PwC Comments on Proposed AICPA Financial Reporting Framework for Small- and Medium-Sized Entities

PwC fully supports efforts to enhance financial reporting for private companies, and believes that the most appropriate way to achieve meaningful change for private company stakeholders is through the collaborative efforts of the recently established Private Company Council (PCC) and the FASB. However, should the AICPA decide to issue this new non-GAAP framework, our comment letter provides observations and recommendations on changes the AIPCA should make to minimize confusion and enhance clarity.

Comment letter

January 29, 2013

Mr. Robert Durak
Director, Private Company Financial Reporting
American Institute of Certified Public Accountants
1211 Avenue of the Americas
New York, NY 10036

Proposed Financial Reporting Framework for Small- and Medium-Sized Entities

Dear Mr. Durak:

PricewaterhouseCoopers appreciates the opportunity to comment on the AICPA's Proposed Financial Reporting Framework for Small- and Medium-Sized Entities (the “Framework” or “FRF for SMEs”) developed by the AICPA FRF for SMES Task Force (the “Task Force”).

In recent years, stakeholders of private companies have raised concerns about the complexity of financial reporting. Complexity increases the cost of preparing financial information and interpreting that information. In addition, when financial reporting is not easily understood, stakeholders may look elsewhere for more relevant information.

Given these concerns, we fully support efforts to enhance financial reporting for private companies.  We believe that the most appropriate way to achieve meaningful change for private company stakeholders is through the collaborative efforts of the recently established Private Company Council (PCC) and the Financial Accounting Standards Board (FASB). Today, the use of U.S. generally accepted accounting principles (GAAP) in preparing private company financial statements is widespread.  Given the establishment of the PCC and its working relationship with the FASB, we expect this practice to continue.  Accordingly, we believe efforts focused on enhancing GAAP will be more beneficial for a broader population of private company stakeholders than creating another non-GAAP framework.

The PCC and FASB have recently taken the first steps in their efforts to improve private company financial reporting. Companies that choose to follow the Framework in lieu of using GAAP would be precluded from sharing in the benefits of applying the GAAP modifications that the PCC and FASB are working to establish.  These modifications should make a well-established and widely accepted framework (i.e. GAAP) more relevant and useful to private company stakeholders. Accordingly, we believe the best course of action for now is to allow time for the PCC and FASB’s processes to work before moving forward with the Framework.  We encourage the AICPA to consider this.

We recognize that financial statements prepared in accordance with GAAP are not required for some private companies.  Another form of reporting may sufficiently meet the needs of these stakeholders. For example, certain private companies have traditionally used the cash or income tax basis of accounting and reporting rather than GAAP.  These stakeholders may be comfortable with alternative non-GAAP frameworks of financial reporting.  In other cases, a private company that has previously prepared GAAP financial statements may also be willing to consider using the Framework.

For companies that would consider using the Framework, it is critical that all stakeholders assess the Framework's quality and suitability, and understand the specific implications of its use. Private companies will likely need to have substantive discussions with their stakeholders on these topics.  If the AICPA is to move forward with the Framework, we suggest that any preamble to the Framework encourage companies considering its use to initiate these important discussions with stakeholders.

With this in mind, the balance of our letter provides recommendations to enhance the Framework.  These include three distinct categories of enhancements: first, we recommend the AICPA expand its due process with respect to the Framework's development.  Second, we suggest making targeted changes to the Framework to minimize some aspects that may cause confusion, and clarifying the types of situations in which the Framework is suitable.  Finally, we encourage the AICPA to provide further assistance to stakeholders in understanding the implications of using a non-GAAP framework. 

Due process
High-quality accounting standards are widely accepted and well-regarded in part because of the due process to which they have been subjected. While we are not suggesting this special purpose framework should be subject to the same rigor as GAAP, we do believe that certain enhancements to the Framework's due process should be made.

• Clear and robust oversight - The development of the Framework should be subject to clear and robust oversight.  One element of that oversight should be the approval of the Framework for issuance by an appropriate committee of the AICPA. Such oversight would enhance the quality of the Framework by ensuring that the process used to develop it is sufficiently rigorous to achieve the Framework's objectives. 
• Transparency - The AICPA should ensure that there is sufficient transparency into the decision making process when establishing and changing aspects of the Framework. This will enable stakeholders to determine whether the Framework's due process is sufficient to achieve the objectives of financial reporting set out in the Framework, and allow for comparison to the due process followed in setting GAAP. For example, it is not clear how the Task Force determined that the objectives of financial reporting are best met by a blend of "traditional" accounting and income tax reporting.  Further, understanding why the Task Force selected certain accounting treatments would help practitioners and preparers consider that rationale when addressing certain concepts or topics not covered in the Framework.  
• Feedback - The 90 days allowed for constituents to comment on the Framework is insufficient for interested parties to perform an in-depth review.  We encourage the AICPA to extend the comment letter deadline to allow those who wish to perform such a review to do so.  We also recommend the AICPA provide an appropriate period to comment on the implementation guidance, including the pension guidance, and any future modifications to the Framework.

Minimizing confusion and clarifying the intended use
The name of the Framework may create confusion. In the context of financial reporting, "SME" is commonly recognized as a reference to "IFRS for SMEs" − a framework of generally accepted accounting principles. The terms "IFRS for SMEs" and "FRF for SMEs" are similar and may cause some private company stakeholders to incorrectly believe that the two frameworks are comparable and that FRF for SMEs is associated with GAAP.  That in turn could lead to the mistaken conclusion that FRF for SMEs is appropriate for general reporting purposes.  By changing the name of the Framework to clearly indicate that it is a special purpose framework and not GAAP, the nature of the Framework would be more clear.  We suggest changing the name to "Special Purpose Reporting Framework for Private Companies issued by the AICPA," or something similar.

In addition, the Explanatory Memorandum and the Foreword refer to the Framework as a "special purpose framework." Later in the Foreword, Framework-based financial statements are described as suitable for "general use."  We believe that references to "general use" and "general purpose financial statements" are confusing, and recommend they be eliminated.

Currently, the Framework states that it is intended for the owners and managers of for-profit companies with no intention of becoming a public entity and for external users where those users have access to management. The Framework goes on to indicate, however, that the AICPA cannot prohibit its use by other companies. We recommend the AICPA state definitively that the Framework should only be used where all potential users have direct access to information and/or management has committed to provide all relevant information requested.

We also recommend that the AICPA discourage use of the Framework by companies for which it is not intended.  Examples of such companies may include:

• Companies that enter into complex transactions, for example, the issuance of stock options, multi-element revenue arrangements, derivatives, and the issuance of complex equity instruments. To faithfully represent the economics of complex transactions, complex accounting may be required. The Framework does not contain guidance for certain complex transactions, and thus may not be effective for such transactions.
• Companies that are not sufficiently aware of the information needs of their users, and the information needed is not static.  These companies may not be in a position to assess the appropriateness of their financial reporting for their stakeholders' needs.
• Companies whose users have access to management, but who have differing informational needs or different levels of access. It may be more efficient for those companies to reflect all information needed by such users once in the financial statements rather than incurring the cost to gather it piecemeal based on individual requests.
• Companies that have insufficient expertise to report under the Framework, specifically with regard to the significant judgments needed to achieve the objectives of financial reporting described in the Framework. For example, there are numerous instances in the Framework where accounting policy elections will need to be made, and there are accounting issues that private companies will face that are not addressed by the Framework at all.  It is important that preparers have sufficient expertise in accounting concepts and a robust understanding of their stakeholders' needs in order to effectively apply the Framework in these instances.

Finally, the Explanatory Memorandum states that the Framework is not an authoritative document.  However, we expect that the Task Force would intend the Framework to be the authoritative source of accounting and disclosures for those companies that chose to use it, and that the Framework should be followed in its entirety.  If this is correct, we would expect the Task Force to assert that the Framework document is the authoritative source for this special purpose framework, and encourage the AICPA to clarify this point. 

Implications of a Non-GAAP framework
For the Framework to be used effectively and appropriately, it is important that stakeholders understand the differences between GAAP and the Framework.  Those differences will need to be weighed when assessing the quality and suitability of the Framework. The AICPA should ensure that this information is easily accessible in the Framework implementation guidance or other materials made available by the AICPA.  In addition, the information provided by the AICPA should discuss the potential implications of using the Framework in lieu of GAAP. Those implications include the following:

• The Framework was developed for owners and managers who need financial statements for internal use and for external users with direct access to management. As a result, it simplifies certain recognition and measurement criteria, provides more latitude in making accounting policy elections, and limits required disclosures. These elements of the Framework may increase the user's responsibility to fully understand the information presented.
• The Framework also presumes that users will independently access any information needed for their decision-making that is not contained in the financial statements. As a result, a private company following the Framework must agree to reasonable and timely access to management by all users of the company's financial statements and management must agree to provide all relevant information.
• The Framework contains significantly less guidance than GAAP and allows alternative accounting policy elections that GAAP does not. As a result, there may be less comparability among private company financial statements. Users who analyze financial information for a number of private companies may have difficulty comparing financial statements.
• A primary goal of financial statements prepared under GAAP is to faithfully portray the economics of transactions. The Framework is based in part on income tax reporting, which typically has differing objectives.  As a result, substantially different financial information could be presented in certain areas.
• The Framework was developed by the Task Force, and was not subject to the same level of due process or oversight as GAAP.  Thus, the transparency into its agenda and decisions is more limited than what GAAP stakeholders may expect. 
• All stakeholders will require adequate training to gain the expertise needed to understand and apply the Framework, including the judgments required to make policy elections. The level of training will vary based on the individual stakeholder.  The Framework is described as being based on "traditional accounting methods," which may set an expectation that training may not be an extensive undertaking; and for some, it may not be. For others, more in-depth training may be necessary, and over time, the training needs may actually increase. What is considered "traditional” will likely evolve over time (e.g., the forthcoming changes in GAAP for lease accounting will cause a discrepancy between the "traditional accounting method" used in the Framework and GAAP).  Also, some stakeholders, notably CPAs, will need to receive training to demonstrate competency in applying the Framework.  Additional costs will be incurred across our financial reporting system as a result.
• Companies will need to assess the level of effort and cost needed to comply with the Framework. This may include revising contracts, such as debt agreements and performance-based compensation arrangements that currently rely on an accounting basis other than the Framework.  It could also include system modifications to address changes in recognition and measurement.

Conclusion
We believe the PCC working with the FASB provides the best opportunity to enhance financial reporting for private companies.  In our view, the collaborative efforts of the PCC and the FASB will benefit a broader population of private companies than the Framework.  For these reasons, we believe the best course of action is to allow the PCC and the FASB time to make progress. 

In some limited cases, the Framework might provide a viable alternative for certain private companies whose stakeholders are comfortable with the limitations of a non-GAAP framework.  If the AICPA decides to move forward, we encourage it to take the additional steps noted above to enhance the Framework.  Improvements to the due process for developing the Framework, targeted changes to the Framework itself, and the availability of expanded information about the implications of using a non-GAAP framework will contribute to the Framework's viability.

If you have any questions regarding our comments, please contact Beth Paul at (973) 236-7270 or Bill Schramm at (973) 236-4586. 

Sincerely,

PricewaterhouseCoopers LLP