Private Entities Should Explore Using a GAAP Alternative to Prepare Financial Statements
The Financial Reporting Framework for Small- and Medium-Sized EntitiesTM (FRF for SME’s) was created by the AICPA in 2013. The intent was to give owner-managed, privately-held businesses a GAAP alternative that would cost-effectively produce relevant, yet simplified, financial statements for the use of lenders and others. Why is FRF for SMEs not more popular? Two main reasons: 1) A lack of confidence that FRF for SMEs would be accepted by lenders, and 2) The perceived pain of change was greater than the pain of not transitioning.
According to a study published by the Journal of Accounting and Public Policy (July 2017), lenders surveyed agree that FRF for SMEs is a viable alternative to GAAP when credit risk is low (i.e., an entity has had three years of stable revenues, and all vendors have been paid within terms). In fact, lenders expressed a preference for FRF for SMEs compared to income tax-basis of accounting. On a scale of 1-100, they rated the likelihood of loan approval at 75.29 for GAAP-basis financial statements, 71.86 for FRF for SMEs-basis statements, and 50.86 for income tax-basis statements. Additionally, the projected interest rate that would be charged was virtually the same between GAAP and FRF for SMEs.
The good news? Private entities that are not required to provide GAAP-basis financial statements for some reason should consider transitioning to FRF for SMEs. This would allow these entities to avoid implementing the new GAAP revenue, lease, and financial instruments rules. In addition, the entities could take advantage of other simplifications related to derivatives, other comprehensive income, fair value measurement, and more.
With lenders expressing confidence in FRF for SMEs, and with GAAP requiring major changes for all entities over the next few years, private entities should revisit their financial reporting framework.
ABOUT THE AUTHOR
Jennifer Louis has over 25 years of experience in designing and instructing high-quality training programs in a wide variety of technical and “soft-skills” topics needed for professional and organization success. In 2003, she founded Emergent Solutions Group, LLC, where she focuses her energy on designing and delivering practical and engaging accounting and auditing training. Jennifer started her career in Audit for Deloitte & Touche LLP. Jennifer graduated summa cum laude from Marymount University with a B.B.A. in Accounting.