implementation guidance may be warranted. Policies and procedures should be established that provide a mechanism for all stakeholders to submit feedback, and a balance should be found that permits important updates to be made to the FRF for SMEs more often than every three to four years. Published rules of procedures and processes should state the criteria and processes for making such updates.

We also encourage the AICPA to establish a process whereby the AICPA (or designated body) periodically assesses the effectiveness of the FRF for SMEs. An objective review process with input from a broad group of stakeholders would enhance its credibility and ensure its relevance.

Conceptual Framework

Parts of the FRF for SMEs are difficult to understand because they are presented as sets of rules pieced together rather than as a framework. Further, there is not a comprehensive set of concepts underlying the sets of rules. The FRF for SMEs would be clearer and easier to implement if there was a conceptual basis underlying it. A conceptual basis would (1) ensure consistency of the Framework’s accounting guidance, (2) increase comparability of financial statements prepared under it, and (3) help preparers exercise professional judgment when applying its principles-based guidance. Although Chapter 1 of the FRF for SMEs describes certain qualitative characteristics, elements of financial statements, and recognition and measurement criteria, we do not believe these constitute a sufficient comprehensive conceptual framework. Further, we do not believe that the Framework clearly identifies users of non-GAAP SME financial statements or their needs.

We generally agree with the observation made by the FASB in its invitation to comment, Private Company Decision-Making Framework, that the most common types of private-company financial statement users are lenders, other creditors, and equity investors. These users are generally concerned about an entity’s ability to meet its obligations and about earnings before interest, tax, depreciation, and amortization (EBITDA), which is commonly used in income-approach valuation models. We believe that users of financial statements prepared by SMEs that are not required to comply with U.S. GAAP are, in many cases, the same lenders and investors that will use financial statements prepared under U.S. GAAP as modified by the PCC and the FASB. The conceptual basis for the FRF for SMEs should clearly identify users of non-GAAP SME financial statements and describe how their needs inform the accounting guidance in the FRF for SMEs and the TF’s decision-making process.

Full text of the comment letter is available below.


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