Financial Reporting Framework for Small and Medium-Sized Entities: Final Release

Financial Reporting Framework for Small and Medium-Sized Entities: Final Release aaup.info/A&AforAU

H. Kyle Anderson, CGMA, CMA, CPA • Find out more at: aaup.info/KyleLinkedIn

Additional Resources in the Dropbox Folder A & A AAIC Internal Controls & Acctg Update 8 hrs2013 A & A AAUC Compilation & Review Update 4 hrs2013 A & A AAUR Traditional Acctg Update 8 hrs2013

Financial Reporting Framework for Small and Medium-Sized Entities: FRF for SMEs aaup.info/A&AforAU You will learn about… • FRF for SMEs conceptual framework • FRF for SMEs major provisions RESOURCES • AICPA’s FRF for SMEs at: aaup.info/FRFSMEs • AICPA’s Toolkit for CPAs: aaup.info/FRFToolsforCPAs • AICPA’s Private Company Financial Reporting • aaup.info/aicpa-pcfr

What is FRF for SMEs? Self-contained special purpose framework designed for privately-held small- to medium-sized entities • FRF for SMEs relies on: • Historical cost concepts • Reduced fair value adjustments • Reduced disclosures • Fewer M-1 adjustments for book to tax reconciliation • Utilization of typical financial statements encountered by SMEs • Reduction of complexity by planned updates approximately every 3 to 4 years.

What is FRF for SMEs? FRF for SMEs is designed for general use financial statements for management and external users that have access to management. We will address: • Basic concepts • General principles • Chapter-by-chapter summaries of materials

Financial Statement Concepts: Chapter 1 The FRF for SMEs allows the presentation of all or part of the financial statements including • the Balance Sheet • Income Statement • Statement of Changes in Equity • Statement of Cash Flows

Financial Statement Concepts FRF for SMEs uses traditional accounting concepts • Cost benefit • Materiality • Understandability • Relevance • Predictive value • Feedback value • Timeliness • Reliability • Representational faithfulness • Verifiability • Neutrality • Conservatism • Comparability in financial statement preparation

Financial Statement Concepts Assets, Liabilities, Revenues, Expenses, Gains, and Losses • Assets are economic resources controlled by the entity that contribute directly or indirectly to future cash flows and are the result of transactions or events that have already occurred. • Liabilities arise from past transactions or events requiring the future transfer of assets or services by the entity and cannot be avoided by the entity.

Financial Statement Concepts Assets, Liabilities, Revenues, Expenses, Gains, and Losses • Revenues, expenses, gains, and losses are based on ordinary, peripheral, or incidental activities of the entity’s transactions and events that increase or decrease an entities economic resources or claims to those resources. • The accrual basis of accounting should be utilized with revenues recognized when performance is achieved and measurable and expenses either matched to the revenues generated or recognized when the expenditure or asset has no future benefit.

Financial Statement Concepts Assets, Liabilities, Revenues, Expenses, Gains, and Losses Historical cost is the overriding criteria for measurement with limited use of other bases such as replacement cost for inventories, realizable or market values for temporary and portfolio investments, and the present value of future obligations such as cash received or cash paid to settle liabilities.

General Principles of Financial Statement Presentation and Accounting Policies: Chapter 2 Management is required to assess whether a going concern issue exists for 12 months after the balance sheet date An entity can choose to present all statements or a single statement. Notes to Financial Statements are required

General Principles of Financial Statement Presentation and Accounting Policies Summary of Significant Accounting Policies” or “Accounting Policies”, a statement is required per Chapter 2; paragraph 2.20 Disclosures regarding the primary differences, for example: “The accompanying financial statements have been prepared in accordance with the Financial Reporting Framework for Small- and Medium-Sized Entities issued by the American Institute of Certified Public Accountants. This framework, unlike accounting principles generally accepted in the United States of America, generally does not require the recognition of deferred taxes. We have chosen the option to recognize only current income tax assets and liabilities.”

Transition to FRF for SMEs: Chapter 3 An entity is required to apply FRF for SMEs to their opening statement of financial position and throughout all financial statements upon transition. The following exemptions from FRF for SME principles must be considered by each entity: • Business Combinations, Chapter 28: An entity can elect out of retrospective application of Chapter 11 if the combination occurred before transition to FRF for SMEs • Financial Assets and Liabilities, Chapter 6, Special Considerations for Certain Financial Assets and Liabilities. • Asset Retirement Obligations (ARO), Chapter 17, Contingencies

Transition to FRF for SMEs In the year of adoption of FRF for SMEs: • An entity is required to disclose changes to equity from transition to FRF for SMEs • A reconciliation of prior net income to net income reported under FRF for SMEs • Any exemption elections adopted by management

Statement of Financial Position: Chapter 4 • Current assets • Long-term assets • Total assets • Current liabilities • Long-term • Total liabilities • Equity • Total liabilities and equity A statement of financial position should identify and present the following:

Current Assets and Current Liabilities Current assets include those normally realizable within one year of the balance sheet date or normal operating cycle and should be reported in the financial statements by major classes. Current liabilities include amounts payable within one year of the balance sheet date or normal operating cycle, deferred income taxes payable, and should be reported in the financial statements by major classes.

Current Assets and Current Liabilities: Chapter 5 Any debt with the unilateral right to demand immediate payment is considered current unless the creditor has waived their right, the obligation has been refinanced with long-term debt prior to issuance of financial statements, or a noncancellable agreement to restructure on a long-term basis has been completed prior to the issuance of financial statements

Special Accounting Considerations for Certain Financial Assets and Liabilities: Chapter 6 Should be reported at amortized cost and equity investments are measured at cost less any impairment reductions

Special Accounting Considerations for Certain Financial Assets and Liabilities Financial Statement Presentation and disclosure of an entity’s items of income should be reported in the face of the statements or footnotes for the related financial assets and financial liabilities and should include: • Net gains and losses recognized • Interest & dividend income • Interest expense on current financial liabilities • Interest expense on long-term financial liabilities including presentation of premiums, discounts, and fees • Impairment losses and impairment recoveries

Special Accounting Considerations for Certain Financial Assets and Liabilities Specific presentation and disclosures include: • The carrying value of financial assets • Accounts and notes receivable • Any impairments by financial type and related allowance

Special Accounting Considerations for Certain Financial Assets and Liabilities Financial liability disclosures include: • A title or description • Interest rate • Maturity date • Terms and covenants in agreement • Outstanding principle and accrued interest • Repayment terms such as sinking fund, redemption, or conversion provisions

Special Accounting Considerations for Certain Financial Assets and Liabilities • Financial liability security provisions including assets pledged as collateral and terms and conditions of the pledge • Aggregate liability and payments for the next 5 years for liability settlement • Any default or breach of loan • Capitalized interest • Unused letters of credit • Long-term debt acceleration clauses

Study Question

FRF for SMEs Financial Statement concepts uses the overriding criteria of ___________ when measuring assets, liabilities, revenues & expenses: • Replacement cost • Market values • Historical Cost • Present value of future cash flows

Statement of Operations: Chapter 7 The Statement of Operations should include: • Major elements of revenue, cost of goods sold, operating expenses, other revenues and gains, and other expenses and losses • Income before discontinued operations • Results of discontinued operations • Net income or loss for the period

Statement of Operations • If applicable, presentation and disclosure should include: • Income from investments including nonconsolidated subsidiaries • Depreciation and amortization • Foreign currency translations • Atypical revenue, expenses, gains, or losses • Income taxes

Statement of Cash Flows: Chapter 8 An entity should prepare the statement of cash flows using the direct or indirect method and separately disclose the major classes of cash receipts and cash payments according to operating, investing, and financing activities. A reconciliation schedule of net income to net cash flows is required for the direct method.

Statement of Cash Flows Operating activities are the key indicator of an entity’s ability to repay loans, maintain operations, make new investments, and provide distributions to owners. Investing activities relate to the acquisition and disposition of resources to generate future income and cash flows and include the acquisition and disposition of: • Capital assets and other long-term assets • Equity and debt instruments of other entities • Cash flows from business combinations using the purchase method • Loans and advances • Futures contracts, forward contracts, option contracts, and swap contracts unless classified as financing activities

Statement of Cash Flows Financing activities represent cash inflows and outflows from capital and debt financing for the entity. Noncash Transactions do not require the use of cash or cash equivalents and are excluded from the statement of cash flows. These transactions are reported as “noncash investing or financing activities” in the face of the statement or disclosed in the notes to financial statements.

Accounting Changes, Change in Estimates, and Correction of Errors: Chapter 9 Changes in principles and discovery of significant errors requires retrospective reporting to the earliest opening balances as if the policy had always been applied. Exceptions are granted for period-specific effects or the cumulative effect if the determination of adjustments is impracticable.

Accounting Changes, Change in Estimates, and Correction of Errors Material errors resulting from intentional and unintentional mistakes in recognitions, presentation, or disclosures in financial statements should be addressed retrospectively to the earliest period presented. An entity’s initial adoption of FRF for SMEs is considered a change in accounting policy and requires the following disclosures: • Nature of the change • Description of any transitional provisions • Amount of adjustments to financial items, including prior periods if practical

Risk and Uncertainties: Chapter 10 Management is required to disclosure the nature of an entity’s operations, use of estimates with additional disclosures for significant estimates, and concentration risks.

Equity, Debt, and Other Investments: Chapter 11 When an investor holds 20% or more of ownership should be accounted for using the equity method unless classified as a Subsidiary, chapter 22. When ownership is less than 20 %, the cost method should be utilized. When an entity ceases to exercise significant influence, the investment should be reported under the cost method using the carrying value at that time.

Equity, Debt, and Other Investments The following disclosures should be separately reported in the balance sheet and income statement: • Subsidiaries accounted for using: • Equity method • Cost method • Other investments using the cost method • Equity and Debt investments held for sale

Equity, Debt, and Other Investments • Income from investments should be separately reported and include: • Equity and cost method investments • Equity and debt investments held for sale • Additional disclosures include: • Basis used to account for investments • Impact of different fiscal periods • Listing and description of significant investments

Inventory: Chapter 12 Measurement should be at lower of cost or market (defined as net realizable value) and costs include all purchase, conversion, or other costs to prepare inventories for sale. Conversion costs include direct cost and indirect costs using a systematic allocation of fixed and variable production overhead based on normal production capacity.

Inventory Entities are allowed to use the standard cost or retail method to estimate inventories if the results approximate cost. Acceptable inventory valuation methods include specific identification, FIFO, LIFO, and weighted average. Net realizable value is appropriate when the value of the inventory has decreased due to damage, obsolescence, or decline in market value and should be applied on a consistent basis such as item-by-item, group of similar items, or geographical area. Reversals of inventory write-downs are recorded in the cost of goods sold.

Intangible Assets: Chapter 13 An intangible asset exists when it is identifiable, an entity possesses the ability to control the asset, and the existence of future economic benefit exists. Typically, an entity’s control results from an enforceable legal right. Identifiability of the intangible asset requires that it: • Is separable and can be divided, sold, transferred, licensed, rented, or exchanged • Arises from a contractual or other legal right

Intangible Assets Internally-generated brands, mastheads, publishing titles, and customer lists do not qualify for recognition as intangible assets and costs are expensed as incurred When R & D expenditures progress from research to the development phase, management must establish a policy and elect to either expense expenditures as incurred or to capitalize expenditures meeting recognition criteria.

Intangible Assets An entity can only recognize an intangible asset in the development phase when all of the following criteria are met: • Technical feasibility for use or sale • Intention to complete and use or sell • Ability to use or sell • Ability to complete the development to use or sell • Ability to measure expenditures attributable to the intangible • Demonstrate how probable future economic benefits will occur

Intangible Assets The useful life of intangibles should include the following analysis: • Expected use by entity • Useful lives of similar assets • Legal or regulatory provisions limiting the life • Obsolescence, demand, competition, and economic factors • Maintenance requirements for future use

Intangible Assets Start-up costs incurred in establishing a new entity, new operations, or launching new products can be expensed as incurred or capitalized and amortized over 15 years. Goodwill is amortized according to federal income tax regulations or, if not amortized for federal purposes, then amortized over 15 years.

Intangible Assets Presentation and disclosure of intangible assets requires an entity to present intangibles and goodwill separately in an entity’s balance sheet. Disclosures include the: • Net carry value in total and by major choice • Aggregate amortization • Amortization methods • Basis to account for internally generated intangible assets

Study Question

Select the incorrect statement in the following list of accounting policies for FRF for SMEs : • An entity can choose to present the Statement of Cash Flows using the direct or indirect method • Retrospective Application is infrequently utilized in FRF for SMEs but must be applied in all cases when required • Inventory can be valued using specific identification, FIFO, LIFO & weighted average. • Goodwill and Startup costs are amortized over 15 years

Property, Plant, and Equipment: Chapter 14 Tangible capital assets should be valued at cost and include the purchase price, commissions, installation costs, architectural, design, engineering fees, legal fees, survey fees, site preparation, freight, insurance, testing, and preparation charges. Assets to be sold are measured at fair value less expected cost to sell

Property, Plant, and Equipment Assets constructed or developed over time include all direct construction or development costs and, if elected, capitalized interest expense until the asset is substantially complete and ready for use. Depreciation charges are based on the greater of costs less salvage over the life of the asset or cost less residual values over the useful life of the asset using a rational and systematic method.

Financial Reporting Framework for Small and Medium-Sized Entities: Final Release