Private Company Financial Reporting

Private Company Council

Purpose of the PCC

• Work jointly with FASB to mutually agree whether and when alternatives from GAAP are warranted for private companies.

• Serves as primary advisory body to FASB on appropriate treatment for private companies for items under consideration on FASBs agenda

Update No. 2014-02—Intangibles—Goodwilland Other

A consensus from PCC

Not applicable to NFP, public entities, and most EBPs

Alternative treatment (election)

Implementation of Election

• Goodwill amortized over period not to exceed 10 years

• Testing of impairment at entity or reporting unit level

• “triggering event”

• Option of performing qualitative assessment to see if it is more likely than not that impairment exists

• If impaired/2-step test

Income Statement

Income from continuing operations

Amortization of goodwill xxxxx

Goodwill impairment loss xxx

Net income from continuing operations xxxxx

(Discontinued Operations Goodwill reported separately)

Balance Sheet

Assets

.

.

Goodwill (net) xxxx

Total Assets xxxxx

Effective Date

• If elected, applied prospectively for goodwill existing at beginning of adoption period and new goodwill recognized in annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, 2015

• Early adoption/election is permitted

Disclosures

• Info about Goodwill in total/major business line/fresh start event/weighted average amortization period

• Gross amounts/accumulated amortization/accumulated impairment loss

• Info about impairment loss

Update 2014-03—Derivatives & Hedging

• Election allows privately held companies to have an alternative treatment, less expensive, avoid FV

• Applies to specific receive variable/pay fixed interest rate swaps (in essence allows entity to treat variable rate interest as fixed through swap)

• Excludes NFP, public companies, most EBPs, and financial institutions

Election

• Allows entity to measure the swap at settlement value rather than FV at each balance sheet date

• Ignore the nonperformance risk in valuation

• Assumption is that the hedge protects private business

6 Conditions Needed to Elect

• Variable rate of interest on swap & debt have same basis

• Terms on swap have no floor or cap (“plain vanilla swap”)

• Repricing and settlement dates are near same

• Swap fair value at inception is near zero

• Notional amount of swap and debt are same

• All interest payments are being hedged

Effective Date

• Simplified hedge accounting approach—annual periods beginning after 12/15/2014

• Interim periods within annual periods beginning after 12/15/2015

• Early adoption is permitted

• Adoption using modified retrospective or full retrospective approach

Update 2014-07—Consolidation

• Variable Interest Entity (VIE)—common control lease arrangement

• Allows lessee to ignore VIE accounting rules if entity is a privately owned company

Conditions Required for Election

1. Lessee and lessor under common control2. Formal lease contract exists3. Substantially all economic activity between 2

entities is related to lease4. If lessee provides any guarantees or collateral

for lessor obligations, the amount is not in excess of value of leased asset(s)

Disclosures/Subsequent Events

• If any of those conditions cease to exist, VIE accounting applies and must consolidate entities for reporting purposes

• Under election, must disclose:• >lessor liability information

relating to exposure to any financial support from lessee

• >discussion of any circumstances that would require lessee to provide financial support to lessor

Effective Date(s)

• If elected, this accounting alternative treatment should be applied retrospectively to all periods presented. Effective for annual periods beginning after 12/15/2014:

• Interim periods, within annual periods beginning after 12/15/2015

• Early application permitted

PCC Issue 13-01A - Accounting for Identifiable Intangible Assets in a Business Combination

• Endorsed by FASB in November 2014 with expected issuance in December 2014

• No recognition of:• Noncompetition agreements• Customer related intangibles that cannot be sold or

licensed independently from other assets

• Will require the adoption of 2014-02 Goodwill

• Prospective adoption for periods beginning after December 15, 2014 with early adoption permitted

Update 2014-15— Going Concern

• Management’s responsibility related to going concern evaluation

• Evaluation about ability to continue from 1 year from date the statements are issued

• Provides required disclosure information

• Effective annual periods after December 15, 2016

ImplementingFRF for SMEs

Session Objective(s):

• Understand FRF for SMEs and its history

• Learn best practices for implementing FRF for SMEs

• Learn lessons from real-life implementation stories

FRF for SMEsReleased June 2013

Background & Context

Current SPF reporting environment:

US GAAP Not RequiredGAAP not required for many small- and medium-sized entities

IFRS for SMEsLack of familiarity, higher learning curve, not US-centric, form of GAAP

Other Special Purpose FrameworksTax or modified cash basis may be inappropriate or insufficient for some SMEs/users

Special Purpose Frameworks (OCBOA):

Another option…

... a framework to deliver tailored financial reporting for America’s small business community

… a framework with streamlined, common-sense requirements based on traditional and proven accounting methods

… a framework to provide robust, meaningful financial reports to business owners, lenders, insurers and others without needless complexity

An additional non-GAAP framework

Separate from FASB and PCC

FRF for SMEs

Not GAAP - Special Purpose Framework

Complementary to efforts by FASB/PCC

AICPA fully supports the work of the PCC and FASB to address the private company environment

Private Company Council

GAAP

Modify GAAP for private companies

Who could use it?

– Small and medium-sized entities

– Owner-managed/for-profit

– Can be used by any industry group

– Incorporated and unincorporated

For use when GAAP-based financial statements are not needed

Who is it for?

Owner-ManagersDepend on reliable financial statements to

– Confirm assessments of performance

– Determine what they owe/own

– Understand cash flows

UsersExternal financial statement users who have direct access to management

Non-issuersNo intent of going public

Characteristics of typical entities

• Entity does not operate in an industry that has highly specialized accounting guidance– such as financial institutions and investment companies

• Entity does not engage in overly complicated transactions• Entity does not have significant foreign operations• Financial statement users may have greater interest in cash

flows, liquidity, statement of financial position strength and interest coverage

Features

• Standalone framework• Concise• Suitable criteria for general-use financial

statements• Accrual based• Blend of traditional accounting and accrual

income tax methods• Fewer adjustments from book to tax

Features

• Excess narrative avoided• Eschews prescriptive rules • Use of professional judgment• Intuitive and understandable• Stable yet nimble

Frameworkin Action

CPAs are putting FRF for SMEs to use…

• Firms assessing client base

• Using tools and resources available on AICPA website

• Taking steps to implement, and actually converting clients

• Otherwise risk losing business or missing opportunities

Identifying Candidates

• Entities using GAAP

• Departures

• Outside requirement for GAAP

• Non-issuers

• Not highly specialized accounting guidance

Identifying Candidates

• Entities using Tax-Basis Accounting

• Significant use of accelerated depreciation

• Debt with outside parties

Identifying Candidates

• Entities using Cash Basis Accounting

• Difficult to convert

• Expanding operations and seeking financing

Identified – Now What?

• Prepared financial information to compare current reporting framework to FRF for SMEs

• Meeting to discuss with client – ensure understanding

• Easier

• “Made sense”

• Discuss cost concerns

Identified – Now What?

• Set up meeting with users of financial statements

• Present comparison of current financial statements to those prepared under FRF for SMEs

• Explain needs are being met

• User’s needs• Business entity’s needs – helps them run

their business

• Potential cost savings

Acceptance Hurdles

• Modify debt covenants

• Lack of user’s understanding that they can still get a compilation, review or audit report

Finding Success

• CPA in Ohio ─ converted clients save a lot on disclosures; financials are more relevant

• CPA in FL ─ influenced local BofA branch to accept FRF for SMEs on behalf of a client

Finding Success

• CPA in AK ─ met with client starting new construction company; bonding agency agreed to use FRF for SMEs

• CPA in WA ─ “We met with 18 banks… They appreciated the framework’s comprehensiveness and relevant disclosures.”

Experience with Bankers & other Users

• CPAs introducing FRF for SMEs and educating state bank organizations

• FRF for SMEs treated as OCBOA

• Mostly positive responses

• Bankers want to see what they are getting

• Use tools – sample financial statements and comparison charts

Banking regulators/acceptance

• Discussed FRF for SMEs with regulators/exam chiefs

• Bankers accept OCBOA today/Flexible with smaller businesses

• Exam chiefs will treat FRF for SMEs as another OCBOA

“A new effort to streamline financial reporting could help credit officers make small-business loans without studying a mountain of footnote-laden documents.”

-American Banker, 1/27/14

“The framework could help our bank land small-business customers…”

‒Banker from MO

Comparative

Financial Statements

Example Financial Statement Extracts

• Example assumes primary difference between FRF for SMEs and GAAP financial statements is that management uses “taxes payable” method rather than “deferred taxes” method.

• Deferred tax balances account for differences in financials

Statement of Financial PositionExtract from Current Assets

Assets FRF for SMEs GAAP

Cash and cash equivalents $ 304,400 $ 304,400

Accounts receivable 3,789,200 3,789,200

Inventory 89,700 89,700

Prepaid charges and other assets 118,400 118,400

Total current assets $ 4,301,700 $ 4,301,700

Statement of Financial PositionExtract from Long-term Assets

Assets FRF for SMEs GAAP

Equity in joint venture $ 205,600 $ 205,600

Note receivable, related party 175,000 175,000

Property and equipment net of accumulated depreciation

976,400 976,400

Total long-term assets 1,357,000 1,357,000

Statement of Financial PositionExtract from Current Liabilities

Liabilities FRF for SMEs GAAP

Current maturities of notes payable $ 110,300 $ 110,300

Current portion of leases payable 62,250 62,250

Accounts payable 2,543,100 2,543,100

Current deferred tax liability 594,000

Other accrued liabilities 88,600 88,600

Total current liabilities $ 2,804,250 $ 3,398,250

Statement of Financial PositionExtract from Long-term Liabilities

Liabilities FRF for SMEs GAAP

Notes payable, less current maturities $ 357,800 $ 357,800

Leases payable, less current portion 135,350 135,350

Long-term accrued liabilities 154,200 154,200

Deferred tax liability 25,200

Total long-term liabilities $ 647,350 $ 672,550

Statement of Financial PositionExtract from Shareholders’ Equity

Equity FRF for SMEs GAAP

Common stock - $1 par value, 500,000 authorized shares…

$ 300,000 $ 300,000

Retained earnings 1,907,100 1,287,900

Total shareholders’ equity 2,207,100 1,587,900

Total liabilities and shareholders’ equity $ 5,658,700 $ 5,658,700

Extract from Statement of Operations

Equity FRF for SMEs GAAP

Revenues earned $ 9,630,800 $ 9,630,800

Cost of revenues earned 7,436,100 7,436,100

Gross profit 2,194,700 2,194,700

Selling, general, and administrative expense 895,600 895,600

Income from operations 1,299,100 1,299,100

Gain on sale of equipment 10,000 10,000

Interest expense (69,500) (69,500)

Income before provision for income taxes 1,239,600 1,239,600

Provision for income taxes 451,700 662,900

Net income 787,900 576,700

Extract from Statement ofCash Flows

Cash flows from operating activities FRF for SMEs GAAP

Net income $ 787,900 $ 576,700

Adjustments to reconcile net income to net cash provided by operating activities

Depreciation and amortization 167,800 167,800

Provision for losses on receivables 6,300 6,300

Gain on sale of equipment (10,000) (10,000)

Increase in deferred taxes 211,200

Increase in long-term accrued liabilities 128,000 128,000

Decrease in inventory 9,400 9,400

Increase in accounts receivable (461,400) (461,400)

Net cash provided by operating activities 628,000 628,000