Recently, a new special-purpose accounting framework was released that may ease financial reporting for smaller, privately held, owner-managed companies that aren’t required to follow Generally Accepted Accounting Principles (GAAP).
This American Institute of Certified Public Accountants (AICPA) guidance — known as the “Financial Reporting Framework for Small- and Medium-Sized Entities” (FRF for SMEs) — was developed to produce “financial statements that provide useful, relevant information in a simplified, consistent, cost-effective way,” says the AICPA. But is the FRF for SMEs for contractors? Read on and we’ll explore the concept.
GAAP and OCBOA
There’s no mandatory accounting standard for private businesses in the United States. Although GAAP is required only for publicly traded businesses, it’s used by many companies to standardize their financial statements.
While GAAP-based financial statements are useful to stockholders and securities analysts covering large public companies, such statements can be difficult and costly to maintain for small to midsize businesses. For construction companies, the complex rules involved often don’t provide much guidance that’s of particular interest or use — especially if the contractor never expects to go public or be acquired by a publicly traded company.
There have also long been a variety of alternatives to GAAP — commonly referred to as other comprehensive bases of accounting (OCBOA). But these don’t always perfectly meet the needs of small to midsize businesses either.
According to the AICPA, the FRF for SMEs was developed by blending aspects of traditional accounting methods and accrual income tax accounting methods. A primary goal is to minimize the amount of recordkeeping a company must do that’s beyond what the IRS requires; GAAP generally requires a lot of additional recordkeeping. Here are some key financial reporting areas affected by the framework:
Income taxes. GAAP stipulates that a deferred income tax method be used. The FRF for SMEs, on the other hand, lets owners use a taxes-payable method.
Intangible assets. Under GAAP, intangible assets may be categorized as having indefinite lifespans. The new framework stipulates that all intangible assets have definite lifespans for amortization purposes.
Goodwill. The FRF for SMEs allows for the amortization of goodwill during a 15-year period, the same time period as the federal tax code.
Revenue. GAAP outlines complex, specific criteria for how income should be categorized. The new framework uses a simplified and expansive definition.
Defined-benefit plans. Under the FRF for SMEs, owners are allowed to use either a current contribution payable method or an accrued benefit obligation method. GAAP stipulates that owners use a projected benefit obligation model.
Inventories. GAAP requires companies to account for inventory using a complex formula that determines the market price for unsold goods. Under the FRF for SMEs, businesses may value inventory using the “lower of cost or net realizable value.” This could be useful to contractors who maintain parts or supplies inventories.
Whether or not the FRF for SMEs suits construction companies is probably best decided on a case-by-case basis. But there are some preliminary issues to consider.
For example, the framework generally isn’t advisable for “specialized” industries with complex financial reporting methods. Is percentage of completion accounting, which is used by many contractors, such a method? Are account billings in excess of costs and estimated earnings on uncompleted jobs compatible with the FRF for SMEs? As of this writing, the answers aren’t clear but are well worth discussing with your financial advisor.
Also, many sureties require detailed financial statements to determine your bonding capacity. Yours may not accept financials generated under the FRF for SMEs — so be sure to raise the issue before converting.
The right fit
The FRF for SMEs may provide certain construction companies with a more efficient means of generating financial statements. But the new framework is but one option of many for how you might better handle your financial reporting. As mentioned, your financial advisor should lead the discussion about whether it or another method would be the right fit for your business.
Sidebar: Is your curiosity piqued? A FRF for SMEs checklist
The new “Financial Reporting Framework for Small- and Medium-Sized Entities” (FRF for SMEs; see main article) may fit the needs of some construction companies. Is your curiosity piqued?
Here’s a checklist of “good fit” criteria to get you a little further along:
• You operate only in the United States.
• You aren’t required to follow Generally Accepted Accounting Principles (GAAP), nor do you do so voluntarily already.
• You’re a privately held business “in which the people who own a controlling ownership interest in the entity are substantially the same set of people who run the company.”
• You don’t intend to go public.
• You don’t work on federal, state or municipal projects.
• You don’t “engage in overly complicated transactions.”
• Your financial statements are primarily used to determine business performance, assets, liabilities and cash flow, and this information is the main concern of the owners and managers who typically review these statements.
• Your bankers use collateral, not just your financial statements, to evaluate your loan applications.
If you’re able to check all these boxes and are still interested, talk to your financial advisor about making the switch.
Bill Poland is a Manager at Clark Schaefer Hackett and a member of the Construction and Real Estate Industry Team. For more information on this topic, or any questions, please contact him at [email protected].