Peeling away financial reporting issues one layer at a time

The AICPA’s Financial Reporting Framework: How Low Should a Professional Go?

The AICPA, in its spat with NASBA over its recently released Financial Reporting Framework for SMEs (my very own critique is here), has loudly and often declaimed that the purveyors of GAAP are supportive of  their new non-GAAP option.

That is, until last week when finally, FAF president Terri Polley set the record straight.  She clearly denied that any such support ever existed, and added a number of concerns with the AICPA’s action.  Her major concern seemed to be that OCBOA should be reserved for things that bear no close resemblance to GAAP; otherwise, it could be misleading.

But, one concern that Ms. Polley did not express – and it is one that really gets my goat – is the (false) premise that the market should be left to decide which basis of accounting is appropriate for investors.  Here’s an excerpt from an Accounting Today article that covered AICPA President Barry Melancon’s rejoinder to NASBA:

“Melancon pointed out that the private market can determine which basis of accounting is appropriate. ‘They do not need a regulatory trade group making that decision,’ he wrote. ‘For many small and medium-sized enterprises, GAAP (including modifications for private companies) will be appropriate, but for others, the FRF for SMEs and other OCBOAs will be more appropriately suited. The AICPA believes that decision is best resolved between businesses and those that use their financial statements, without interference from outside parties.‘” [emphasis added]

The irony, which I am sure escapes Mr. Melancon, is that he owes his job to a legislative decision made eighty years ago (Securities Act of 1933) that accounting should not be left to market forces.  Too often – in both regulated and unregulated markets – innocent investors without sufficient say in the basis of presentation will get the shaft; and with the AICPA’s laissez faire attitude toward defining an SME, it’s a sure thing that the AICPA’s FRF will become an instrument for more of the same.

It seems that the AICPA’s conception of ‘market’ is its dues-paying segment that is not willing to take on much more  beyond auditing GAAP for dummies.  Surely, that must be different from what users of financial statements expect, and what the public expects, from CPAs. I am unable to conceive of users that care nothing about off-balance sheet financing risks, derivative financial instruments, non-cash compensation paid to insiders, overstated assets, understated liabilities, etcetera, etcetera, etcetera.

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In a completely free market, any two parties could agree to anything.  But, there are always ethical constraints.  In particular, when one party holds itself out as a professional dedicated to public service, there must be limits on the acts the professional may agree to perform.

NASBA, in so many words, is telling the AICPA that the FRF is beneath the dignity and responsibilities of the CPA.  In different words, it seems that the FAF has echoed those sentiments.


  1. Reply James Ulvog July 15, 2013

    There is a different galaxy beyond publicly traded, SEC-supervised companies with their PCAOB inspected auditors.

    I’m thinking about small businesses that may have 1 or 3 or a dozen owners who are involved in management, a couple of leases, and one or maybe two bank loans.

    In that little world, I don’t think lenders care about 5 year lease disclosures, separating capital lease amortization from depreciation expense, splitting investments between level 1, 2 & 3, the 5 year loan amortization, or how many tax years are open for inspection.

    In that world of tiny companies where total revenues and the total amount of the bank loan would be merely rounding errors in comparison to publicly traded financials, GAAP adds to the borrowers costs without doing anything for the user of the financials (yes, ‘user’ is often singular).

    In that other galaxy, there are no off-balance sheet financing risks or derivatives, either bifurcated or embedded.

    In that galaxy, financial statements using tax basis, modified cash basis, or FRF-SMEs would have value.

    The company has lots of faceless investors out there someone in the market? GAAP applies. The small world with inside investors and one bank? I think that’s a different story.

  2. Reply Keith Mautner July 18, 2013

    I don’t really understand the need for FRF-SME, and I suspect this is part of the AICPA’s ongoing strategy to conjure up new revenue streams. None of this would be happening without the support of the large international accounting firms who appear to control the AICPA; I wonder what the large firms’ interest in FRF-SME is.

    It seems to me that under existing GAAP, materiality and the nature of the business determine which rules are necessary and appropriate to follow. Certainly, companies without derivatives have no reason to be concerned about complexity of derivative accounting rules. If a company only has Level I investments, they should have no problem applying GAAP, and if they have Level III investments, how do you justify a departure from fair value?

    This is why I don’t really understand the need for FRF-SME. GAAP is only as complicated as it needs to be. For example, I own a CPA firm. Because there is nothing complicated about accounting for my business, complying with GAAP would not be complicated either. (My financial statements are prepared on a cash basis, and are not audited.)

    Since there are already less rigorous financial reporting frameworks, is FRF-SME simply an attempt by the AICPA to create and control a new, substandard, GAAP?

  3. Reply Cory July 25, 2013

    I agree with Keith. I don’t see the need for FRF- SME. I really think it’s due to AICPA’s trying to get more money scheme. I too own a CPA business and we follow everything that GAAP says. We don’t need to make things more complicated by adding in FRF or SME.

  4. Reply Neil August 6, 2013

    Excellent post on this. I too struggle with the whole FRF-SME scheme. Not sure if it’s AICPA’s way to make money, but it sure makes things a lot more complicated than I think it needs to be.

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