Do Multiple Reporting Frameworks Enhance Financial Statement Usefulness?

Standards setting continues to evolve in tiie United States. Since 1972, FASB has been the primary standards-setting body in the United States. The AICPA's Accounting Standards Executive Committee (AcSEC) had issued Statements of Position that appeared to compete with FASB's standards, but discontinued doing so after a protracted time period. This may have marked the end of the profession's early turf battle, but the issue of multiple standards setters has become more acute in recent years.

Today's Standards Setters

Specific standards-setting authority is increasingly questioned on two levels: 1) the international level, with IFRS battling against U.S. GAAP; and 2) the domestic level, with private-company standards potentially being represented by the Private Company Council (PCC), which is affiliated with FASB; the AICPA's Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs); and the IASB's IFRS for SMEs. In addition, the IASB plans to issue guidance for micro-sized entities applying IFRS for SMEs, which could potentially extend the options available for private companies even further.

Expanding the possibilities, the AICPA recently issued Statement of Auditing Standards (SAS) 122, Clarification and Recodification', this represented the core of the Clarity Project, which aimed to converge U.S. GAAS with International Standards on Auditing (ISA). SAS 122 includes section 800, "Special Considerations-Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks." Such special-purpose frameworks are primarily used by smaller entities and allow four reporting options other than GAAP: cash, tax, regulatory, and contractual basis of accounting.

In many countries, the government takes the lead in establishing accounting standards and in deciding which principles companies should adopt. In so doing, governments ensure that financial reporting bene- fits the public trust and advances a country's goals. In the United States, however, the government mandate is confined to a relatively small number of companies, those registered with the SEC and in regulated industries. This regulation void has fueled the present turf battle, where both FASB and the AICPA are vying for their share of approximately 20 million businesses. The integrity of financial reporting hinges on this battle. Members of the accounting profession must ensure that the resulting financial statements provide relevant information, are useful for economic decision making, and allow for the efficient allocation of resources and economic growth.

Potential External Reporting Frameworks

Tbe potential external reporting frameworks for public and private companies are presented in the Exhibit. If all entities involved in the current standards-setting battle prevail, most private companies might have a variety of reporting choices. If GAAP-issued financial statements are not mandated, then all choices are viable. Even with GAAP-mandated financial statements, reporting choices can include U.S. GAAP, IFRS, IFRS for SMEs (in some jurisdictions), or PCC standards.

Public Company versus Private Company GAAP

For decades, "big" versus "little" GAAP has been debated; that discussion, in broad terms, implies that big means public companies, whereas little refers to private companies. This debate has intensified in the past few years, partially with the growing dissatisfaction of "one size fits all" GAAP. The increased acceptance of IFRS for SMEs has placed additional pressure on standards setters to create standards especially relevant to private companies. Private companies have successfully argued that they are not "scaled-down" versions of public companies, but rather have unique pursuits, with autonomy, survival, and stability of greater concern than financial growth (Boj an Nastar and Stefan Bojnec, "Small Businesses and the Shadow Economy," Czech Journal of Economics and Finance, 2008, pp. 68-81).

The actual or planned adoption of IFRS for SMEs by more than 70 countries has placed pressure on U.S. standards setters to determine which GAAP best applies to private companies. The stakes are high, considering that only about 25,000 of file some 20 million businesses in the United States have a statutory requirement to prepare GAAP financial statements (Paul Pacter, "IFRS for Most Private Companies Goes Live," Financial Executive, September 2009, pp. 28-30). This pressure resulted in the 2009 creation of the Blue Ribbon Panel on Standard Setting for Private Companies by the AICPA, FAF, and the National Association of State Boards of Accountancy (NASBA). The Blue Ribbon Panel addressed the needs of users of U.S. private company financial statements and recommended the following:

* GAAP for private companies should be based on existing U.S. GAAP, with necessary exceptions and modifications to meet the objectives of financial reporting for the users of private company financial statements in a cost-effective manner.

* A private company accounting standards board, independent of FASB, but under the FAF's oversight, should determine and set exceptions and modifications in GAAP for privately held companies.

The PCC

Contrary to the Blue Ribbon Panel's recommendations, the FAF created the PCC in May 2012. The PCC will not be independent of FASB, as originally agreed upon; rather, it will-

* develop, deliberate, and formally vote on exceptions or modifications to U.S. GAAP;

* submit their recommendations for FASB endorsement;

* distribute those FASB-endorsed recommendations for public comment;

* publicly deliberate those conclusions;

* vote on proposed exceptions and final changes; and

* submit the vote to the FASB for final endorsement.

Essentially, these standards will modify existing U.S. GAAP for private companies that desire financial statements prepared in accordance with GAAP. FASB will endorse any exceptions or modifications to GAAP, solidifying its role as the ultimate standardssetting authority in the United States, for both private and public companies. Any exceptions or modifications that do not receive endorsement from FASB will include the reasons why they were not endorsed and modifications that could result in final endorsement.

Responding to the PCC's lack of independence, AICPA president and CEO Barry Melancon, in a prepared statement, wrote:

Three thousand private company constituents and a majority of the state CPA societies, representing more than a quarter million CPAs, have spoken. They want a separate independent standard-setting board, and they have sent letters to FAF asking for change. (Matthew G. Lamoreaux, "FAF Rejects Independent Standard Setter for Private Companies," Journal of Accountancy, November 2011, p. 92.) Similarly, in a press release, AICPA Chairman Paul Stahl in stated:

We don't think the concerns of smaller private companies can be fully appreciated until there is an independent board dedicated and focused solely on the needs of private companies. Therefore, we will continue to ask our members and others who support more relevant, more cost beneficial standards for private companies to make their voices heard loud and clear that the best answer is an independent private company board. (Lamoreaux, 2011)

Nonetheless, the FAF argued that having a separate standards-setting board for private companies could lead to the undesirable outcome of two separate sets of U.S. accounting standards.

FRF for SMEs

Turning its words into action, the AICPA is moving ahead with its own financial reporting framework for small and medium-sized entities. FRF for SMEs will be a less complicated and less costly system of accounting, designed for companies that do not need U.S. GAAP financial statements. This roughly 200-page framework can be used by a variety of organizations, including small and medium-sized, owner-managed, for-profit entities, in every industry, whether unincorporated or incorporated. FRF for SMEs will be principles-based and will not provide industry-specific guidance. The FRF for SMEs task force and AICPA staff will assess the need for reporting modifications based upon stakeholder input, but perhaps not before three to four years after issuance. It is estimated that as many as 20 million SMEs could use this framework in the United States ("IFRS for SMEs in Your Pocket," April 2010). But because the AICPA has no authority to set U.S. GAAP, or to mandate frie use of FRF for SMEs, it must rely upon voluntary adoption. No effective date for implementation has been identified.

Specifically, the FRF for SMEs is intended for owner-managers who rely on financial statements to confirm their assessments of performance, what they own and what they owe, and to understand cash flows. In addition, these financial statements can support applications for banking finance décidons. The AICPA expects lenders to embrace frie FRF for SMEs because it encompasses traditional accounting principles and accrual income tax accounting methods.

Hie FRF for SMEs will be based on historical cost, rather than fair value. It will not require accounting for complicated issues, including derivatives, hedging activities, or stock compensation. Moreover, mandatory disclosure requirements are reduced, because users have the ability to obtain desired additional information from management. The FRF for SMEs will focus on reporting of the performance of the company, its assets, its liabilities, and its cash flows. The FAF's approach to private company standards setting is designed for companies that desire GAAP financial statements, whereas FRF for SMEs constitutes an independent framework specifically designed for owner-managers of private companies and their external stakeholders, for whom GAAP financial statements are not required or necessary.

FRS for SMEs

Sometimes referred to as "IFRS light," IFRS for SMEs is another alternative reporting framework for small and medium-sized companies. This IASB framework was developed for those entities that have no public accountability, but are required or choose to publish general-purpose financial statements for external users. The IASB defines publicly accountable entities as those that 1) have issued debt or equity instruments in a public market, or 2) hold assets in a fiduciary capacity for a broad group of outsiders as its primary purpose of business. This latter category includes banks, credit unions, insurance companies, securities broker/dealers, pension funds, mutual funds, and investment banks. By not imposing a size test, IFRS for SMEs would be available to approximately 99% of private companies around the world (Denise Dickens and Barry Cooper, "IFRS: A Summary and Update," Internal Auditing, November/December 2010, pp. 3AA0).

Specifically, IFRS for SMEs intends "to provide information about the financial position, performance and cash flows of an entity that is useful for economic decisionmaking by a broad range of users who are not in a position to demand reports tailored to meet their particular information needs." In most instances, initial measurements of assets and liabilities are at historical cost. Subsequently, those items are measured at amortized cost, less impairment. Although most financial assets and liabilities are measured at amortized cost, certain items may be measured at fair value.

IFRS for SMEs is only 230 pages long, as compared to the 250-page FRF for SMEs exposure draft, the 2,500 pages of full IFRS, and 17,000 pages of FASB's codification. This reduction is accomplished through eliminating irrelevant topics, reducing the choices of accounting treatments, simplifying recognition and measurement methods, and reducing disclosure requirements. IFRS for SMEs contains roughly 300 disclosures; under full IFRS, there are more than 3,000. Similar to the U.S. private company options, IFRS for SMEs will be updated infrequently, approximately once every three years via an "omnibus" standard. In May 2008, the AICPA recognized the IASB as an official standards setter, meaning that U.S. companies can use IFRS for SMEs today.

Implications

CPAs who exclusively serve private companies might welcome these multiple frameworks. The complexity of full GAAP (as promulgated by FASB) and full IFRS can be avoided. Nevertheless, practitioners must be aware of all of these competing frameworks; for their initial reporting choice, companies might want to search out the framework that is most advantageous to their reporting situation. Prior to adoption of a framework, companies should conduct a thorough and comprehensive analysis of the potential impacts of the decision. Interested parties, including investors, owners, and creditors, should be a part of this discussion and implementation. These users might mandate a particular reporting framework for the private company, based upon their particular needs; CPAs can especially add value in this decision process.

But multiple frameworks will add strain to financial statement users, practitioners, preparers, educators, students, and regulators. The specific requirements of these competing frameworks must be understood. Similar entities electing differing frameworks might not produce comparable financial statements without modification by users. Regulators and auditors must determine whether the company elected an appropriate reporting framework and applied its principles accurately. It will be a challenge for accounting educators to provide an adequate introduction to these multiple frameworks. An introductory level of knowledge might be beneficial, both for students' professional demands and for potential CPA exam questions. Accounting internships might be in a single accounting framework environment, potentially limiting a student's job prospects to either a public or a private company. Beyond college, accounting career transitions between public and private companies might be impeded.

Businesses come in all shapes and sizes, with varied internal and external interests. These differences make a one-size-fits-all approach to standards setting problematic. Nevertheless, these competing accounting frameworks, while purportedly tailored to users' specific information demands, might actually create confusion among users and reduce comparability among similar entities that choose to adopt differing frameworks. Education and training must be adequate in order to ensure that a reporting framework is properly selected and implemented.

Jerry G. Kreuze, PhD, CPA, and Sheldon A. Langsam, PhD, CPA, are professors in the Haworth College of Business at Western Michigan University, Kalamazoo, Mich.James W. Penner, PhD, CPA, is an assistant professor, also in the Haworth College of Business.