Sunday, October 6, 2013

Financial Reporting Update

Back in March I wrote about the possible changes on the horizon regarding revenue recognition in the construction industry.  These proposed changes would alter how we report on construction company operations and consequently would require a significant retraining of all those who prepare and use those statements. 

There has been an effort put forth by the American Institute of Certified Public Accountants (AICPA) wherein they have created a model for financial reporting for small and medium-sized businesses.  This model, published in a report entitled “Financial Reporting Framework for Small and Medium Sized Entities" (abbreviated as FRF for SME), provides a pathway enabling qualifying entities to report via a non-GAAP "Other Comprehensive Basis of Accounting" (OCBOA).  By choosing this pathway, any burdensome changes in generally accepted accounting principles (GAAP) would not necessarily affect a company reporting under this FRF –SME.  This would enable a more cost effective and clearer methodology under which to report the results of operations and avoid any unnecessary complexities brought forth by an ever changing GAAP model while providing a clear, concise, relevant and useful report.  The costs saved would of course be primarily outside professional fees, but also internal cost savings as interim internal financial statements would also be reported under the FRF – SME model to outside users.  Beyond the cost savings, any confusion created in the market by some of the proposed changes in GAAP would be avoided.

The National Association of State Boards of Accountancy (NASBA) and the AICPA have now joined together in support of this new framework.  On July 15, 2013, the two organizations issued a joint statement indicating that NASBA will assist in the development of a decision making tool for businesses to help them decide if this reporting framework is right for them.  I suspect many businesses in the market we serve here in Southern California would be good candidates as they are privately owned and operated.

One of the greatest challenges facing those interested in adopting this reporting methodology is acceptance by the market – the users of these financial statements.  Many creditors require financial statements to be presented in accordance with GAAP.  These very same users might very well find the FRF – SME model more useful, concise and relevant to their needs vs. GAAP as it is proposed to change.  Some of the proposed changes to GAAP, besides the revenue recognition change discussed in my March posting, include accounting for leases.  The simple summary here is that essentially all leases will be capitalized.  Rent expense will be a thing of the past and the reader will see amortization of the right to lease assets along with interest expense in its place.  Banks, bond companies and others who use financial statements need to gain an understanding of the changes in GAAP coming down the road.  They need to assess how those changes will affect the reporting for the businesses they work with and whether those changes to the reporting are useful to them as creditors and users of those statements.  Given recent developments with the AICPA and now NASBA, it appears there are viable options to consider.

If the banks and bond companies could begin re-writing their credit documents such that the financial reporting/records requirement reads “financial statements to be provided in accordance with current accounting pronouncements” versus “…maintain its books and records in accordance with GAAP” then this FRF – SME framework could be an attractive option.  The markets need to take notice of these proposed changes to GAAP now so that any unintended consequences can be avoided and small to medium-sized businesses will not be burdened with the reporting requirements that are generally meant for much larger businesses.  This will help everyone involved including the users of the statements and the business owners.