MHM Executive Education Series: What Private Companies Need to Know about the AICPA’s Proposed Framework

Presented by: Mike Loritz, Keith Peterka

April 18, 2013

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Mike Loritz, CPA Shareholder 913.234.1226 | mloritz@cbiz.com Mike has 17 years of experience in public accounting with diversified financial companies and other service based companies, including banking, broker/dealer, investment companies, and other diversified companies ranging from audits of public entities in the Fortune 100 to small private entities. He is a member of MHM's Professional Standards Group, providing accounting knowledge leadership in the areas of derivative financial instruments, investment securities, share-based compensation, fair value, revenue recognition and others.

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Today’s Presenters

Keith Peterka, CPA Shareholder 610.866.2274 | kpeterka@cbiz.com With more than 18 years of experience in public accounting, Keith performs national firm responsibilities for IFRS, fair value accounting and auditing, revenue recognition and business combinations. He is a member of the MHM SEC taskforce in charge of updating the Firm’s SEC Audit Methodology. Additionally, he is a subject matter expert for IFRS, SEC reporting and fair value accounting in MHM’s Professional Standards Group. He also is a member on the IFRS Foundation's Small & Medium-sized Entities (SMEs) Implementation Group.

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Today’s Agenda

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Point/Counterpoint – What is the issue?

Private Company Financial Reporting – Background & Status

AICPA Financial Reporting Framework for SMEs – FRF for SMEs

Significant Concepts & Differences with GAAP

WHAT IS THE ISSUE?

The Standard-Setting Dilemma

15,000 issuers vs. 28.5 million private companies but GAAP driven by public company investor issues.

Small businesses employ more than half of all private sector workers.

Private companies and their financial statement users generally have information needs different from public companies.

Not Just a US Problem

Canadian Accounting Standards Board decided one size does not fit all and published Accounting Standards for Private Enterprises in Dec. 2009.

UK Accounting Standards Board proposing three-tier system of financial reporting.

Germany has become the first major country to have two standard setters.

Not Just a US Problem

Council on Accounting for Unlisted Companies formed in Japan to determine if changes should be made to standard-setting process for unlisted companies

IFRS for SMEs – being used in many areas of the world and being considered in some others

What US Constituents Say about GAAP for Private Company Financial Reporting

Too many GAAP-specific requirements not useful or relevant for private companies’ financial statement users

Greater FASB emphasis on equity/public company investors

Most important problem: relevance

Increased complexity is burdensome, time-consuming

Private companies incurring significant unnecessary cost for financial statement preparation and audit, review or compilation services.

Private companies are increasingly taking GAAP exceptions.

What This Means for GAAP in Practice Today

Current system is not attuned to the needs of private company financial statement preparers and users

PRIVATE COMPANY FINANCIAL REPORTING – BACKGROUND & STATUS

Key Events for Standard Setting for Private Companies

Private Company Financial Reporting Committee (PCFRC)

In 2006, the FASB created the PCFRC in an effort to further improve its ability to incorporate the views of private company constituents in its standard-setting process. The mission of the PCFRC was to provide recommendations to the FASB on issues related to standard setting for private companies and to focus on how standard setting affects day-to-day technical activities at private companies.

Key Events For Standard-setting For Private Companies In 2009 the FAF Board of Trustees undertook a nationwide “listening tour.”

–Many constituents continued to be concerned about the cost and complexity of standards for private companies and not-for-profit organizations and were not satisfied with the results of the collaboration between the FASB and the PCFRC.

A major issue cited by constituents was that the FASB and the PCFRC did not develop and agree upon a framework for considering exceptions or modifications to U.S. GAAP for private companies.

Financial Accounting Foundation — Listening Tour

Key Events for Standard-Setting for Private Companies

Blue -Ribbon Panel on Standard Setting for Private Companies

The FAF Trustees collaborated with the American Institute of Certified Public Accountants (AICPA) and the National Association of State Boards of Accountancy (NASBA) to create the Blue-Ribbon Panel on Standard Setting for Private Companies. The panel was charged with studying the needs of users of private company financial statements and making recommendations about how the standard setting process can best meet those needs.

Private Company Council

The PCC has two principal responsibilities: 1. The PCC will determine whether exceptions or

modifications to existing non-governmental U.S. Generally Accepted Accounting Principles (U.S. GAAP) are required to address the needs of users of private company financial statements.

2. The PCC will serve as the primary advisory body to the Financial Accounting Standards Board (FASB) on the appropriate treatment for private companies for items under active consideration on the FASB’s technical agenda.

The PCC will conduct a review of existing U.S. GAAP and identify standards that it will consider for possible exceptions or modifications. The PCC will develop, deliberate, and vote on proposed exceptions or modifications, which must be approved by a two-thirds vote of all PCC members (super majority).

PCC Agenda Setting and Due Process for Existing U.S. GAAP

Proposed modifications or exceptions to U.S. GAAP approved by the PCC will be provided to the FASB for a decision on endorsement. If endorsed by a simple majority of FASB members, the proposed modifications will be exposed for public comment.

AICPA FINANCIAL REPORTING FRAMEWORK FOR SMES —

FRF FOR SMES

AICPA Framework for SMEs

A less complicated and less costly system of accounting for SMEs that are not required to produce U.S. GAAP-based financial statements.

A cost-beneficial solution for owner-managers and others who need financial statements that are prepared in a consistent and reliable manner in accordance with a framework that has undergone public comment and professional scrutiny.

Principles based framework is intended to be responsive to the issues and concerns stakeholders currently encounter when preparing financial statements for SMEs.

AICPA Framework for SMEs

The FRF for SMEs draws upon a blend of traditional methods of accounting with some accrual income tax methods.

The framework is being developed by a working group of CPA professionals and AICPA staff with experience serving smaller-to-medium-sized private entities.

Comments received during the open comment period were mixed while users expressed both support as well as certain concerns in the Framework Implementation concerns Auditibility concerns NASBA recommended that the AICPA drop the project

Learning Center S lide No. 37

Who are FRF or SMEs for?

Small and medium-sized entities

Owner-managed/for-profit

Many industry groups

Incorporated and unincorporated

No entity precluded

Learning Center S lide No. 38

Who are FRF or SMEs for?

Owners Owner-managers in need of reliable financial statements Confirm assessments of performance What they owe/own Understand cash flow

Users External financial statement users who have direct access to

management Non-Issuers No intent of going public Not intended for non-profits

Not Authoritative

The FRF-SME will not be approved, disapproved or otherwise acted upon by any senior technical committee of the AICPA and will have no official or authoritative status.

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Features of FRF for SMEs

1) Traditional accounting methods with accrual income tax methods

2) Reduced adjustments from book to tax

3) Relevant

4) Simplified/straight-forward principles

5) Stable yet nimble

6) Reduced disclosures

Approximately 250 pages Self-contained Excess narrative avoided Avoidance of bright lines Use of professional judgment

Principles-based, Standalone, Compact

Principles-based

Standalone

Compact

AICPA Framework for SMEs

Developed for smaller- to medium-sized, owner-managed, for-profit entities where internal or external users have direct access to the owner-manager and GAAP financial statements are not required.

The AICPA has no authority to require the use of the FRF for SMEs for any entity. Therefore: The FRF for SMEs will have no effective date An owner-manager can decide to use the FRF for SMEs once it is

released. An owner-manager should make that decision in conjunction

with those who may use the entity’s financial statements.

Concepts & Principles Transition Risks and Uncertainties Accounting Changes,

Estimates, Errors Measurement Uncertainty Current assets/liabilities Statement of Income Balance Sheet Statement of Cash Flows Business Combinations Subsidiaries

Consolidation and NCI Joint Ventures Push-Down Accounting FX Translation Nonmonetary Transactions Inventories Investments Property, Plant & Equipment Intangible Assets Leases Equity Subsequent Events

Comprehensive and Relevant Framework

Commitments Contingencies Revenue Retirement and Other

Postemployment Benefits Income Taxes

Long-Lived Assets & Disc Ops

Related Party Financial Instruments and

Long Term Debt

Comprehensive and Relevant Framework (cont.)

Does not include: Earnings per share guidance Segment reporting Other comprehensive income Interim reporting Stock compensation Many of the complex issues associated with debt/equity

Comprehensive and Relevant Framework

SIGNIFICANT CONCEPTS & DIFFERENCES

Chapter 1 introduces the financial statement concepts Similar to the FASB Concept Statements

Discusses concepts including the following: Benefit vs Cost Materiality Measurement Qualitative Characteristics

Understandability Relevance Reliability Comparability

Financial Statement Concepts

Historical cost is the measurement basis primarily utilized

Departs from increased use of fair value for many instruments required by GAAP

Only equity securities held-for-sale measured at fair value

Reduction in Fair Value Measurements

Inventories are measured at the lower of cost or market, with market defined as net realizable value. Market is defined differently than US GAAP

The cost of inventories should be assigned by using the first-in, first-out (FIFO), last-in, first-out (LIFO), or weighted average cost formula. No disclosure of the difference between FIFO and LIFO

pools or inventory basis differences for entities which utilize LIFO is required

Allows for previously recorded inventory impairment losses to be reversed

Inventories

Less than 20% ownership Presumed investor does not have significant influence

Greater than 20% ownership Rebuttable presumption that significant influence exists

If significant influence exists = equity method Equity method accounting is similar to the existing

GAAP guidance However, allows the reversal of previously recognized

impairments

Equity Method Investments (Investments)

No Concept of Variable Interest Entities (VIEs)

Consolidation is not appropriate when an entity has a limited right and ability to determine or influence the strategic policies of another entity but does not control it.

A holding of an interest in an entity that is not a subsidiary qualifies as an investment. Either equity method or cost basis

Subsidiaries & Consolidation

Recognition and Presentation Does not require consolidation An entity should make an accounting policy choice to

either: a. Consolidate its subsidiaries or b. Account for its subsidiaries using the equity method

Parent-only (unconsolidated) financial statements are permitted.

Subsidiaries & Consolidation

Depreciation should be recognized in a rational and systematic manner appropriate to the nature of the item with a limited life and its use by the entity. Depreciation recognized is the greater of: the cost, less salvage value over the life of the asset or the cost, less residual value over the useful life of the asset

Allows for the subsequent reversal of impairments Analysis is still performed using undiscounted cash flows Asset group concept is the same as GAAP

Allows capitalization of finance costs

Property, Plant & Equipment — Depreciation

Straight-line method Constant charge as a function over time

Variable charge method An increasing charge method may be used when an entity

can obtain a constant rate of return on the investment in the asset.

A decreasing charge method may be appropriate when the operating efficiency of the asset declines over time.

PP&E – Different Depreciation Methods

Goodwill is not tested for impairment. Goodwill should be amortized: the same period as that used for federal income tax

purposes or if not amortized for federal income tax purposes then a

period of 10 years.

Goodwill

Closely aligned with requirements of U.S. Income Tax Code

Criteria for capitalizing a lease for tax purposes generally matches criteria in FRF for SMEs

Evaluation of capital vs. operating leases are the same as US GAAP Retains “rules” based approach

Lease Accounting

Lease Accounting

22.09 A lease that transfers substantially all the benefits and risks of ownership related to the leased property from the lessor to the lessee should be accounted for as a capital lease by the lessee and as a sales-type of direct financing lease by the lessor

22.10 A lease in which the benefits and risks of ownership related to the leased property are substantially retained by the lessor should be accounted for as an operating lease by the lessee and lessor

Revenue

27.04 Revenue from sales and service transaction s should be recognized when the requirements regarding performance…are satisfied, provided that at the time of performance, ultimate collection is reasonably assured.

Recognition

The seller of the goods has transferred to the buyer the significant risks and rewards of ownership… Reasonable assurance exists regarding the measurement of the consideration…

Performance

In the case of rendering of services and long-term contracts and modifications to those contracts, performance should be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished.

Very limited discussion of multiple element deliverables

Limited, but similar, guidance on gross vs net reporting of revenues

Revenue

Accounting Policy Election An entity should make a policy election to account for

defined benefit plans Current contribution payable method One of the accrued benefit obligation methods

Current Contribution Payable Method Only the contribution attributable to the current year is

expensed

Accrued Benefit Obligation Methods More to come

Defined Benefit Plans

Accounting Policy Election An entity should make an accounting policy election to account

for income taxes using either the taxes payable method or the deferred income taxes method

Taxes Payable Method Under the taxes payable method, only current income tax assets

and liabilities are recognized Current income taxes, to the extent unpaid or refundable, should

be recognized as a liability or asset The liability for current income taxes included in the balance

sheet is the cost (benefit) or current income taxes for current and prior periods less amounts already paid in respect of these income taxes

Income Taxes

Financial Instruments & L-T Debt

At each reporting date, an entity should measure: a. Investments in equity

instruments at cost, less any reduction for impairment,

b. All other financial assets at amortized cost; and

c. Financial liabilities at amortized cost

• An entity should measure investments in equity instruments held for sale at fair value.

• Changes in fair value should be recognized in net income in the period incurred.

• Impairments may be reversed.

Derivatives Accounting is unclear – Cash basis? Much more broad definition Disclosures Face or contract amount (or notional principal amount if there is

no face or contract amount) The nature and terms — including a discussion of the credit and

market risk of those instruments The cash requirements of those instruments

In addition, an entity should provide a description of

the entity’s objectives for holding derivative financial instruments.

Financial Instruments

When preparing financial statements, management should make an assessment of whether the going concern basis of accounting is appropriate. Management should take into account all known and

available information about the future, which is limited to twelve months from the balance sheet date.

If applicable, the entity should disclose those uncertainties along with its plans for dealing with the adverse effects of the conditions and events.

Going Concern Assessment

Comment period ended January 30, 2013

2.Your text here

3.Your text here

Remaining Timetable

AICPA staff/task force address comments/input received

Final FRF for SMEs released first half of 2013

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Questions?

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Join us for these related EES courses: July 25: Is a Simpler Accounting Framework in the Future

for Private Companies August 22: Private Company Framework - Comparing

AICPA vs. IFRS Standards

Read these related MHM Messengers 6-13: AICPA's Special-Purpose Framework Proves

Controversial 5-13: Progress on Standard-Setting for Private Companies

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If You Enjoyed This Webinar…

Mike Loritz, CPA Shareholder 913.234.1226 | mloritz@cbiz.com Mike has 17 years of experience in public accounting with diversified financial companies and other service based companies, including banking, broker/dealer, investment companies, and other diversified companies ranging from audits of public entities in the Fortune 100 to small private entities. He is a member of MHM's Professional Standards Group, providing accounting knowledge leadership in the areas of derivative financial instruments, investment securities, share-based compensation, fair value, revenue recognition and others.

‹#› #MHMWebinar

Today’s Presenters

Keith Peterka, CPA Shareholder 610.866.2274 | kpeterka@cbiz.com With more than 18 years of experience in public accounting, Keith performs national firm responsibilities for IFRS, fair value accounting and auditing, revenue recognition and business combinations. He is a member of the MHM SEC taskforce in charge of updating the Firm’s SEC Audit Methodology. Additionally, he is a subject matter expert for IFRS, SEC reporting and fair value accounting in MHM’s Professional Standards Group. He also is a member on the IFRS Foundation's Small & Medium-sized Entities (SMEs) Implementation Group.

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