THE FINANCIAL REPORTING FRAMEWORK FOR SMALL- AND
MEDIUM-SIZED ENTITIES—PART 1
CPA Firm Support Services, LLC
By Larry L. Perry, CPA
LEARNING OBJECTIVES
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To learn the presentation format for the statement of financial position under the
FRF for SMEs.
To understand the basic principles in the FRF for SMEs for presentations and
disclosure of certain account classifications in the statement of financial position.
To learn accounting treatment and disclosures for commitments and
contingencies.
INTRODUCTION
The AICPA has recognized that many non-public, small- and medium-sized companies
are not required to use U.S. GAAP as their reporting framework. These companies are
generally those with long-range ownership interests, those in specialized industries and/or
those with no intentions to file for public offerings of their securities. While other special
purpose frameworks may be appropriate for some of these entities, many of these entities
are looking for ways to provide more comprehensive financial information to financial
statement users that are not as burdensome as U.S. GAAP. Detailed guidance for the
FRF for SMEs is available at www.aicpa.org.
For these reasons, the AICPA has developed this non-authoritative, special-purpose
framework to provide simplified, consistent and relevant financial statements.
Characteristics of the framework include:
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A combination of traditional accounting methods from special purpose
frameworks such as the cash basis and the income tax basis.
A historical cost basis with some modifications for market values.
Specific, simplified footnote disclosures.
Uncomplicated, consistent and principles-based accounting.
A consolidation model that excludes variable interest entities.
In these materials, part two of a four-part series, we will present these topics for the FRF
for SMEs:
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Presentation of the statement of financial position.
Special accounting issues for financial assets and liabilities
Principles of accounting and disclosure for:
o Cash and cash equivalents
o Accounts receivable
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o
o
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o
o
o
o
Inventories
Long-lived tangible assets
Investments
Intangible assets
Equity
Commitments
Contingencies
PRESENTATION OF STATEMENT OF FINANCIAL POSITION
Some basic presentation issues under the FRF for SMEs are as follows:
1. The title of this statement is not limited to a prescribed title. Some common
options are:
a. Statement(s) of Financial Position
b. Statement(s) of Assets, Liabilities and Equity
c. Consolidated Statement(s) of Financial Position
d. Consolidated Statement(s) of Assets, Liabilities and Equity
2. Each statement should include this reference or other descriptive wording under
the statement title: (FRF for SMEs Basis).
3. As with other frameworks, a comparative format is considered the most
meaningful but is not required. In fact, for the first period of application of the
FRF for SMEs, restating prior period financial statements prepared using another
framework will usually be cost-prohibitive. Single period financial statements
will usually be the most appropriate in the first period of application.
4. This statement should be classified, i.e., current assets and liabilities should be
totaled and identified separate from other assets and liabilities.
5. Line item references to footnotes aren’t required but a reference on the bottom of
the statement to the notes and an accountant’s report is required. Example: “See
Independent Accountant’s Review Report and Notes to Financial Statements.”
Appendix A of these materials includes a basic illustrative statement of assets, liabilities
and equity prepared on an FRF for SMEs basis. Read this statement and related footnotes
and list below the differences in this framework from U.S. GAAP.
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SPECIAL ACCOUNTING ISSUES FOR FINANCIAL ASSETS AND
LIABILITIES
Current Assets
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Current assets include those that are likely to be realized in the year following the
reporting date, or in the entity’s normal operating cycle if longer. Common
classifications include:
 Cash and cash equivalents. Cash equivalents include those financial instruments
with a maturity date of 90 days or less held by an entity. This limitation is
intended to prevent changes in fair value of an instrument from affecting its
carrying amount.
 Accounts and notes receivable. Accrual accounting requires recording revenue
and receivables transactions when they are earned or realizable. Trade
receivables should be separated from balances due from related parties. An
adequate allowance for uncollectible accounts should be provided or accounts
may be written off as they are deemed uncollectible by management.
 Inventories. The value of inventories should be determined at the lower of cost or
net realizable value (sales price less costs of completion and disposal).
 Prepaid expenses. Expenses that should be matched with revenues of future
periods, or expenses directly applicable to the next reporting period, should be
recorded as prepaid.
 Deferred income tax assets. Entities electing the deferred income taxes method
should record future deductible amounts as deferred tax assets and any necessary
valuation allowance.
 Refundable income taxes. Refunds due on or before the reporting date would be
recorded.
 Costs and estimated earnings in excess of billings on uncompleted contracts. The
percentage of completion method will generate this current asset account unless
excess billings create a current liability.
Current Liabilities
Amounts payable within one year from the reporting date or a longer operating cycle
should be recorded as current liabilities. Customer deposits on products or services to be
delivered within one year represent current deferred revenues. Common classifications
are:
 Current portion of long-term debt and capital lease obligations.
 Loans and notes payable. Short-term notes or other obligations due within in the
next operating cycle should be recorded with amounts owed to related parties
presented separately. Demand notes would be classified as current if the creditor
has not waived the right to demand repayment within the next operating cycle.
Violations of loan covenants on long-term obligations would be classified as
current unless the creditor waives its rights to demand payment or violations are
cured.
 Trade accounts payable. Amounts due vendors in the next operating cycle.
 Accrued expenses. Salaries and wages, real estate taxes, interest and other period
expenses should be included.
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 Income taxes payable. Current income taxes due would be included under the
taxes payable method.
 Deferred income taxes liabilities. Current future taxable amounts giving rise to
deferred tax liabilities would be recorded when the deferred taxes method is
elected.
 Deferred revenues. Any revenues that will be earned in the next operating cycle
will be recognized as current deferred revenues.
 Billings in excess of costs and estimated earnings on uncompleted contracts. This
current liability may arise when the percentage of completion method is used and
there are excess billings (not a common occurrence!).
Other Issues
Financial assets and liabilities should be recognized at the time a reporting entity enters
into a contract, except for derivatives. Derivatives arrangements, while disclosed in
footnotes, are recorded at the net cash paid or received upon settlement. Financial assets
and liabilities, other than derivatives, are recorded at their transaction amount adjusted by
directly attributable financing fees and costs.
Financial instruments issued by an entity that contain component parts, i.e., a liability or
equity amount, should be classified according to the substance of the arrangement. In
other words, the intentions of management will guide the classification of the instrument.
Conversion options, their exercise and maturity dates, conversion ratios and conditions
enabling exercise of the options should be disclosed.
Similar to U.S. GAAP, a financial asset and liability should only be offset if the entity
has a legally enforceable right of offset or if the entity intends settlement on a net basis or
the realization of the asset and settlement of the liability is intended to be simultaneous.
Commonly, questions about offset occur in connection with bank overdrafts. When the
agreement with a bank or other depository includes offsetting overdrafts against other
deposits in that institution, an overdraft may be netted against those deposits. Otherwise,
material overdrafts would be presented as current liabilities.
Transfers of financial assets result in derecognition when control is given up. When a
liability is eliminated by payment or otherwise, it should be derecognized. Replacement
of debt instruments with another instrument having significantly different terms, or a
substantial modification of existing agreement, should be treated as the creation of a new
liability. The difference between the carrying amount of a liability transferred and the
market value of consideration received should be recorded in net income at the date of
transfer, unless the transfer is between related parties in which case the transfer may be a
capital transaction.
Certain Disclosures
Financial assets:
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The carrying amounts of financial assets should be disclosed on the face of the statement
of financial position or in the footnotes. Related party receivables or unusual amounts
receivable should be presented separately from trade accounts receivable. Amounts of
receivables with maturity dates beyond one year should be presented and/or disclosed
separately.
Transfers of financial assets:
Disclosures for transfers that are sales include:
 The aggregate of all gains or losses during the period.
 When interests in the assets are retained, the accounting policies used to initially
and subsequently measure the retained interests.
 Servicing, recourse and restrictions regarding an entity’s continuing involvement
with the transferred assets.
 Disclosures of the carrying amounts of assets transferred that are not sales, any
continued exposure to risks or rewards related to such transfers and the carrying
amounts of liabilities assumed.
Financial Liabilities:
For long-term obligations, such as bonds, debentures, mortgages and other long-term
debt, required disclosures are similar to those under U.S. GAAP.
 A description of the obligation.
 The interest rate.
 The maturity date.
 Special terms such as restrictive covenants.
 The principal and accrued interest balances.
 Repayments terms.
 Principal maturities for the next five years.
 A description and carrying amount of any collateral for each obligation.
 Whether any default or violation of terms has occurred along with any remedies
or renegotiations.
 Any capitalized interest.
 Unused letters of credit.
 Any subjective acceleration clauses.
Derivatives:
Remembering that derivatives are only recorded upon settlement and hedge accounting is
not permitted, required disclosures include:
 The face, contract or notional amount.
 The nature and terms including cash requirements, credit and market risk.
 Management’s purposes for holding the derivatives.
 The net settlement amount at the current reporting date.
Income:
For financial assets and liabilities interest income, components of interest expense and
recognized net gains and losses should be disclosed in the statements or footnotes.
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INVENTORIES
Accounting policies for inventories in the FRF for SMEs include the determination of
cost, the subsequent recognition as costs of good sold and write-downs to net realizable
value. Specialized industries accounting policies may be used with appropriate
disclosures. Similar to other reporting frameworks, inventories include retail goods
purchased and held for resale, finished goods, work-in-process, and materials and
supplies used in production.
Inventories are valued at the lower of cost or net realizable value (sales price less costs of
completion and disposal). Costs of inventories include purchase and production
(conversion) costs. Purchase costs include all direct costs and credits related to the
acquisition of goods or services. Production or conversion costs generally include direct
labor, direct materials, and allocations of fixed and variable manufacturing overhead.
Direct costs attributable to jointly-produced products should be allocated based on some
reasonable method, such as the relative sales value of the finished products. Allocations
of fixed manufacturing overhead, such depreciation, maintenance and factory
administration costs, are based on the normal production capacity of the facilities.
Variable manufacturing overhead costs, such as indirect labor and materials, are allocated
based on the volume of production. Unallocated manufacturing overhead is recognized
as a period cost.
Cost Measurement Techniques and Formulas
Measurement methods used to determine the value of inventories should approximate
cost or, as the framework specifies, the lower of cost or net realizable value. The
framework mentions the standard cost and retail method as examples. Standard costs
include estimates of materials, labor and overhead for assigning costs to specific
inventory items, with any necessary adjustments being made after periodic comparisons
with actual costs. Inventory losses and write-downs should be recorded as period
expenses. The retail method involves valuing inventory items at the latest retail prices
and applying gross margin percentage reductions to approximate the cost of products and
to determine costs of goods sold for a period.
The specific identification method may be used when goods and services are produced
for specific products and are not interchangeable with other products.
Cost-flow methods for goods and services other than those above under the FRF for
SMEs are similar to U.S. GAAP:
 First-in, first-out (FIFO)—the pricing assumption is that inventory items
purchased first are sold first resulting in prices of goods purchased last being
applied to inventory items. These prices approximate replacement costs.
 Last-in, last-out (LIFO)—this method assumes that the latest inventory production
or purchases are sold first with older “layers” of inventory being assigned prices
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from the periods produced or purchased. This method may produce a more
accurate matching of costs and revenues in income in some circumstances.
 Weighted average cost—prices assigned to inventory items at the end of a period
represent the average cost of items purchased in prior periods plus the cost of
similar items purchased during the current period.
The cost-flow method selected by an entity should resemble actual cost flows and result
in the most accurate presentation of its financial position and results of operations.
Inventories valued by the above methods must be lower than net realizable value. While
the effects of a cost-flow method on income taxes may be considered when selecting a
method, it should not be the principal reason for making a selection.
For obsolete or damaged inventory items that are purchased or produced, some costs
assigned under various cost-flow methods may not be recoverable. Applying the
principle of the lower of cost or net realizable value may necessitate write-downs of
recorded costs. The determination of net realizable value is based on facts and
circumstances affecting the inventory item, based on the best evidence available, and
should emphasize the amounts inventories are expected to realize. Materials and supplies
should be valued at cost unless the products in which they will be used have suffered a
significant decline in value.
Inventories disclosures include:
 The accounting policies and cost method used by the entity.
 The recorded balances of the various classes of inventory, e.g., raw materials,
work-in-process, finished goods, merchandise etc.
 A separate presentation of periodic costs of goods sold.
 Separate disclosure of any material write-downs or losses of inventory.
 Contractual purchase commitments and any potential losses.
 Any capitalized interest costs.
Following is a simplified standard cost build up for a company’s products assembled by
the CFO by reference to a prior period end-of-year schedule:
Work-In
Process (B)
Standard Costs for Widgets (C)
Direct Materials:
WIP Bill of Material Percent Complete
25.00%
50.00%
75.00%
Finished Goods
10.00
20.00
30.00
100.00%
Direct Labor:
WIP Percent Complete
25.00%
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Finished
Goods
40.00
5.00
50.00%
75.00%
Finished goods
10.00
15.00
100.00%
Manufacturing Overhead
WIP 150% of labor (A)
25.00%
50.00%
75.00%
20.00
7.50
15.00
22.50
Finished Goods
30.00
Total WIP
25.00%
50.00%
75.00%
Total Finished Goods
100.00%
22.50
45.00
67.50
135.00
90.00
(A) (Total manufacturing overhead divided by labor)
(B) (All costs must be tested to entity cost accounting records; cost accounting records
must be tested for reliability)
(C) (When the entity doesn't calculate standard costs, costs must be identified and
allocated to units for pricing year end inventory using a cost=flow method)
This client uses the specific identification method of accounting based on standard costs.
As a new CFO for this entity, what additional activities or procedures would you consider
necessary to accurately recognize inventories in current year financial statements under
the FRF for SMEs?
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INTANGIBLE ASSETS
Intangible assets described in the FRF for SMEs encompass all intangible assets,
including goodwill. Guidance for recognition, measurement, presentation and disclosure
is included. This section will apply to the recognition of goodwill in periods subsequent
to its initial recognition. The initial recognition of goodwill will be discussed later in
connection with business combinations. Other intangible assets included in this section
are, among others, are:
 Licensing agreements, patents and copyrights.
 Advertising campaign costs.
 Business start-up costs.
 Research and development costs.
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 Franchise agreement costs.
 Marketing agreement costs.
Capitalization of an intangible asset requires that it meet the definition in this framework,
which is identifiability, control over a resource and the existence of future economic
benefit.
Identifiable Criterion
This criterion is met when the asset:
 Is separable, i.e., capable of being sold, transferred, licensed.
 Arises from contractual or other legal rights.
 Must be distinguishable from goodwill (amount of consideration given up in a
business combination in excess of the market value of assets received).
Control Criterion
When an entity has the power (by legal or other means) to obtain future economic
benefits from an underlying resource, and to restrict access to those benefits by others,
the control criterion is met. The absence of legal rights or other means to control benefits
from resources obtained in business combinations, such as customer lists and other
relationships, normally indicates the resources are not separable from goodwill.
Future Economic Benefits
These benefits may vary but generally are increases in revenue or various forms of cost
reductions. Patents, for example, may reduce the costs of future production and thereby
increase future gross margin and net income amounts.
Recognition and Measurement
Intangible assets may be recorded when they meet the definition of an intangible assets
described above and when the recognition criteria are met. Additionally, recognition will
occur when it is probable future economic benefits will be received, cost can be
determined and a useful life can be determined. There normally will be no future
additions to amounts recognized as intangible assets.
Separate Acquisition of Intangibles:
Costs associated with the acquisition of an intangible asset, either purchased outside or
generated inside an entity, normally reflect the expectation or probability of future
economic benefits. Directly attributable internal costs may include salaries, wages and
employee benefits, professional fees and costs associated with testing the asset.
The total of intangible assets should be presented separately in an entity’s statement of
financial position with disclosure of:
 Major classes of intangible assets.
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 Total amortization expense for the period.
 Amortization methods and rates by major class.
 Accounting policies for internally-generated intangible assets including
development costs expensed or capitalized.
 Policies related to start-up costs expensed or capitalized.
INTERNALLY-GENERATED GOODWILL
The FRF for SMEs does not permit recognition of internally-generated goodwill since
expenditures incurred to generate future economic benefits do not meet the definition of
intangible assets, i.e.,they are not an identifiable resource created by contractual or other
legal rights that can be reasonably valued at cost.
Goodwill resulting from business combinations will be discussed later in this series.
Generally, such goodwill will be amortized for financial reporting over the same period
as it is amortized for income tax reporting, or 15 years if it is not amortized. Initiallyrecognized goodwill, less its accumulated amortization, should be presented separately in
an entity’s statement of financial position.
INTERNALLY-GENERATED INTANGIBLE ASSETS
Because it is often difficult to distinguish between an internally-generated intangible
asset and internally-generated goodwill or the cost of day-to-day operations, additional
guidance may be necessary to determine a separately identifiable asset that has expected
future economic benefits. This framework differentiates between the research phase and
the development phase of projects.
For costs incurred during the research phase of a project, no asset is recognized because
an entity cannot determine the asset has probable future economic benefit. All costs of
research are recognized as period expenses when incurred.
Development phase costs may either be expensed or capitalized based on a consistent
application of the accounting policy selected by management. A capitalization policy
requires measurable costs to result in a technically feasible product that management
intends to complete, one that is saleable or usable by the entity, and one that has future
economic benefit.
As an example, assume an entity is exploring the possibility of developing a circular crop
irrigation system to add to its lines of manufactured agricultural equipment. Costs
incurred initially include:
1. Trips to a foreign manufacturer’s facility to better understand the process of
manufacturing irrigation systems.
2. Numerous trips to U.S. cities to investigate alternative materials, sub-contractor’s
products and engineering resources availability.
3. The design of two alternative plans for the irrigation system by company
engineers and outside specialists.
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4. After selecting one of the plans, a prototype product is constructed and tested.
5. After successful testing, the production facility, production line, dies, tools and
electronic equipment is designed using company employees and outside
specialists.
6. A pilot production line is constructed and its operation tested.
7. A final production facility is constructed and tested.
The CFO of this entity is responsible for determining which of the above costs are
research phase costs and which are development phase costs. How would you advise the
CFO? Write your answer here:
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The cost of an internally generated intangible asset includes all costs to create, produce
and prepare it for use in an entity’s operations. All such costs should be recognized as
period costs unless they are incurred during the development phase and management has
elected capitalization or they are part of the cost of an intangible asset that has future
economic benefit.
Start-up costs can either be expensed or capitalized and amortized over 15 years based on
management’s policy election.
Under the FRF for SMEs all intangible assets are considered to have definite useful lives.
Such useful lives are determined from their related contractual and legal rights or, if none
exist, the assets are amortized based on management’s best estimates. When residual
values exist they would not be included in the amortization.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is recorded under the FRF for SMEs similar to U.S.
GAAP, i.e., at acquisition costs. Acquisition costs, among others, include:
 Purchase prices.
 Shipping charges.
 Installation and testing costs.
 Real estate commissions and legal fees.
 Other costs related to acquiring and preparing fixed assets for use.
For fixed assets constructed or developed by an entity, all direct costs, overhead costs and
interest or carrying costs related to the fixed asset are capitalized as its carrying amount.
Similar to the “improvement or betterment rule” used in practice under U.S. GAAP, costs
incurred to increase the life or capacities of a fixed asset are considered improvements
and, along with the remaining carrying amount of the asset, are depreciated over its
extended useful life. Costs to maintain the service potential of a fixed asset are recorded
as repairs and maintenance in the period incurred.
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Depreciation expense of the carrying amount is calculated in a systematic and rational
way over an asset’s useful life. The useful life of an asset is limited to the shortest of its
physical, technological, commercial or legal life. Straight-line and variable methods of
depreciation may be used, provided they are representative of a fixed asset’s economic
return or use in the operations of an entity. Depreciation methods and the lives of
property, plant and equipment should be reviewed periodically to determine any changes
in the use of an asset, changes in technology affecting productivity, impairments to the
operation or use of the asset and other events that could change the expected use of fixed
assets. Depreciation methods and useful lives should be adjusted prospectively.
Asset retirement obligations should be included in the carrying amounts of property,
plant and equipment. For example, the cost of replacing underground gasoline storage
tanks as required by a state law, if probable and estimatable, should be included in the
acquisition costs of a convenience store.
Disclosures for each major class of property, plant and equipment include:
 Acquisition cost.
 Depreciation methods and useful lives or rates.
 Carrying amounts of any significant asset under construction or not in use for
other reasons.
 Capitalized interest costs if it is the entity’s policy.
 Aggregate amount of depreciation expense for each period presented.
 When carrying amounts of long-live assets have been reduced due to decreased
use or impairment write-downs, the disclosures are necessary:
o Descriptions of the asset.
o Explanation of the cause of the reduction in carrying amount.
o Amount of the reduction in carrying amount if not presented elsewhere.
Asset Disposals
The framework requires long-lived assets to be classified as held for sale when all of the
following criteria are satisfied:
 Management has initiated a probable plan and taken actions to locate a buyer, and
the sale is likely without significant changes to the plan.
 The asset is available for immediate sale “as is” at a reasonable price.
 The sale is expected to be completed and recognized within one year, unless
circumstances beyond the control of the entity prevent sale completion.
The carrying amount of a long-lived asset held for sale represents its recorded value.
Costs to sell the asset are recognized as period expenses. No depreciation or amortization
is recognized for assets held for sale.
When a disposal group of assets and liabilities that represent a business-like activity is
available for sale, goodwill should be included in the carrying amount of the group.
Interest expense related to liabilities of a group would continue to be accrued. The assets
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and liabilities of a disposal group should be presented separately in an entity’s statement
of financial position.
Discontinued Operations
Results of operations of business segments (referred to as components) that have been
sold, abandoned or otherwise disposed of should be presented as discontinued operations
when a disposal transaction has occurred and the entity will no longer be involved in the
component’s operations. Income taxes should be allocated to discontinued operations in
the current and prior periods.
Disclosures include:
 A description of the reasons for the disposal.
 The amount of any gain or loss on disposal and where it is classified in the
statement of operations.
 Revenues and pre-tax profit or loss reported in discontinued operations.
 Any decision not to sell an asset previously held for sale.
INVESTMENTS
The equity method of accounting should be used for investments when an entity is able to
exercise significant influence over the operating, investing and financing activities of the
investee. It is presumed that an investment of 20% or more constitutes significant
influence, unless the investee is a more than 50% subsidiary.
Investors owning more than 50 % of a subsidiary can elect either the equity method or a
consolidation model for valuing such investments. For investments less than a 20%
financial interest it is presumed the investor does not have significant influence over the
investee; in such circumstances the cost method should be used to value the investment.
Equity and debt investments held for sale should be valued at market value, changes in
which should be reported in periodic income.
Equity Method
Similar to U.S. GAAP, income, losses and other reported information (such as
discontinued operations, accounting policy changes and restatements and equity
transactions) from equity investments is calculated based on the investor’s proportionate
share of ownership in the investee. Such amounts are added to the carrying amount of
the investment and reported in periodic income. Dividends received by the investor
reduce the carrying amount of an equity investment.
Cost Method
The carrying amount of equity investments under the cost method will be the acquisition
price less any return-of-capital dividends. Debt investments will be carried at their
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acquisition prices plus or minus any amounts of unamortized premium or discounts.
Other assets purchased for investment will be valued at their acquisition prices. Interest
and dividends from investments should be classified separately in the statement of
operations.
When an investor ceases to have significant influence and the investment has been
carried under the equity method, the cost method should be used prospectively from the
date the significant influence ceased.
Presentation and Disclosure
Equity and debt investments should be presented in the statement of financial position or
footnotes in these classifications:
 Investments in entities accounted for with the equity method.
 Investments carried under the cost method.
 Equity and debt investments held for sale.
The same classifications should be used to report income from investments.
Disclosures include the accounting basis for investments, significant events occurring in
periods between different reporting periods of investees and the names, descriptions,
carrying amounts and ownership percentages of each investment.
LONG-TERM OBLIGATIONS
Bonds, debentures, and similar securities, mortgages and other long-term debt are
accounted for under the accrual basis of accounting similar to U.S. GAAP. The current
and long-term principal portions of obligations are classified in the statement of financial
position according to the payment dates in related debt agreements. Unpaid interest due
at the reporting date Required disclosures are:
 Description of the liability.
 Interest rate.
 Maturity date.
 Significant terms or covenants.
 Repayment terms.
 Carrying amounts of collateral.
 Principal maturities in each of the five years after the reporting date.
 Any defaults in payments or terms that could accelerate payment demands and
whether the defaults were cured.
 Any capitalized interest.
 Unused letters of credit or other financing arrangements.
COMMITMENTS
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Future material commitments should be disclosed in the footnotes. This may include
facilities or major assets purchase or construction, debt reduction or refinancing,
restrictive covenants in debt agreements and purchase commitments.
CONTINGENCIES
Contingencies may arise in connection with guarantees of obligations of others,
threatened litigation or other matters. Accounting for contingencies, similar to U.S.
GAAP, depends on the probability of occurrence of an event causing the contingency and
whether the amount is determinable. Professional judgment should be used to determine
appropriate amounts. Uncertainties about an event are categorized as:
 Probable of occurrence—the event is likely to occur; a greater likelihood than
“more likely than not” (generally considered 50+%) but not absolutely certain.
 Remote—a slight chance of occurrence exists.
 Reasonably possible—the chance of occurrence is greater than remote and less
than probable or likely.
Contingent losses should be recorded when it is probable future events confirm that the
carrying amount of an asset has been impaired or a liability has been incurred the amount
of the loss is reasonably determinable. Contingent gains normally would not be recorded
because they do not meet the requirements for revenue recognition; namely, they may
never be realized.
Disclosures for contingent losses that exist at the reporting date include:
 The nature of the contingency from probable future events even if amounts are
not determinable.
 Estimated accrual for probable losses with indication the loss could exceed the
accrual or an indication that an amount could not be estimated.
 Events that are reasonably possible.
When it is probable a future event will result in the acquisition of an asset or reduction of
a liability a contingent gain should disclose the nature of the contingency and an estimate
of its amount or a statement an estimate is not determinable.
As CFO for ABC Corporation, assume you are evaluating the necessary disclosures for a
contingent loss. Your attorney has informed you that a settlement of $30,000 is probable
for a $100,000 lawsuit against your company, although certainty of the amount is about
60%. What is your suggested accounting treatment for this contingency?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
GUARANTEES
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Accounting treatment for guarantees should be the same as for contingent losses.
Disclosures, even for a remote likelihood the guarantor will become obligated, are as
follows:
 The nature and approximate term of the guarantee, how it arose and
circumstances triggering performance.
 The maximum, undiscounted amount of future payments that could be required or
a statement that the amount can not be determined.
 The amount of any currently existing recorded liability.
 Recourse provisions that enable the guarantor to recover any amounts paid on
behalf of a guaranteed party.
 Any assets held as collateral by third parties which can be liquidated by the
guarantor.
EQUITY
When an entity redeems or acquires shares of its own stock, the transactions are usually
recorded as capital transactions. Management can elect one of two methods of
accounting:
 Cost method.
 Constructive retirement method.
The cost method is similar to the treasury stock method under U.S. GAAP in that shares
are carried at cost and reported as a deduction from stockholders’ equity or as treasury
stock. When reacquired shares are sold, amounts received in excess of cost are treated as
paid-in capital. Any deficiency should be charged to additional paid-in capital related to
the previous issuance of the stock with any excess amounts charged to retained earnings.
If shares are retired or cancelled, their cost is allocated to the appropriate capital stock or
additional paid-in capital accounts.
Under the constructive retirement method, the aggregate par or stated value of the
acquired shares reduces the capital stock account with any excess amounts paid charged
against paid-in capital. Subsequent retirement or cancellation of the shares would require
no further accounting.
Dividends should be recognized when declared and should only be provided for
outstanding shares.
Accounting for Stock and Equity Compensation
The FRF for SMEs does not recognize compensation expense when stock or other equity
compensation is issued. Certain disclosures are required however. When options are
exercised, they are recorded as a normal stock issuance, equity transactions.
Equity transactions with non-employees are recognized when goods or services are
received by an entity. Such transactions are measured based on either the value of the
16
goods or services received or the equity instruments exchanged, whichever valuation is
most appropriate.
Presentation and Disclosure
The components of equity and changes in equity during the reporting periods should be
presented separately in the statements (a statement of changes in stockholders’ equity or
retained earnings added to a statement of operations if no other changes) or in the
footnotes. Such changes include:
 Net income attributable to a parent and any non-controlling interests.
 Other retained earnings changes.
 Additional paid-in capital changes.
 Capital stock changes.
 Any other equity changes.
Disclosures should include facts and circumstances similar to those required by U.S.
GAAP such as the following”
 Restrictions on the distribution of retained earnings (such as a restrictive debt
covenant).
 Description of a stock-based compensation plans’ general terms, vesting
requirements and the maximum option terms. Similar informative disclosures are
also necessary for equity transactions used for purchasing goods and services
from non-employees.
 Disclosures should be made for shares of capital stock authorized, issued and
outstanding that include descriptions, dividend rates, redemption prices if
redeemable, conversion provisions, amounts received or receivable for each class,
dividend arrearages and commitments to issue or resell shares.
 Disclosure of the number of shares and related transactions values from the
beginning to the end of a period that were issued, redeemed, acquired or resold.
Note: A tabular reconciliation may be the most practical way to present such
information.
 Limited liability companies should present changes members’ equity during a
period in a separate statement, combined with the statement of operations or in a
note to the financial statements.
APPENDIX A--ILLUSTRATIVE STATEMENT OF ASSETS, LIABILITIES AND
EQUITY (or Statement of Financial Position)
Following is an illustrative, basic set of financial statements and footnotes prepared under
the FRF for SMEs. A brief review of the statement of assets, liabilities and equity will
reinforce the concepts discussed in this presentation. The other statements will be
discussed in other materials in this series.
Illustrations of comparative, detailed financial statements for this framework, U.S. GAAP
basis and the income tax basis are available in the FRF for SMEs section of the AICPA’s
website (www.aicpa.org).
17
When management and users of an entity’s financial statements agree upon use of the
FRF for SMEs as the applicable reporting framework, financial statement and footnote
preparation and audit will often be most efficient choice among the alternatives.
ALWAYS BEST CORPORATION
STATEMENT OF ASSETS, LIABILITIES AND EQUITY
(FRF for SMEs Basis)
December 31, 2014
ASSETS
CURRENT ASSETS
Cash
Accounts receivable—trade
Accounts receivable—related parties
Inventories
Prepaid expenses
Total Current Assets
$
13,000
488,000
55,000
400,000
1,300
957,300
INVESTMENTS
260,000
PROPERTY AND EQUIPMENT
Land
Buildings
Machinery and equipment
Office furniture and equipment
5,000
90,000
85,000
6,000
186,000
(108,000)
Less accumulated depreciation
Net Property and Equipment
78,000
OTHER ASSETS
Note receivable
Deposits
36,000
5,800
Total Other Assets
41,800
TOTAL ASSETS
$1,337,100
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LIABILITIES AND EQUITY
CURRENT LIABILITIES
Current portion of long-term debt
Accounts payable
Accrued expenses
Income taxes payable
Payroll tax liabilities
$
Total Current Liabilities
75,000
410,000
10,500
24,000
1,100
520,600
LONG-TERM DEBT, net of current portion
125,000
TOTAL LIABILITIES
645,600
EQUITY
Common stock—no par value, 450 shares authorized, issued
and outstanding
Retained earnings
45,000
646,500
TOTAL EQUITY
691,500
TOTAL LIABILITIES AND EQUITY
$.1,337,100
See Independent Accountant’s Review Report and Notes to Financial Statements.
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ALWAYS BEST CORPORATION
STATEMENT OF REVENUES AND EXPENSES
(FRF for SMEs Basis)
Year Ended December 31, 2014
NET SALES
$ 4,185,000
COST OF SALES
3,700,000
GROSS PROFIT
485,000
OPERATING EXPENSES
Selling, general and administrative
Interest expense
543,900
17,000
Total operating expenses
560,900
OPERATING INCOME (LOSS)
( 75,900)
OTHER INCOME
Vending machine franchise income
Interest and dividends on investments
Gain on sale of fully-depreciated assts
Cell towers rent
Miscellaneous income
121,000
24,000
8,900
24,000
14,100
Total Other Income
192,000
PROVISION FOR INCOME TAXES
21,000
NET INCOME
$
95,100
See Independent Accountant’s Review Report and Notes to Financial Statements.
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ALWAYS BEST CORPORATION.
STATEMENT OF CASH FLOWS
Year Ended December 31, 2014
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation
Increase in accounts receivable
Decrease in inventories
Decrease in prepaid expenses
Increase in accounts payable and accrued expenses
Decrease in income taxes payable
$ 95,100
32,000
(137,000)
100,000
900
30,100
(11,100)
Net Cash Provided by Operating Activities
110,000
CASH FLOWS USED BY INVESTING ACTIVITIES
Purchase of machinery and equipment
Purchase of marketable securities
(20,000)
(10,000)
Cash Used By Investing Activities
(30,000)
CASH FLOWS USED BY FINANCING ACTIVITIES
Payments on debt obligations
(100,000)
NET DECREASE IN CASH
(20,000)
CASH AT BEGINNING OF YEAR
33,000
CASH AT END OF YEAR
$
13,000
See Independent Accountant’s Review Report and Notes to Financial Statements.
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ALWAYS BEST CORPORATION
NOTES TO FINANCIAL STATEMENTS
Year Ended December 31, 2014
NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of the Organization
The Corporation manufactures precast concrete products, including various types of blocks and
patio and yard decorations. Its business is located in Anywhere, USA.
The Corporation is wholly-owned and is classified as a “C” corporation for income tax purposes.
The sole shareholder of the Corporation has controlling investments in several other corporations
that purchase its products. All transactions with affiliates are at fair market values and the
Corporation has no monetary investment in, or significant influence over, the affiliated
corporations.
Basis of Accounting and Financial Statement Presentation
Financial statement presentation is based on the American Institute of Certified Public
Accountants’ Financial Reporting Framework for Small- and Medium-Size Entities (FRF),
which is a special purpose framework. This FRF differs from U.S. generally accepted
accounting principles. For example, this FRF does not require the consolidation of variable
interest entities and, instead of tests of impairment of goodwill, permits its amortization.
Accounts Receivable
The Corporation records all trade receivables at gross amounts billed to customers. A directwrite-off method is used for bad debts due to insignificant uncollectible accounts in the past.
Management continually analyzes accounts with slow-paying customers and they are written off
as bad debts if they are deemed uncollectible.
Inventories of Raw Materials and Finished Goods
The inventory consists of raw materials (sand, gravel and cement), concrete construction blocks,
patio blocks and various landscaping precast products. The inventory is stated at the lower of
cost or net realizable value and accounted for on an average cost basis.
Property and Equipment
Property and equipment expenditures of $1,000 or more are capitalized at cost and depreciated
over the estimated useful lives of the respective assets on a straight-line basis. Buildings are
depreciated over 30 years, 7 years for machinery and equipment and 5 years for office furniture
and equipment. Routine repairs and maintenance are expensed as incurred.
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Income Taxes
The Corporation has elected the taxes payable method for recording income taxes. Current
income taxes payable or refundable are recorded as a liability or asset and are based on income
tax rates and laws enacted and effective at the reporting date. Statutory rates do not differ
significantly from the effective tax rates used to calculate the provision for income taxes. There
are no unused tax loss or tax credit carryforwards.
Use of Estimates
The preparation of financial statements in conformity with the Financial Reporting Framework
for Small- and Medium-Sized Entities requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates.
Concentrations Risk
Concentrations risk consists of cash deposits. The Corporation maintains its cash in various
bank deposit accounts that, at times, may exceed federally insured and other insured limits. The
Corporation currently has no deposits in excess of insured limits, has not experienced any losses
in such accounts and does it expect to incur any such losses in the future.
Cash
Cash consists of funds on deposit at financial institutions. The Corporation has no cash
equivalents.
Subsequent Events
Management of the Corporation has evaluated subsequent events through April 30, 2015, the
date financial statements are available to be issued.
NOTE B—INVESTMENTS
The Corporation has invested in various marketable equity securities. All of the investments are
accounted for at cost since the Corporation does not have significant influence over the iinvestee
companies.
Description
Shares
Dorcus, Intl.
Pork Belly Feeds
Shovels, Inc.
Bean Bagger Co.
100
390
510
10,105
Ownership %
.00001
.00005
.0001
.0007
23
Carrying Amount
$ 25,000
40,000
80,000
75,000
U.S. Motors
215
.00001
40,000
$ 260,000
NOTE C—RELATED PARTY TRANSACTIONS
The Corporation sells products to companies that are wholly or partially owned by its President
and sole shareholder. Transactions with these companies are at sales prices charged other
customers.
Sales Volume
Pine Tree Lumber Co.
$ 275,000
Open Space Development Co. $ 430,000
Accounts Receivable at December 31, 2014
$ 22,000
33,000
$ 55,000
A note balance of $36,000 is receivable from the Corporation’s President and sole shareholder.
The note bears interest at 7% compounded annually and payments are due on demand.
NOTE D—DEBT OBLIGATIONS
Debt obligations as of December 31, 2014 consist of:
Note payable to bank, payable in monthly installments of
$ 8,000 including interest at 5.0%, collateralized
by inventories
$ 200,000
Less current portion
(75,000)
Long-term debt
$ 125,000
Principal maturities on these obligations are:
Year Ending December 31,
2015
2016
2017
$ 75,000
85,000
40,000
$146,098
Interest paid during the year ended December 31, 2014 amounted to $ 17,000.
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NOTE E—CHANGES IN EQUITY
Balance at January 1, 2014
Common
Stock
Retained
Earnings
$ 45,000
$ 551,400
Net income
95,100
Balance at December 31, 2014
$ 45,000
$ 646,500
NOTE F—OPERATING LEASE
The Corporation leases three GMC delivery trucks under an operating lease for a 36 month
period which provides for all vehicle maintenance and repairs. The residual value at the end of
the lease term is the fair market value of the vans; there is no bargain purchase option. This lease
is classified as an operating lease because the risks and rewards of ownership are retained by the
lessor. Rent expense classified in costs of goods for the period ended December 31, 2014 was
$72,000. Future lease payments are as follows:
Years Ending December 31,
2015
2016
$ 72,000
72,000
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