Peeling away financial reporting issues one layer at a time

The FRF for SMEs is a “Sack of Mush” — According to Walter Schuetze

Shortly after my most recent post on the AICPA’s new FRF for SMEs,  NASBA issued a press release that was clearly intended to keep the public spat between the two national organizations from escalating:

“The AICPA and NASBA are committed to engaging in an effort to ensure that the FRF for SMEs, as a non-authoritative framework, is not confused with GAAP and that entities that utilize GAAP or a non-GAAP solution do so in a suitable and transparent manner. To that end, the AICPA, with NSBA input, will develop a decision-making tool to assist entities with determining whether use of the FRF for SMEs is suitable or not. Additionally, illustrative financial statements and disclosures will be developed to distinguish FRF for SMEs-based  financial statements from GAAP-prepared  statements.”  [emphasis supplied]

Unless some back-room deal has taken place, I don’t see how NASBA’s position could have changed very much from its strenuous opposition.  It will never come to the point where NASBA will be recommending adoption by its member boards of accountancy.   So, it seems to me that the planned “decision-making tool” and additional disclosures could be NASBA’s way of preventing the FRF from being a giant step backward in providing U.S. investors with high quality financial reporting whatever its ultimate status with regulators may be.

My position is that the FRF for SMEs would never be “suitable” for all of the reasons set forth in my first post; and my hope is that NASBA manages to whittle down the parameters for “suitable” to almost never.

Moreover, I’m far from enamored with what the FASB is doing with the Private Company Council.  It is undeniable that GAAP is overly complex, but the “solutions” from the PCC or the AICPA that simply exempt non-public companies is ludicrous.  Small companies do in fact engage in complex transactions: they use derivatives, they give stock to their employees, they have intangible assets, they hold “variable interests” in other entities, etc.  Yet, the excision of these nettlesome requirements with a blunt instrument is a distraction from the most fundamental of questions: why does accounting have to be so complex, anyway?

Along these lines, Walter Schuetze (former SEC Chief Accountant and charter member of the FASB) kindly sent me this letter:

“For your information, I enclose three letters that I wrote to the AICPA about accounting standards for SMEs….    The AICPA followed none of my recommendations. Now we have the sack of mush the AICPA has issued.

NASBA was right to say what it did. So were you in your piece.” [emphasis added]

I’m going to devote the rest of this post to the recommendations Walter made over eight years.  It will soon become obvious that the only real choice of the AICPA was to ignore them, lest the real agenda for the FRF for SMEs be revealed: i.e., chicken salad for the AICPA (they are already charging fees for CPAs to learn about them) and the accountants who want audit clients, albeit without the attendant risk.

(NOTE: I have made slight changes to wording out of consideration for flow and space.  However, the embedded links are to the original letters.  All emphasis is added.)

August 2005:

The AICPA is now asking the FASB “to identify and implement a process that would evaluate, where appropriate, potential  changes to recognition, measurement and disclosure differences from current GAAP …” I infer that the thrust of that request is for the FASB to take current GAAP and pare it down, reduce it, to fit nonpublic business entities (NBEs).

That approach will not work. There will be no way to determine or justify a reduced FASB-promulgated GAAP as being appropriate for NBEs but not for public companies. What would the FASB do — cut out or modify FASB accounting or disclosure for leases or pensions or income taxes or consolidation to name  but a few? Where would the FASB stop cutting or modifying? Would the FASB add something that is not part of GAAP generally but would be applicable only to NBEs?

I suggest a different approach. The AICPA instead should ask the FASB to allow two sets of GAAP for NBEs: (1) FASB GAAP as it is today and as it may be in the future or (2) fair value accounting for assets and liabilities.

Most NBEs are owned by individuals. Individuals are already required to prepare their financial statements on the basis of fair value pursuant to AICPA Statement of Position 82-1. So, it is a small step, and a logical one, to have NBEs  prepare their financial statements on the basis of fair value. …

I think that commercial bankers, who are the primary users of the financial reports of NBEs, be very pleased to receive reports of NBEs with asset and liability amounts at fair values. The bankers would, for the first time, be receiving relevant, decision-useful information.

February 2010:

I recognize that others may have different opinions of how best to satisfy [the needs of users of the financial statements of private companies]. For this reason, it is critical that the Blue Ribbon Panel solicit the views of bona fide users of the financial savings of private companies, for example, commercial bankers and bonding companies, and weight those views most heavily in reaching the Panel’s recommendations.

I further recommend that the Panel engage an independent organization, skilled in soliciting opinions, to develop the appropriate survey insurance and data collection methods so that the matter of collecting and verbalizing the views of commercial bankers, bonding companies, and other users will not themselves become a source of controversy. Only in this way will the Panel have a solid basis for its recommendations.

January 2013:

The AICPA should not issue in final form the Exposure Draft dated November 1, 2012 without explaining why historical cost of assets is acceptable even when fair value is materially different and therefore obviously relevant.

The description of “relevance” in paragraph 1.12 implies that historical cost of asset should give way to fair value whenever fair value is materially different from historical cost. But, the ED in paragraph 2.20 says that “… This framework generally does not make use of fair value accounting…”

We all know that historical cost loses its relevance whenever fair value differs materially from historical cost. The final document should recognize that reality. The AICPA cannot command that historical cost is relevant when it is not. The AICPA cannot make the sun shine at midnight. The AICPA, in the final document, needs to explain why historical cost is acceptable even when it is not relevant.

* * * * * * *

Walter is smart, experienced and above all, independent-minded. He cares deeply about the quality of financial reporting. That’s why it’s crystal clear that everything Walter wrote is pointed due north.

What does the AICPA’s leadership care deeply about?  If they cared about the same things as Walter does, they wouldn’t be ignoring him.

In which direction are the AICPA and the PCC taking financial reporting?  Perhaps “direction” is too generous a characterization; they seem more like two dogs chasing their own tails.

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