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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 …

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.

Published in: Economy & Finance

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  • 1. March 2013MHMMessenger TMM AY E R H O F F M A N M C C A N N P. C . – A N I N D E P E N D E N T C PA F I R MA publication of the Professional Standards GroupAICPA’s Special-Purpose Framework Proves ControversialThe AICPA wrote another important chapter in the AICPA describe the document as a “set of criteria”history of the search for simpler accounting practices that can be used to determine the measurement,when it issued an exposure draft of a proposed special- recognition, presentation, and disclosure of all materialpurpose framework in November 2012. But this won’t items in financial statements that are not requiredlikely be the final chapter, since some aspects of the to be prepared according to US generally acceptedframework have proven controversial. Although the accounting principles (US GAAP).comment letters expressed widespread support forthe notion of simpler accounting practices for smaller The differences between statements preparedcompanies, the details are likely to continue to evolve according to GAAP and statements prepared using thein response to the many concerns raised about the proposed framework can be summarized as follows:proposed approach. This approach calls for theAICPA to issue and maintain a non-authoritative, non- • GAAP. Generally accepted accounting principlesGAAP framework for use in special-purpose financial are suitable for preparing general-purpose financialstatements starting in late Spring 2013. The volume of statements. They include US GAAP issued by thequestions raised and the tone of the views expressed FASB, IFRS issued by the IASB, and IFRS forclearly show this approach is considerably more Small and Medium-Sized Entities issued by thecontroversial among accounting practitioners than IASB. Typically, GAAP is the required basis forinitially expected. financial statements prepared for use by external users who lack the ability to prescribe the financialThis Messenger summarizes the basic approach and information they receive from the company.the reasons for the controversy. • Proposed framework. In contrast, the AICPA’sThe AICPA’s concept framework would be considered one of a number of other comprehensive bases of accountingBasically, the proposed framework is a document of (OCBOA) available to US companies forabout 250 pages. Its full title is “Proposed Financial special-purpose financial statements. Currently,Reporting Framework for Small- and Medium-Sized companies typically prepare special-purposeEntities.” Supplemental materials released by the 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 CPAour roots run deep TM firms introduce and explain the framework to clients and financial statement users. The AICPA has not © 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.
  • 2. MHMMessengeryet decided whether the final framework and/or the who need easier-to-understand, useful financialaccompanying implementation guides and toolkits will statements that are based on a reliable,be made available at no cost or for a fee. principles-based framework.Reasons for the controversy • Concerns: Some accounting practitioners and state societies of CPAs feel the AICPA is misinterpretingThe AICPA describes its proposed framework as one the market demands and its approach will causethat is suitable for smaller- to medium-sized owner- confusion. Their views:managed, for-profit entities that need reliable financialstatements for times when users have direct access • The demand is for a single set of authoritativeto the owner-manager and GAAP financial statements standards. A non-authoritative framework likeare not required. The goal was to develop a framework the one proposed by the AICPA would causebased on a “blend of traditional accounting methods unnecessary confusion among practitionersand accrual income tax methods.” To accomplish this and preparers.goal, the framework makes a number of assumptionsabout the needs of users and the desirability of key • The Financial Accounting Foundation’sfeatures. The controversy arises because there are recently-formed Private Company Councildifferent views about the validity of these assumptions (PCC) is better positioned to meet market-basedand how best to mitigate any adverse effects. demands by developing suitable modifications and exceptions to authoritative GAAP.Following are highlights of the four most controversialissues. • Suggestions: To help mitigate the concerns about confusion, many practitioners suggested different1. Does an OCBOA framework respond names for the framework, and one firm suggested effectively to marketplace demands? different titles for financial statements because terms like “statement of financial position” areThe AICPA’s stated intent in developing the proposed indicative of financial statements prepared inOCBOA framework is to respond to marketplace accordance with GAAP. The concerns aboutdemands. Below are the major assumptions, concerns marketplace needs are more difficult to mitigate.and suggestions. The National Association of State Boards of Accountancy took a strong position on this issue by • Assumptions: The AICPA’s research indicates the urging the AICPA to table or withdraw its proposed marketplace is demanding a financial reporting framework so the PCC can carry out its mission framework that is more cost-effective than GAAP. alone and without confusion. The Institute feels its framework will meet the needs of two types of users: 2. Does a principles-based OCBOA framework provide a cost-effective solution? • Privately-owned small and medium-sized entities that are looking for a more relevant, The AICPA has proposed the use of a principles-based less complicated and cost-beneficial framework framework as a practical compromise between GAAP for their financial reporting needs. and the unmet needs of some financial statement users. The appendix highlights a number of areas in • Bankers and other financial statement users which the OCBOA framework would depart from or be 2 © 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.
  • 3. MHMMessengerless prescriptive than US GAAP. Below are the major • The costs associated with educating users willassumptions, concerns and suggestions regarding also likely be significant because the AICPA’sthis approach. framework is based partly on GAAP and partly on income tax reporting. The former is • Assumptions: The use of a principles-based designed to faithfully portray the economics of framework is seen as a cost-effective solution transactions while the latter has very different because: objectives, and the resulting differences may not be readily apparent to some users without • It is simpler, easier to learn, and less prescriptive significant education and training. than US GAAP. In effect, this means the framework permits more options, requires • Suggestions: To temper these practical concerns fewer disclosures and involves more judgment. with respect for the AICPA and its good intentions, practitioners made a number of suggestions, • It provides more benefits than tax-basis or including the following: cash-basis statements because it is more robust than the existing OCBOA frameworks. • The AICPA should reconsider some policy elections and issue guidance on how to handle • Concerns: Some accounting practitioners and areas that are missing from the framework, state societies of CPAs have a different view of the such as “follow GAAP as closely as possible.” costs and benefits. Their thoughts: • More research and information are needed • The accounting policy elections and gaps in the to evaluate the costs and benefits for all the framework will reduce the benefits by creating participants in the financial reporting process. diversity in practice and impairing the credibility To help firms with this analysis, the AICPA of the financial statements. They will also add should provide additional information for public to the costs because significant transactions comment, including a comparison with US will fall outside the scope of the framework, and GAAP and/or IFRS for SMEs and a draft of the preparers, users and practitioners will likely implementation guidance. need to devote additional time to effectively address the accounting for the outlying 3. Should the framework be driven by CPA firms transactions. and be available to all companies? • The costs associated with learning time will The proposal calls for CPA firms to play a major role in likely be significant. Practitioners find it time- gaining acceptance for the framework by explaining it consuming to review the proposed materials to the entities and users for whom it would be beneficial. and respond to exposure drafts, and the Below are the related assumptions, concerns, and new framework would add another layer to suggestions regarding this approach. accounting firms’ training and quality control efforts. Some firms feel the added efforts will • Assumptions: The framework will work best by also have an opportunity cost because they leveraging the expertise of CPA practitioners and will detract from time spent on keeping up with allowing them to determine which companies will changes in GAAP and the activities of the PCC. benefit from the use of the framework. 3 © 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.
  • 4. MHMMessenger • The AICPA plans to call upon CPA firms to take additional training and changes to underwriting the lead in persuading suitable companies and systems, and these costs would likely be lenders to use this framework, and it plans passed along to companies preparing OCBOA to issue toolkits to help them do so after the statements. Another surety company said the framework is finalized. usefulness of the framework would be limited to certain entities that are on the low end of the • No entities would be precluded from using risk spectrum where extensive disclosures are the framework. But the framework will not necessary; others would need to provide contain language cautioning readers that GAAP statements or make disclosures that are it is not appropriate for some companies, not required by the framework. including those that hope to go public, and it is not recommended for use by not-for-profit • Suggestions: Some practitioners suggested the organizations When evaluating potential use AICPA should conduct more research into the by lenders, the Institute made the assumption types of companies that would benefit from the that the framework would be useful in framework and issue more restrictive guidance. supporting applications by smaller entities For example, this type of OCBOA might be limited for bank financing when the banker does not to statements used only by management. base a lending decision solely on the financial statements. 4. Should the framework be rolled out quickly and revisited in three or four years?• Concerns: Both practitioners and users of financial statements expressed concerns that the framework The AICPA has designed the model to be helpful to does not contain language that severely restricts small companies and practitioners who do not have time its use. Their letters explained that the framework to keep up with a rapid level of change in accounting will not provide a benefit over GAAP in many standards. Here are the major assumptions, concerns, cases, especially to lenders and others who wish and suggestions in this regard. to compare the financial statements of private companies. Their thoughts: • Assumptions: The framework needs to be developed quickly and changed infrequently. • Many clients of CPA firms will not benefit from a non-GAAP framework because they are small • The framework can best be developed quickly businesses whose owners often pursue exit by modeling it after the approach taken by strategies that involve going public or being the International Accounting Standards Board purchased by a public company. when it issued International Financial Reporting Standards for Small and Medium-sized Entities • Lenders and surety bond underwriters will get (IFRS for SMEs). little benefit from a non-GAAP framework. A survey by a construction industry association • Small companies and practitioners will spend found most surety bond underwriters are less time keeping up with changes in accounting aware of the proposed framework but generally standards because the framework will not prefer GAAP financial statements. One surety change much for the next 3 to 4 years. company said use of the AICPA’s framework would likely result in increased costs due to • Concerns: Some practitioners feel the quick roll- 4 © 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.
  • 5. MHMMessenger out and lack of updating could be weaknesses Next Steps rather than strengths. Their views: The AICPA will need to consider the concerns • The framework leaves many questions expressed in the letters. In summary, the common unanswered because it was developed by themes are that a non-authoritative, non-GAAP an AICPA Task Force based on input and framework is not the best way to meet the demands of assumptions that are not transparent to others. today’s marketplace and that the OCBOA framework proposed by the AICPA would cause confusion, • Although the OCBOA framework is intended be inappropriate for many smaller companies and to be updated only every three or four years, unacceptable to many lenders, and result in greater GAAP will change more frequently, and updated costs and fewer benefits than initially contemplated. comparisons of the AICPA’s framework with Many suggestions were made to help the AICPA revise GAAP will be important for preparers, users, the model, and further outreach may be forthcoming and practitioners. before the AICPA makes a final decision about how to proceed with the framework. If not, then the AICPA• Suggestions: Many practitioners suggested the may go ahead with its original timeline which calls framework should be updated more often and a for issuance of the final framework in the first half of more robust “due process” should be put in place 2013, concurrently with a turnkey toolkit (to help CPA to develop and maintain the framework. firms explain the framework to clients and users) and an implementation volume with illustrative financial • The process should include an extension of time statements, checklists, and application examples. to review and comment on the initial proposal, as well as the implementation guidance and In the meantime, the ED and webcast are available on toolkits. the AICPA’s website at http://apps.aicpa.org/pcfr/. • More information should be made available For more information about the level of outreach already conducted by the Task Force in developing the framework. MHM’s Professional Standards Group will monitor progress on the AICPA’s OCBOA framework. We • The AICPA should consider establishing a more provided our input to the AICPA in our comment letter. rigorous “due process” that would include such techniques as publication of comprehensive If you have any specific questions, comments or rules of procedures and processes, holding concerns, please share them with Ernie Baugh or Keith public hearings, commissioning “fatal flaw” Peterka of MHM’s Professional Standards Group or reviews, establishing future funding and your MHM service professional. You can reach Ernie staffing plans, making the guidance available at ebaugh@mhm-pc.com or 423-870-0511, and you to the public free of charge, and establishing can reach Keith at kpeterka@cbiz.com or 610-862- oversight by an appropriate AICPA Committee, 2744. such as the Technical Issues Committee.The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. Please contact your MHM service provider to further discuss the impact on your financial statements. 5 © 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.
  • 6. MHM Messenger 6-13 Appendix: Significant Differences with US GAAPBelow 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. © 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.