THE FINANCIAL REPORTING FRAMEWORK FOR SMALL- AND
MEDIUM SIZED ENTITIES—PART 3
CPA Firm Support Services, LLC
By Larry L. Perry, CPA
LEARNING OBJECTIVES
 To learn the presentation format for the statements of operations under the FRF
for SMEs.
 To understand the basic principles in the FRF for SMEs for presentation and
disclosure of certain account classifications in the statements of operations.
 To learn accounting treatment and disclosures for accounting changes and risks
and uncertainties.
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, others 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 three of a four-part series, we will present these topics for the FRF
for SMEs:
 Presentation of the statements of operations.
 Principles of accounting and disclosure for:
o Revenues
o Expenses
o Leases
o Pension and post-employment benefit plans
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o Income taxes
o Accounting changes
o Risks and uncertainties
PRESENTATION OF STATEMENTS OF OPERATIONS
Some basic presentation issues under the FRF for SMEs are as follows:
1. The titles of these statements are not limited to a prescribed title. Some common
options are:
a. Statement of Operations
b. Statement of Revenues and Expenses
c. Statement of Revenues, Expenses and Retained Earnings
d. Consolidated versions of above statements
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. 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.”
STATEMENT OF OPERATIONS
Results of operations should be presented fairly in the statement of operations in
accordance with the provisions of the FRF for SMEs. Three basic categories are
normally included in the statement:
 Income or loss before discontinued operations—major elements comprising this
category include sales and other revenues, costs of sales, operating expenses,
income taxes and other expenses.
 Discontinued operations—results of operations of components that are sold,
abandoned, otherwise disposed of or held for sale should be classified in this
category.
 Net income or loss—when statements are consolidated the portion attributable to
non-controlling interests and to the parent should be presented.
Treatment of Major Classifications on the Statement of Operations
Recognizing Revenues
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Recognizing revenue under this FRF requires completion of performance of a transaction
and reasonable assurance of collection of invoices and billings. Similar to U.S. GAAP,
revenue must be earned or realizable to be recognized.
Specifically for the sale of goods, performance is achieved when the seller has transferred
ownership of the goods to the buyer and the seller retains no continuing involvement in
the goods transferred.
When services are provided under long-term contracts, performance should be
determined under the percentage of completion method or the completed contract
method. The method that best relates the revenue to the work performed should be used.
Achievement of performance occurs when:
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There is persuasive evidence of an arrangement.
Goods have been delivered or services have been provided.
The seller’s price is fixed or determinable.
Evidence of an arrangement: Business practices or prior transactions with a customer,
side agreements, consignment sales, the right to return a product or requirements to
repurchase a product may be indicators of whether an arrangement exists.
Delivery: Delivery generally occurs when a product is delivered to a customer’s facility
or another specified site. As it is when recognizing revenue under other reporting
frameworks, consideration of several factors may be necessary. Such factors include bill
and hold agreements, required customer acceptance, layaway sales, non-refundable fees,
licensing and other fees and who bears the risk of loss.
Seller’s price: Factors that should be considered to determine if a price if fixed or
determinable include cancellable provisions, the right of return of a product, price
protections or inventory credit arrangements and refundable fees for service agreements.
Generally, performance of a transaction determines when revenue is earned and
recognized. For the sale of goods or providing services, performance is considered
achieved when a seller has transferred goods to a buyer or provided services, i.e., a point
of sale or delivery has occurred, when the buyer assumes the risks and rewards of
ownership of a product or accepts the services, when there is reasonable assurance a
specified amount of consideration will be received (collectability) in return and when an
appropriate allowance for returns of products has been determined. A sale would not be
recorded when the seller retains significant risks of ownership, such as in the case of
consignment sales. An appropriate allowance for uncollectible accounts should be
provided based on the evaluation of collectability.
For long-term contracts or rendering services, performance should be determined under
either the percentage of completion method or the completed contract method, whichever
best presents revenues in relationship to the work that has been accomplished. Revenue
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should be recognized under the percentage of completion method base on some
systematic, rational and consistent basis such as sales value, related costs, and extent of
progress or number of acts. Amounts billed are an appropriate basis only if they are
indicative of work completed.
The completed contract method normally should be used when the extent of progress
cannot be reasonably estimated. Management may elect to use the completed contract
method when it is used for income tax reporting or when the financial position and results
of operations are similar to the percentage of completion method. This may occur when
an entity performs numerous short-term contracts.
Contract claims may be recorded when amounts have been awarded or received or at
times when it becomes probable the claims will result in additional contract revenue (if
amounts can be reasonably estimated). In the latter case, revenue should be recorded
only to the extent related costs are incurred.
Multiple Deliverable Arrangements
For multiple deliverable arrangements, performance of transactions should be considered
separately in accordance with the recognition criteria above. An example would be the
sale of software with separately priced installation, training, maintenance and warranty
agreements. Revenue from elements such as maintenance and warranty agreements will
normally be recognized on a straight-line basis over the term of the agreement unless the
services are provided in an identifiable, significantly different pattern.
U.S. GAAP includes provisions for recognizing revenues in connection with
arrangements that have multi-deliverables. ASU 2009-13 clarified those requirements by
requiring a sales price to be assigned to each of the deliverables at the inception of an
arrangement.
Under the FRF for SMEs, similar provisions will apply. When a sales transaction
includes the delivery or performance of multiple products, services or rights to use assets,
and the delivery or performance occurs at different times, revenue recognition criteria
will be applied to each of the deliverables. A vendor of large appliances, for example,
will ordinarily sell the product, charge additionally for delivery, and make warranty
and/or maintenance agreements available for separate purchase. Separate revenue
recognition criteria would be applied to each of these deliverables. For fixed fee
warranty or maintenance agreements, revenue would be recognized over the term of the
agreement, ordinarily on a straight line basis.
Other Income
Investment income is recognized similar to U.S. GAAP. Interest is recognized over time,
royalties are recognized as they accrue under an agreement and dividends are recognized
when a shareholder has the right to receive payment.
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Principal vs. Agent
Also like U.S. GAAP, an agent in a transaction will report only commissions as revenues.
Companies that conduct business as agents rather than as principals sometimes face a
dilemma as to how to record revenues, gross amount of billings or net amounts of
commissions. Judgment based on facts and circumstances should guide resolution.
Indicators of gross revenue reporting include whether the entity:
 Is the primary obligor in the arrangement.
 Has general inventory risk.
 Has latitude in establishing price.
 Changes the product or performs part of the service.
 Has discretion in supplier selection.
 Is involved in the determination of product or service specifications.
 Has physical loss inventory risk.
 Has credit risk.
Indicators of net commission reporting include:
 The supplier, not the entity, is the primary obligor in the arrangement.
 The amount the company earns is fixed.
 The supplier has credit risk.
Improper Revenue Recognition
For the FRF for SMEs, improper revenue recognition may occur in any of these and other
situations:
 Letters of intent are used in lieu of signed contracts.
 Products are shipped before the scheduled shipment date without the customer’s
approval.
 Products can be returned without obligation after a free “tryout” period.
 Customers can unilaterally cancel a sale.
 Obligations to pay for products are contingent on a customer’s resale to a third party
or on financing from a third party.
 Sales are billed for products being held by the seller before delivery.
 Products are shipped after the end of the period.
 Products are shipped to a warehouse (or other intermediate location) without the
customer’s approval.
 Sales are invoiced before products are shipped.
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 Part of a product is shipped and the part not shipped is a critical component of the
product.
 Sales are recorded based on purchase orders.
 Obligations to pay for the product depend on the seller fulfilling material unsatisfied
conditions.
 Products still to be assembled are invoiced.
 Products are sent to and held by freight companies pending return to the seller for
required customer modifications.
 Products require significant continuing vendor involvement (such as installation or
debugging) after delivery.
Improper Revenue Recognition in Smaller Entities
Many CPA firms have experienced revenue recognition problems with smaller reporting
entities. Here are a few examples:
 A nightclub that continually reports a very low gross margin from beer and liquor
sales (Skimming).
 An operator of nursing homes includes numerous relatives on multiple payrolls
(Inflating Medicaid reimbursements).
 A construction contractor that purchases all materials for certain contracts to
increase actual costs before its year-end (Dumping materials at sites to inflate the
percentage of completion).
 A trailer leasing company that bills customers for extra, unused trailers each month
(Fraud).
 Products shipped subject to customer approval are recorded before receiving such
approval (Improper cutoff).
 Billing customers for products shipped on consignment, or before products are
shipped and recording revenue prematurely (Inflating revenues).
 Recording multi-year contracts or revenues benefiting future periods, at the date of
the contract or customer order (Improper matching of costs and revenues).
 Recording grant revenues when received rather than as expended (Improper
matching costs and revenues).
 An entity that won’t provide inventory quantities and pricing information until the
CPA informs management of the taxable income before the inventory adjustment
(Fraud).
Disclosures
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Basic disclosures under the FRF for SMEs include the following:
 Revenue recognition policies for all types of revenues, including the policies,
recognition methods and determination of revenues from multiple deliverable
arrangements.
 All major categories of revenue should be disclosed in the statement of
operations or in the footnotes.
 When the completed contract method is used, an entity must disclose why the
method is used instead of the percentage of completions method.
 Revenue recognized from contract-related claims should be disclosed.
 When management elects to record revenues from contract-related claims only
when received or awarded, the amounts of claims due should be disclosed.
Discussion Exercise:
Referring to the Statement of Revenues and Expenses for Always Best Corporation in
Appendix A, list below any additional disclosures you consider necessary for a fair
presentation of revenue recognition.
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NONMONETARY TRANSACTIONS
Normally, the most reliable market value for the asset given up or the asset received
should be the measure for assets received or exchanged in nonmonetary transactions.
Exceptions include transactions that lack commercial substance (increases in cash flows),
that are exchanges of products in the normal course of business, that have no reliable
market values for assets exchanged, that are nonreciprocal transfers to owners and that
are between related parties.
When these exceptions apply the carrying amount of the asset given up, adjusted for any
monetary consideration in the transaction, should be used for measurement purposes.
The party paying the monetary consideration values the nonmonetary asset received at
the carrying amount of the asset given up plus the monetary consideration paid. The
party receiving the nonmonetary asset values it at the carrying amount of the asset given
up less the monetary consideration received. If the monetary consideration exceeds the
asset’s carrying amount, a gain is recognized.
Other matters
 Nonreciprocal transfers to owners that are spin-offs or other forms of
restructuring in liquidation should be valued at the carrying amounts of
nonmonetary assets or liabilities transferred.
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 Gains and losses from nonmonetary transfers should be reported in net income at
the date of the transfer.
 Restructuring or spin-off distributions do not result in gains or losses to the
transferor.
 Disclosures include the nature and amount of the transaction, the basis for
measurement and the method of valuation used and any gains or losses.
OPERATING EXPENSES
The matching of costs with revenues in the same reporting period is a basic principle
underlying the presentation of operating expenses. Costs of goods sold and other
operating expenses should be recorded in the same period related revenues are
recognized.
Generally, operating expenses are recognized on an accrual basis, when an expense is
incurred. Fixed assets are depreciated over their useful lives. Intangible assets are
amortized over their useful lives (or contractual periods as in the case of asset retirement
obligations) or periods specified in the FRF for SMEs (goodwill is amortized over the
period specified by the Internal Revenue Code or 15 years).
LEASE ACCOUNTING
The FRF provides guidance for lessees’ accounting for capital and operating leases, and
for lessors’ accounting for sales-type, direct financing and operating leases. The
principles are based on the view that property has benefits and risks related to ownership.
Further, the FRF takes the position that when a lease transfers substantially all the
ownership benefits and risks it is essentially an acquisition of an asset and the incurrence
of an obligation and should be accounted for as a capital lease by the lessee and either a
sales-type or direct financing lease by the lessor.
This guidance does not apply to copyrights, patents and other licensing agreements which
are account for as intangible assets. Following is a discussion of basic lease accounting
principles under the FRF.
One or more criteria in a lease agreement indicating transfers of substantially all the
benefits and risks of ownership to lessees, similar to currently applicable U.S. GAAP,
includes:
1. Transfer of ownership at the end of the lease term or a bargain purchase option
(that would cause the lessee to purchase).
2. A lease term that will enable the lessee to receive substantially all the economic
benefit from the asset. This would normally be a term that is 75% or more of the
remaining useful life of the asset. This criteria normally would not apply to land
unless there is reasonable assurance ownership will transfer at the end of the lease
term.
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3. The lessor has some assurance of recovering the cost of the assets and earning a
return on that investment. This assurance exists if, at the inception of the lease,
the present value of the minimum lease payments excluding executory costs is
90% or more of the market value of the asset. The discount rate that should be
used to determine present value is the lower of the lessee’s incremental borrowing
rate or the interest rate implicit in the lease if it can be obtained or estimated (the
implicit rate will be used by a lessor).
For lessors, the benefits and risks of ownership normally are transferred when:
1. Any one of the criteria above is met.
2. Credit risk is similar to other receivables.
3. Non-reimbursable costs likely to be incurred by the lessor can be estimated to
determine if substantial risks are retained, thereby preventing capitalization of the
lease
A lease of an asset that transfers substantially all the benefits and risks of ownership
should be accounted for as a capital lease by the lessee and a sales-type or direct
financing lease by the lessor.
Lessee’s Accounting
Capital Leases:
A capital lease should be accounted for by a lessee as the acquisition of an asset and the
creation of an obligation. The amount of the asset and obligation to be recorded at the
inception of the lease is the present value of the minimum lease payments over the lease
term, excluding any known or estimated executory costs (such as insurance, maintenance
and taxes) in the lease payments. The calculated value of the asset, of course, cannot be
greater than it’s market value.
The lessor’s interest rate implicit in the lease would be used to discount minimum lease
payments if it can be obtained and is lower than the lessee’s incremental borrowing rate.
The capitalized value of a leased asset should be amortized over the expected period of
use with rates and methods used for other similar assets. If ownership passes to the
lessee at the end of the lease, or if there is a bargain purchase option sufficient to induce a
lessee to buy, the asset should be amortized over its economic life. Otherwise, it should
be amortized over its lease term. Interest expense on the obligation is calculated using
the discount rate applied when calculating the present value of the minimum lease
payments.
Capitalized lease assets and obligations should be presented separately in the statement of
financial position or in the footnotes.
Operating Leases:
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Rental expenses for operating leases (those for which substantially all benefits and risks
are not transferred to the lessee) are accounted for on a straight-line basis over the lease
term, unless another method is more representative of the lessee’s use of benefits.
Land and Building Leases:
When a capital lease allows ownership to be transferred at the end of the lease term or
provides a bargain purchase option sufficient to induce the lessee to purchase the asset,
land should be capitalized separately from buildings in proportion the their market values
at the inception of the lease. When such provisions are not included in the lease, and the
market value of the land is minor compared to the total market value of the land and
buildings, the assets are considered a single unit. The economic life of the building
would ordinarily be the economic life of the single unit. If the market value of the land is
significant, the portion of applicable to the land would be accounted for as an operating
lease by both the lessee and the lessor.
Disclosure:
Disclosures for each major category of capitalized leased assets include:
 Cost
 Accumulated amortization, including any write-downs of asset values
 The amortization method, including the period and rate used
Capitalized leased obligations disclosures include:
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Interest rate
Maturity date
Outstanding balance
Any collateral under the leases
Interest expense disclosed separately or as part of interest on long-term debt
Payments for each of the next five years in accordance with terms of the lease
Operating leases disclosures should include future minimum lease payments in the
aggregate and for each of the five succeeding years. Short term leases of one year or less
are excluded from this disclosure requirement.
Lessor’s Accounting
The FRF permits three methods of accounting for lessors::
 Direct financing lease
 Sales-type lease
 Operating lease
Direct Financing Lease:
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Direct financing leases normally provide financing between a manufacturer or dealer and
a lessee and generate financing income. Income from such leases is comprised of the
difference between total net minimum lease payments and the carrying amount of the
leased asset.
The lessor’s investment in the lease is comprised of the net amount of:
 Minimum lease payments receivable, net of any executory costs (insurance,
maintenance and taxes) and any profit on the sale.
 The unguaranteed residual value of the leased asset.
 Unearned finance income, net of any initial direct costs to be allocated over the
lease term.
 Any investment tax credits to be allocated over the lease term.
Initial direct costs should be expensed as incurred with an equal portion of unearned
income recognized in the same period. Unearned finance income should be deferred and
recognized in income so that a constant rate of return on the investment is included in the
statement of revenues and expenses.
The estimated residual value of the asset should be reviewed annually to determine if its
value has declined. For permanent declines, the accounting for the transactions should be
revised. Any reduction in the investment should be recorded as a loss in the period of
decline.
Sales-Type Lease:
Sales-type leases are used by manufacturers and dealers to sell products. Income from
these leases consists of a profit or loss on the sale and finance income over the lease term.
Sales revenue is determined by discounting the minimum lease payments, net of any
executory costs and included profit, using the interest rate implicit in the lease. The cost
of sale is the carrying amount of the leased asset reduced by the present value of the
unguaranteed residual, also calculated using the interest rate implicit in the lease.
Finance income is calculated as the difference between total net minimum less payments
plus any unguaranteed residual and the aggregate of the present value of minimum lease
payments determined using the interest rate implicit in the lease.
Initial direct costs are recognized as an expense at the inception of the lease. Profit or
loss is recognized at the date of the transaction. Unearned finance income is deferred and
recognized in income to produce a constant rate of return over the term of the lease. The
estimated residual value will be reviewed annually and adjusted for a permanent decline
in value.
All leases should be reviewed annually for collectability and/or recoverability issues.
When a significant adverse change has occurred the carrying amount of the asset should
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be reduced to the highest of the discounted value of expected cash flows (discounted at a
current market rate) from holding the asset or the net amount of sales proceeds that could
be realized at the reporting date.
Operating Lease:
Rental revenue from an operating lease should be recognized on a straight-line basis over
the term of the lease unless another method more appropriately reflects income earned.
Initial direct costs should also be deferred and amortized in the same manner.
Presentation and Disclosure:
The lessor’s net investment in a capital lease is a long-term receivable that should be
presented separately from other assets. The net investment in the lease includes:
 The net minimum lease payments receivable.
 Any unguaranteed residual value.
 Unearned finance income
The lessor’s net investment should be presented as both current and long-term amounts in
the statement of financial position. Footnote disclosure should include the net investment
in direct-financing and sales-type leases along with interest rates implicit in the leases.
Discussion Exercise:
A health care organization leases all of its medical and patient-room equipment directly
from a manufacturer. The manufacturer structures its leases as short-term operating
leases with no renewal terms or bargain purchase options. Historically, the health care
organization has renewed these leases annually, each for at least 10 renewal terms, and
then purchased each piece of leased equipment for one dollar. Since you have attended
webcasts on the new FRF for SMEs and are now the expert in your community, the
health care organization has asked you how these leases should be treated in their
financial statements under the FRF for SMEs.. For simplicity, they want to account for
these leases as operating leases. How would you advise them? What are your reasons?
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PENSION AND POST-RETIREMENT BENEFIT PLANS
The principles for recognition, measurement and disclosure of the cost of retirement and
other post-retirement benefits in the FRF for SMEs generally require cost recognition of
the plans in the periods in which employees perform services.
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Pension and other retirement benefits may include pension income, health care benefits,
life insurance and other benefits provided to employees after their retirement. Postemployment benefits provided to employees during employment and after retirement
include long- and short-term disability income, severance benefits, salary continuance,
supplemental unemployment benefits, job training and counseling and health care and life
insurance benefits. If deferred compensation contracts as a group are similar to a pension
plan they should be accounted for similarly.
These principles apply to any arrangement that is a benefit plan regardless of its form or
funding provisions. It is assumed that past practice will extend into the future and applies
to benefits for which an entity pays all or part of the cost.
An obligation for payment of benefits under these plans meets the defined characteristics
of a liability:
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An entity has a responsibility to pay the benefits at a specified future time.
While the obligation may not be practical in some cases, the entity has little or no
choice but to pay it.
The rendering of service by the employee or the employee’s applying for certain
benefits such as long-term disability obligates an entity.
Defined Contribution Plans
Pension cost should be recognized as an expense for a period. Pension cost should
normally be the accrual basis contribution to a plan for a period.
Footnote disclosures should include a general description of each plan and the cost
recognized for a period.
Multiemployer Plans
Pension cost in these plans is also recognized as a period expense. Pension cost normally
includes the contribution to the plan. In addition to the disclosure requirements for
defined contribution plans, any obligation for a probable or reasonably possible
withdrawal from a plan should be disclosed.
Individual Deferred Compensation Contracts
Only accruals of benefits attributable to current employment should be recognized.
Future benefits attributable to more than one year of service should be accrued at present
value over the employee’s period of service.
Defined Benefit Plans
Management of an entity can chose either (1) a current contribution payable method or
(2) an accrued benefit obligation method to account for these plans. Under the first
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method, the current plan contribution is expensed. Disclosure include a plan description
including participants, the method of determining benefits, information about the funded
status of the plan, the contributions for the current and the future years (expected), the
expected plan rate of return and the obligation discount rate.
Selecting an accrued benefit obligation permits an entity to use an immediate recognition
approach or a deferral and amortization approach. For the immediate recognition
approach, the obligation is determined by an actuarial valuation report prepared for
funding purposes. The deferral and amortization approach requires recognition of the
accrued benefit obligation or asset representing the sum of the current and prior years’
benefit costs, less the accumulated contributions to the plan. Prior service costs are
deferred and amortized over future periods, normally along with actuarial gains and
losses. Any market value of plan assets and the accrued benefit obligation are disclosed
in the footnotes.
INCOME TAXES
Here is some major good news! The FRF for SMEs offers entities subject to income
taxes a choice of two methods for accounting for income taxes:
1. The taxes payable method.
2. The deferred income taxes method.
A brief summary of the two methods follows. A detailed discussion of the deferred
income taxes method will be included in my next blog.
Taxes Payable Method
An asset or liability will be recognized to the extent of refundable and unpaid income
taxes, which unpaid taxes should include any from prior years. Carrybacks of tax losses
should be recognized as a current asset and tax benefit in the period the tax loss occurs.
Income taxes refundable or payable are calculated in accordance with the applicable
capital gains or ordinary income tax rates and laws in effect at the date of the statement of
financial position.
Deferred Income Taxes Method
Similar to U.S. GAAP, deferred tax assets and deferred tax liabilities are recognized for
future deductible amounts and future taxable amounts, respectively. Differences in the
tax bases of assets and liabilities and their carrying amounts for financial reporting
purposes are called temporary differences. Temporary differences may be future taxable
or deductible differences. Deferred tax assets result from amounts that will be deductible
for tax reporting in the future. Deferred tax liabilities result from amounts that will be
taxable in the future.
Common Book/Tax Differences
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ACCOUNTING TREATMENT
1. Installment sale—Not recognized unless
collectability of receivable is in doubt.
2. Bad debts—Allowance method is
required to measure uncollectibility
3. Overhead in inventories—Only
manufacturing overhead can be allocated to
work-in-process and finished goods.
4. Depreciation methods and rates—Must
be comparable to the useful lives of assets.
5. Construction contracts—Percentage of
completion method may be used for longterm contracts.
6. Rent received in advance—Deferred
until it is earned.
7. Estimated litigation expenses—
Recognized when they become known and
subject to estimation.
TAX RETURN TREATMENT
1. Installment sale—Prorata portion of gain
is recognized as payments are received.
2. Bad debts—Only the direct write off
method is allowed for tax purposes.
3. Overhead in inventories—IRC Section
263(a) allows allocation of certain general
and administrative expenses to inventories.
4a. Depreciation methods and rates—
Accelerated methods can be elected.
4b. IRC Section 179 property—Listed
property can be written off within limits.
5. Construction contracts—Large contracts
on percentage of completion; small
contracts on accrual or cash methods.
6. Rent received in advance—Taxable in
the year received under cash or accrual
methods.
7. Estimated litigation expenses—
Deductible when actual expenses are paid
or accrued.
Temporary Differences
As illustrated above, differences in the tax bases of assets and liabilities compared to
carrying amounts in financial statements give rise to temporary differences, i.e.,
differences that will reverse and/or be recovered in future periods. The temporary
difference determines the amounts of deferred tax assets or liabilities.
When the carrying amount of an asset is greater than its tax basis, the recovery of the
carrying amount for accounting purposes will result in an amount greater than the future
amount deductible for tax reporting. This is a temporary difference that will result in a
deferred tax liability.
When the carrying amount of an asset is less than its tax basis, the future deductible
amount for tax reporting will be greater. This temporary difference results in a deferred
tax asset that will be recoverable in future periods.
If the carrying amount of a liability is equal to its tax basis, there is no temporary
difference. Amounts related to liabilities that are deductible for future tax reporting have
a tax basis of zero and are deductible when settled. This book/tax difference results in a
deferred tax asset.
Future realization of a deferred tax asset, unused tax losses and unused income tax
deductions will result in a tax benefit. The amount recognized as a deferred tax asset
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should be limited to the amount that is more likely than not to be realized. The potential
realization of a deferred tax asset will be based on an evaluation of the sufficiency of
future expected taxable income. A valuation allowance should be recognized to the
extent that it is more likely than not that some or all of the deferred tax asset will not be
realized.
Illustration of the Deferred Tax Method
ABC Company Facts

Deferred tax account balances at their 2012 yearend:
o Deferred tax asset—current
$
75
o Deferred tax asset—non-current
300
o Deferred tax liability—current
200
o Deferred tax liability—non-current
1,200

Temporary differences:
o Installment sale receivable—tax balance greater;
no allowance; future taxable amount (DTL)
2013
$1,000 $
2014
0
o Inventory—tax balance less due to IRC 263(a) adjustments;
future deductible amount (DTA)
(1,000) (1,500)
o Depreciable assets—tax balance less due to impairment
losses, exit and disposal activities; future deductible amount
(DTA)
(1,500) (1,500)
o Accumulated depreciation—tax balance greater due to
accelerated depreciation methods; future taxable amount
(DTL)
6,000
7,500

The enacted tax rate for federal and state taxes for all years is 20%.

At the end of 2013, a $5,000 tax credit carryforward was available which was earned
in 2013. It is expected to be used in 2014.

No valuation allowances are necessary for deferred tax assets since all are expected to
be realized because of sufficient future income.
Calculations for 2013
16
Current
Taxable
DTL
Temporary Differences
Installment sale receivable
Inventory
Depreciable assets
Accumulated depreciation
Tax rate
Taxable
DTL
Deductible
DTA
$1,000
$1,500
20%
Totals
Less beginning balances from 2009
$5,125
$5,125
Balance Sheet Classification:
$5,200
(200)
$5,000
Net non-current amount:
Deferred tax asset--non-current
$ 300
Deferred tax liability--non-current
1,200
Net non-current deferred tax liablility $ (900)
Footnote Disclosures:
Deferred tax asset:
Current
Non-current
Total deferred tax asset
$5,200
300
$5,500
Deferred tax liability:
Current
Non-current
Total deferred tax liability
$ 200
1,200
$1,400
17
$6,000
20%
20%
1,200
200
5,000
$0
Adjusting entry:
20%
200
200
(200)
2010 Adjustments
Net current amount:
Deferred tax asset--current
Deferred tax liability--current
Net current deferred tax asset
Deductible
DTA
$1,000
Deferred tax liability
Deferred tax asset
Deferred tax asset from tax credit carryforward
DR--Deferred tax asset--current
CR--Deferred tax benefit
Non-Current
5,200
(75)
$5,125
300
1,200
(1,200)
$0
300
(300)
$0
Measurement, Presentation and Disclosure
Income tax assets or liabilities should be measured based on enacted income tax rates and
income tax laws. Deferred tax assets and liabilities are not discounted to present value.
Intraperiod allocation of income tax expense or benefit, both current and deferred, should
be made to income or loss before discontinued operations, discontinued operations,
certain capital and other transactions.
The provision for income tax expense and income tax benefit, current and deferred,
included in the determination of net income or loss before discontinued operations should
be presented on the face of the statement of operations.
Disclosures should include the choice of method for accounting for income taxes. Under
the taxes payable method, disclosures include:
 The expense or benefit included in income or loss before discontinued operations.
 A discussion of differences between current period tax rates or expense and
statutory rates.
 Amount of unused tax loss carryforwards and tax credits.
 Any portion of tax expense or benefit applying to transactions charged to equity.
These disclosures are necessary for the deferred income tax method alternative:
 Current and deferred income tax expense or benefit included in net income or loss
before discontinued operations.
 Any portion of tax expense or benefit applying to transaction charged to equity.
 Any portion of unused tax losses, income tax reductions or deductible temporary
differences not recognized as a deferred tax asset.
 A discussion of differences between current period tax rates or expense and
statutory rates.
 Amount of unused tax loss carryforwards and tax credits.
Discussion Exercise:
As CFO of your organization, you are planning to select the FRF for SMEs as your
applicable financial reporting framework. The user of your financial statements, a
commercial bank, has agreed to your use of the FRF for SMEs and plans to use the
financial statements to determine if they can offer loan the funds to finance your
construction of a new office facility. Having used U.S. GAAP as your reporting
framework in the past, the deferred income tax method was required. As a result of using
this method, you have accumulated a large net balance of deferred tax assets, both current
and long-term. These deferred tax assets are material in comparison to retained earnings.
Should you continue using the deferred income tax method or change to the income taxes
payable method based on these limited facts? What are your reasons?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
18
ACCOUNTING CHANGES
Changes in accounting policies, accounting estimates and correction of errors are treated
similarly to U.S. GAAP.
Accounting Policies
Accounting policies should be consistent among periods and should be changed only if
the change is required by the FRF for SMEs or the results of the change produce more
reliable and relevant financial information. Changes in accounting policies should be
presented retrospectively by restating the opening balance of the appropriate equity
account in the earliest period presented and by restating all comparative amounts in the
financial statements. Unless comparative statements are required by users of the
financial statements, it will usually be more cost efficient to present only the current
period balances in the first period of application of the FRF for SMEs.
Accounting Estimates
Estimates based on current facts and circumstances are necessary for determining certain
amounts presented in financial statements, such as:
 The allowance for uncollectible accounts.
 Inventory write-downs to net realizable value.
 Depreciation and amortization.
 Accounts arising from application of the percentage of completion method of
revenue recognition.
 Allowances for sales discounts and returns.
 Warranty and maintenance obligations.
New information may require revision of accounting estimates. Such revisions are not
corrections of an error and should be accounted for prospectively.
Errors
Errors related to prior periods financial statements should be corrected by restating the
opening balances of the earliest period presented that is affected by the error and by
restating all comparative amounts in prior periods presented.
Disclosures
Initial Application of the FRF for SMEs Policies:
 Explanation that changes are made for transition to the FRF for SMEs, if
applicable, and a description of such changes.
 Nature of the changes in accounting policies.
19
 Changes to current period line items in financial statements, to the extent
practical. If not practical, an explanation of conditions causing the changes and
how they were applied.
 Amounts of adjustments to prior periods’ statements not presented.
Voluntary Changes in Policies:
 Nature of the change in accounting policy.
 Reasons why the changes provides more reliable and relevant information.
 Line item adjustments to the extent practical.
 Amounts of adjustments to prior periods’ statements not presented, if practical. If
not practical, an explanation of conditions causing the changes and how they were
applied.
Changes in Estimates:
 Nature and amount of material changes in the normal course of business
(allowance for uncollectible accounts, inventory obsolescence, useful lives of
assets, etc.) affecting the current period.
Errors:
 Nature and amounts of prior period errors.
 Amount of correction at the beginning of the earliest period presented (adjustment
to opening balance of retained earnings).
RISKS AND UNCERTAINTIES
The first note to the financial statements should include descriptions of recurring
accounting policies to enable users to properly evaluate an entity’s financial position and
results of operations. Major products and services and the entity’s principal markets
should be disclosed in the accounting policies note. This disclosure, along with the
organizational structure of an entity, is normally presented first in this note.
Other items that should be disclosed in footnotes include:
 Discussion of management’s use of estimates and that the estimates are based on
circumstances that exist at the date financial statements are available for issue and
may change in the future. Common examples of estimates are allowances for
uncollectible accounts, sales returns and allowances, warranty costs, and
compensated absences.
 Descriptions of concentrations and any risk of loss in the near-term future.
Common concentrations include bank deposits over insured limits, material
amounts of key person life insurance from a single company, major customers
and vendors, geographic market concentration or material amounts of revenue
from a single product.
APPENDIX A--ILLUSTRATIVE STATEMENT OF OPERATIONS
Following is an illustrative, basic set of financial statements and footnotes prepared under
the FRF for SMEs. A brief review of these statements will reinforce the concepts
discussed in this presentation.
20
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).
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
21
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.
22
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
RETAINED EARNINGS, January 1, 2014
RETAINED EARNINGS, December 31, 2014
551,400
$
646,500
See Independent Accountant’s Review Report and Notes to Financial Statements.
23
ALWAYS BEST CORPORATION.
STATEMENT OF CASH FLOWS
(FRF for SMEs Basis)
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.
24
ALWAYS BEST CORPORATION
NOTES TO FINANCIAL STATEMENTS
(FRF for SMEs Basis)
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 and Revenue Recognition
Revenues consist primarily of sales of concrete constructions blocks, patio blocks and various
landscaping precast products. Sales are made to construction contractors, governmental
organizations and private parties. There is no economic dependency on any one, or a group, of
customers.
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.
25
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.
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.
26
Description
Shares
Dorcus, Intl.
Pork Belly Feeds
Shovels, Inc.
Bean Bagger Co.
U.S. Motors
100
390
510
10,105
215
Ownership %
Carrying Amount
.00001
.00005
.0001
.0007
.00001
$ 25,000
40,000
80,000
75,000
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
27
$146,098
Interest paid during the year ended December 31, 2014 amounted to $ 17,000.
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
Discussion Exercise:
While discussing the FRF for SMEs with the user of your financial statements, you were
asked to point out the policy differences on the illustrative statement of revenues and
expenses above from U.S. GAAP. Write your answers below.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
28