Name of presenter Audience Date Financial Reporting Framework for Small- and Medium Sized Entities FRF for SMEsTM Accounting Framework Name of presenter Audience Date I am going to talk to you about an innovation in financial reporting for smaller, owner-managed, for-profit businesses in the U.S. [[NOTE to presenter: Feel free to trim out slides, as-appropriate for your audience.]]

Our discussion today What is FRF for SMEs? FRF for SMEs in Action What Does the Market Say? Key Principles Comparison: FRF for SMEs to U.S. GAAP Reporting by CPAs Extracts from Illustrative Financial Statements FRF for SMEs Toolkits Here’s our agenda for today’s presentation. AICPA | FRF for SMEsTM Accounting Framework

What is FRF for SMEs?

An additional non-GAAP framework The FRF for SMEs is an additional accounting framework when GAAP-compliant reports are not needed. The other special purpose frameworks remain and may still be appropriate for smaller enterprises. Which reporting option to use is something we will be discussing with our small business clients. AICPA | FRF for SMEsTM Accounting 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 FRF for SMEs is separate... AICPA | FRF for SMEsTM Accounting Framework

Who could use it? For use when GAAP-based financial statements are not needed Small and medium-sized entities Owner-managed/for-profit Can be used by many industries Incorporated and unincorporated The FRF for SMEs is intended as a financial reporting option for certain for-profit companies. AICPA | FRF for SMEsTM Accounting Framework

Who is it for? Owner-Managers Depend on reliable financial statements to Confirm assessments of performance Determine what they owe/own Understand cash flows Users External financial statement users who have direct access to management Non-issuers No intent of going public The FRF for SMEs helps owner-managers know what’s going on with their companies, enables users to glean information in a clear and concise fashion – any additional information can be obtained from the companies’ owners or management. Companies anticipating going public in the near future should consider the likelihood of needing GAAP financial statements. AICPA | FRF for SMEsTM Accounting Framework

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 Brand name and presentation title

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 The framework features include… AICPA | FRF for SMEsTM Accounting Framework

Features Excess narrative avoided Eschews prescriptive rules Use of professional judgment Intuitive and understandable Stable yet nimble Here are some other features of the framework. AICPA | FRF for SMEsTM Accounting Framework

Framework in Action The framework is catching on and we’re hearing more and more about it.

CPAs are putting FRF for SMEs to use… Firms assessing client base Using tools and discussing with clients and bankers Holding seminars for local bankers Taking steps to implement, and actually converting clients Otherwise risk losing business or missing opportunities Practitioners are staring to use the framework and are educating clients and financial statement users about it. Let’s hear about some CPAs who are helping the framework gain traction in the marketplace. AICPA | FRF for SMEsTM Accounting Framework

…And finding success CPA in WI demonstrated before-and- after financial statements to large regional and local banks. Banks received positively. Has had success converting compilation clients. CPA in FL influenced local BofA branch to accept FRF for SMEs on behalf of a client. Here’s a true story about a CPA in Wisconsin, who’s had some great successes with the framework. She’s a real person, but to protect her privacy, let’s call her Jill. Jill’s greatest success with both a large regional bank and local banks has been to take 12/31/12 financials as they were given to the banks and over lunch she’s gone through what financials would look like under FRF for SME. Bankers have given Jill positive responses – if $250K loan or less, they think the FRF for SME financials give them a better picture.  Tax basis has had such high depreciation for several years and bankers have been doing asset based lending, so they prefer FRF for SME over tax.  Hesitancy is taken away if they can actually see the numbers. On a few clients Jill implemented on interim statements and that’s been very effective.   Jill hasn’t had trouble selling it to staff.  Her firm did several lunch-and-learns to explain the principles and they’ve done some more in-depth staff training.  She took some of her clients’ prior year financials and demonstrated the impact changing can have on their financials.  Jill believes FRF for SMEs can help clients understand their financials better.  She converted 40-50% of monthly write-up clients.  On year end clients, she identified 20% of clients that X expects to convert this year end.  All of the conversions are compilation clients. Jill’s reviews are primarily construction and not having much luck there. She hasn’t brought it up for audit clients.   Jill’s advice: Start with the banker first and if banker is willing, have the banker go back to the client to say: here’s the approach you should consider… AICPA | FRF for SMEsTM Accounting Framework

CPAs’ experiences with bankers CPAs introducing FRF for SMEs and educating state bank organizations FRF for SMEs treated as Special Purpose Framework (SPF) Mostly positive responses Bankers want to see what they are getting Use tools – sample financial statements and comparison charts [[NOTE to presenter: please include your own experiences here as well.]] AICPA | FRF for SMEsTM Accounting Framework

CPAs’ experiences with clients CPA in Ohio says one converted client saves a lot on disclosures; financials are more relevant. CPA in AK met with client starting new construction company; bonding agency agreed to use FRF for SMEs. [[NOTE to presenter: please include your own experiences here as well.]] “Tracy” in Ohio has had a couple of successes and a couple of conversations.  One client discussion led Tracy to a bank conversation.  Banker wanted to see re-cast financials so he could see differences. Once he saw the re-cast financials, he was good with FRF SME. The covenants have now been reworked to allow GAAP or FRF SME.  The client had VIEs, a defined benefit pension plan and comprehensive income from marketable securities so converting to FRF SME saves a lot of disclosures and the financials are now more relevant.  One client approached them but didn’t want to amortize goodwill so they decided to stay with GAAP.  Other clients have brought it up but when analyzed, the framework wasn’t a good fit. “Laura” in Alaska met with a new client that was creating a new construction company.  Bonding agency agreed to using FRF for SMEs. AICPA | FRF for SMEsTM Accounting Framework

Banking regulators/acceptance Discussed FRF for SMEs with regulators/exam chiefs Bankers accept SPF today/Flexible with smaller businesses Exam chiefs will treat FRF for SMEs as another special purpose framework AICPA | FRF for SMEsTM Accounting Framework

What Does the Market Say?

CPAs in the Field Say “We met with 18 banks… They appreciated the framework’s comprehensiveness and relevant disclosures.” CPA from WA “For many of my clients, I use the FRF for SMEs because it makes the financial statements more understandable from their perspective.” CPA from WI “We quickly put in place a strategy to offer FRF for SMEs-based financial statement preparation to our clients.” CPA from CO Here are some real testimonials. AICPA | FRF for SMEsTM Accounting Framework

“The framework could help our bank land small-business customers…” “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 This article appeared in the American Banking Association’s Banking Journal in March 2014 AICPA | FRF for SMEsTM Accounting Framework

Key Principles Let’s talk about the key principles of the framework.

Historical cost Framework primarily uses historical cost basis, steering away from complicated fair value measurements Most relevant and reliable measurement basis for small business financial reporting needs Well-suited as a metric for evaluating an entity’s cash flow Objective, verifiable, straight-forward AICPA | FRF for SMEsTM Accounting Framework

Historical cost Directly relates to the past experience and past decisions of an entity Sound basis for financial forecasts Best measurement basis to help evaluate the performance of a small business Stands the test of time AICPA | FRF for SMEsTM Accounting Framework

Optionality in certain accounting policies Answers the varying informational needs of different financial statement users Financial reporting that is truly representative of the underlying economics of a small business Optionality nothing new to accountants – make choices today AICPA | FRF for SMEsTM Accounting Framework

Primary accounting policy options Income tax accounting – taxes payable method or deferred income taxes method Subsidiary accounting – consolidate or equity method Long-term contracts – percentage of completion method or the completed contract method AICPA | FRF for SMEsTM Accounting Framework

Targeted disclosures Only targeted disclosures in the financial statements Stakeholders receive the pertinent, understandable information they need Avoid excess narrative or irrelevant “noise” in the financial reports AICPA | FRF for SMEsTM Accounting Framework

Comparison: FRF for SMEs to U.S. GAAP

Comparison of FRF for SMEs to U.S. GAAP Fair Value Uses the term “market value” - consideration that would be agreed upon in an arm’s length transaction. Fair value is an exit price. Market value used only in very limited circumstances Business combinations. Certain nonmonetary transactions. Marketable securities held for sale. Greater use of fair value measurements. Provides an overall framework to measuring fair value. Standardized disclosure requirements for fair value measurements. Nonpublic entities are exempt from certain fair value disclosures. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Income Taxes Policy choice to account for income taxes using either the taxes payable method or the deferred income taxes method. No evaluation or accrual of uncertain tax positions. Deferred income tax method is used. Uncertain income tax positions must be evaluated and accrual made if certain conditions are met. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Comprehensive Income No concept of comprehensive income or items of other comprehensive income. Certain items are classified as other comprehensive income (OCI) and displayed as such. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Consolidation/Subsidiaries Policy choice to either consolidate subsidiaries or account for subsidiaries using the equity method. Subsidiary defined as an entity in which another entity owns more than 50 percent of the outstanding residual equity interests. No concept of variable interest entities. Consolidation is required for reporting entity with controlling financial interest in another entity. Variable interest entity (VIE) model is used when controlling financial interest is achieved through arrangements that do not involve voting interests. PCC Alternative: Permits a private company lessee (the reporting entity) to elect an alternative not to apply VIE guidance to a lessor entity under certain conditions. SPEAKER NOTE ABOUT PCC ALTERNATIVES: The Private Company Council (PCC) advises the FASB on accounting treatment for private companies for items on the FASB’s technical agenda and on possible alternatives within GAAP for the needs of the users of private company financial statements. Any proposed changes to GAAP are subject to endorsement by the FASB. These alternatives have been noted under the applicable topic.   AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Impairment No assessment of impairments for long-lived assets. A depreciated or amortized cost approach is followed. Assets no longer used are written off. Long-lived assets are tested for impairment upon a triggering event. Indefinite-lived intangible assets are subject to an impairment test annually. PCC Alternative: May elect to amortize goodwill on a straight-line basis for the lesser of 10 years or the useful life. An impairment test should be performed when a triggering event occurs which indicates the fair value of an entity may be below the carrying amount. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Leases Traditional accounting approach blended with some accrual income tax accounting methods. Lessee classifies leases as either operating or capital leases. Lessor accounts for leases as sales type, direct financing, or operating. Extant GAAP: Prospective GAAP: Following the effective date of 12/15/19  for ASU 2016-02, leases will be accounted for depending on lessee/lessor accounting.  AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Goodwill Amortized over the same period as that used for federal income tax purposes or 15 years. No impairment testing. Private companies allowed to amortize over a period of 10 years or less. Trigger-based impairment testing. PCC Alternative: May elect to amortize goodwill on a straight-line basis for the lesser of 10 years or the useful life. An impairment test should be performed when a triggering event occurs which indicates the fair value of an entity may be below the carrying amount. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Revenue Recognition Broad, principle-based guidance. Revenue should be recognized when performance is achieved and ultimate collection is reasonably assured. Effective 12/15/2017 for public companies and 12/15/18 for private companies: The FASB’s new revenue recognition standard is a broad principles-based revenue recognition model that fundamentally changes the approach to accounting for revenue (and it replaces industry- specific revenue guidance). AICPA has a revenue recognition guide to assist preparers and auditors implement the standard in many industries.   AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U. S Comparison of FRF for SMEs to U.S. GAAP Investments/Financial Assets & Liabilities FRF for SMEs U.S. GAAP Historical cost approach. Market value measurement required only for investments being held for sale. Changes in market value included in net income. Classification required based on management intent and ability. Securities classified as “available for sale” or “trading” measured at fair value. Debt securities classified as “held-to-maturity” measured at amortized cost. Accounting for changes in fair value depends upon classification. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Derivatives Disclosure approach. Recognition at settlement (cash basis). No hedge accounting. Generally derivatives recognized as either assets or liabilities. Accounting for changes in fair value depends on the use of the derivative. Hedge accounting permitted. PCC Alternative: If certain criteria are met, interest rate swaps may have variable rate borrowing converted to a fixed rate borrowing.   AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Stock-based Compensation Disclosure only. Stock-based compensation is reported on the balance sheet and income statement. AICPA | FRF for SMEsTM Accounting Framework

Comparison of FRF for SMEs to U.S. GAAP Defined Benefit Plans Policy choice to account for plans using either a current contribution payable method or one of the accrued benefit obligation methods. Plans accounted for using a projected benefit obligation model. AICPA | FRF for SMEsTM Accounting Framework

Reporting by CPAs

Reporting by CPAs CPAs performing audit, review or compilation engagements on financial statements prepared under the FRF for SMEs will follow the same standards as they do today when reporting on other SPF financial statements Compilation: AR-C section 80, Compilation of Financial Statements Review: AR-C section 90, Review of Financial Statements Audit: AU-C section 800, Special Considerations— Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks AICPA | FRF for SMEsTM Accounting Framework

Sample standard review report Independent Accountant’s Review Report Board of Directors XYZ Company ↓ Accountant’s Conclusion Based on our reviews, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in conformity with Financial Reporting Framework for Small- and Medium-Sized Entities. AICPA | FRF for SMEsTM Accounting Framework

Sample basis of presentation note Basis of Accounting We draw attention to Note X of the financial statements, which describes the basis of accounting. The financial statements are prepared in accordance with Financial Reporting Framework for Small- and Medium-Sized Entities, which is a basis of accounting other than accounting principles generally accepted in the United States of America. Our conclusion is not modified with respect to this matter. [Signature of accounting firm or accountant, as appropriate] [Accountant’s city and state] [Date] AICPA | FRF for SMEsTM Accounting Framework

Extracts from Illustrative 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 AICPA | FRF for SMEsTM Accounting Framework

Statement of Financial Position Extract from Current Assets FRF for SMEs GAAP Cash and cash equivalents $ 304,400 Accounts receivable 3,789,200 Inventory 89,700 Prepaid charges and other assets 118,400 Total current assets $ 4,301,700 AICPA | FRF for SMEsTM Accounting Framework

Statement of Financial Position Extract from Long-term Assets FRF for SMEs GAAP Equity in joint venture $ 205,600 Note receivable, related party 175,000 Property and equipment net of accumulated depreciation 976,400 Total long-term assets 1,357,000 AICPA | FRF for SMEsTM Accounting Framework

Statement of Financial Position Extract from Current liabilities FRF for SMEs GAAP Current maturities of notes payable $ 110,300 Current portion of leases payable 62,250 Accounts payable 2,543,100 Current deferred tax liability - 0 - 594,000 Other accrued liabilities 88,600 Total current liabilities $ 2,804,250 $ 3,398,250 AICPA | FRF for SMEsTM Accounting Framework

Statement of Financial Position Extract from Long-term liabilities FRF for SMEs GAAP Notes payable, less current maturities $ 357,800 Leases payable, less current portion 135,350 Long-term accrued liabilities 154,200 Deferred tax liability - 0 - 25,200 Total long-term liabilities $ 647,350 $ 672,550 AICPA | FRF for SMEsTM Accounting Framework

Statement of Financial Position Extract from Shareholders’ Equity FRF for SMEs GAAP Common stock - $1 par value, 500,000 authorized shares… $ 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 AICPA | FRF for SMEsTM Accounting Framework

Extract from Statement of Operations Equity FRF for SMEs GAAP Revenues earned $ 9,630,800 Cost of revenues earned 7,436,100 Gross profit 2,194,700 Selling, general, and administrative expense 895,600 Income from operations 1,299,100 Gain on sale of equipment 10,000 Interest expense (69,500) Income before provision for income taxes 1,239,600 Provision for income taxes 451,700 662,900 Net income 787,900 576,700 AICPA | FRF for SMEsTM Accounting Framework

Extract from Statement of Cash 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 Provision for losses on receivables 6,300 Gain on sale of equipment (10,000) Increase in deferred taxes 211,200 Increase in long-term accrued liabilities 128,000 Decrease in inventory 9,400 Increase in accounts receivable (461,400) Net cash provided by operating activities 628,000 AICPA | FRF for SMEsTM Accounting Framework

FRF for SMEs Toolkits The AICPA has created a number of resources for CPAs to use to understand and educate others (financial statement users and small business owners) about FRF for SMEs. Separately, there are toolkits for financial statement users and small business owners as well.

Illustrative financial statements checklist is also included in the toolkit. AICPA | FRF for SMEsTM Accounting Framework

Comparisons with other frameworks FRF for SMEs compared to: U.S. GAAP Tax basis IFRS for SMEs …And comparisons between the framework and other special purpose frameworks. AICPA | FRF for SMEsTM Accounting Framework

PowerPoint for use with clients/users Brand with firm name/information A PowerPoint document geared towards small business clients and users of financial statements is also included in the toolkit. AICPA | FRF for SMEsTM Accounting Framework

Flyer and backgrounder for clients, users Your firm’s logo here Hand out / mail Co-brand with your firm Flyers can be co-branded with the name of your practice to help promote the framework and your firm to potential clients and lenders. AICPA | FRF for SMEsTM Accounting Framework

Disclosure checklist checklist is also included in the toolkit. AICPA | FRF for SMEsTM Accounting Framework

Continuing education In addition, to learn more, the AICPA offers a CPE publication Financial Reporting Framework for SMEs by Richard Gesseck. Link is here: http://www.cpa2biz.com/AST/Main/CPA2BIZ_Primary/ManagementAccounting/Finance/PRDOVR~PC-745140/PC-745140.jsp#TabContent7 AICPA | FRF for SMEsTM Accounting Framework

Questions?