For small, private companies, generally accepted accounting principles can be useful — up to a point. In particular, such companies may need to base their financial statements on GAAP in order to satisfy the needs of lenders and investors. But GAAP is generally too complex, onerous, and expensive for many small companies to adopt wholesale.
There are simpler alternatives, including four widely used “other comprehensive basis of accounting” (OCBOA) methods: cash or modified cash basis, income-tax basis, regulatory basis, and using a definite set of criteria that can be applied to all material items in the financial statements. Now, more options are becoming available.
For one, the Financial Accounting Foundation, parent of the Financial Accounting Standards Board, announced in May that it had formed a council to modify GAAP for private companies. (See “New Board for Private GAAP,” June.) Also in May, the American Institute of Certified Public Accountants said it would begin working on a new OCBOA for small and medium-size entities (SMEs). Intended to be finished in the first half of 2013, the Financial Reporting Framework should be welcomed by most smaller companies; it will have fewer reporting steps than GAAP, will not require a cash-flow statement, and will be cheaper to prepare. The framework is also expected to include an additional basis of accounting that will coexist with the other four OCBOA methods for preparing financial statements.
Meanwhile, a streamlined version of international financial reporting standards (IFRS) introduced three years ago is finally beginning to gain favor among smaller firms. All three options will enable small companies to prepare financial statements in a consistent, credible, and cost-effective manner.
In theory, GAAP should work for small, private companies, but in practice it often doesn’t, says Kim Lamplough, partner at accounting advisory firm Marcum. Small companies, for example, often create GAAP reporting problems when they invest in the buildings that house them, she says. “All of a sudden, the small-business owner finds himself involved in variable-interest-entity accounting conversations, where he has to explain to the [building’s] banker that in order to comply with loan covenants he has to provide GAAP statements,” says Lamplough. “They now have to consolidate the operations of the entity that owns the building into the [company’s] financial statements.”
The AICPA’s formal approach to small-business financial reporting should give companies an extra layer of credibility with their lenders, since the standards will be much more uniform, says Lamplough.
IFRS Light: Increasing Appeal
In June 2009, the International Accounting Standards Board released a special version of IFRS for SMEs, often called “IFRS light.” Initially companies turned up their noses at the new version, which pared down IFRS’s 2,500 pages to just 230, but today more and more SMEs are warming up to it.
The increasing appeal of IFRS light comes as more companies look to expand overseas or attract international investors. “There are now more jurisdictions in the world that recognize IFRS light than U.S. GAAP,” said Salvatore Collemi, quality control senior manager at accounting firm Rothstein Kass, at a New York State Society of CPAs conference in June. More than 70 countries have either adopted IFRS light or announced plans to adopt it, according to an IASB report earlier this year.
But a full leap to IFRS light could still be years away. “An entity that wants to report that way has to get a blessing from the infrastructure in the United States — its bankers, lawyers, vendors, suppliers, all the people it does business with,” Collemi tells CFO. “That’s the challenge, and it takes time for that infrastructure to get the knowledge so that when they look at those financial statements, they will know what they are looking at.”
The Securities and Exchange Commission hasn’t helped to speed things along, either. The agency had hoped to decide late last year whether to require U.S. public companies to adopt IFRS, but the decision was still pending in July. If the SEC doesn’t make IFRS mandatory, then it’s less likely that IFRS light will be adopted anytime soon.
In the meantime, U.S. GAAP is gradually becoming less common with suppliers and customers overseas as alternate versions of other accounting standards proliferate, says Lamplough. “In an international environment, companies that are not publicly held have more choice [of reporting standards],” she says. “In the United States, we are moving to that model.”
The public-comment period on IFRS for SMEs ends on November 30, and the IFRS Foundation SME Implementation Group will hold its first physical meeting on the topic in the first quarter of 2013.