Because of the increasing complexity of U.S. GAAP, some CPA firms are considering accounting and reporting alternatives during engagement planning. Here is a brief discussion of some of the most common.
Using an Alternative Reporting Framework:
Previously known as other comprehensive bases of accounting (OCBOA), the most common are the modified cash basis and the income tax basis of accounting. While any reporting framework must include all disclosures necessary to prevent the financial statements from being misleading, the complex disclosures of “rules-based” U.S. GAAP can be avoided by using an OCBOA.
Deciding Not to Apply a Generally Accepted Principle:
When GAAP reporting is required by a user of an entity’s financial statements, the user and the reporting entity may agree to not apply a specific accounting standard. Some entities and the users of their financial statements have agreed that application of FIN 46R (SFAS No. 167), Variable Interest Entities, and FIN 48, Uncertainty in Income Taxes, to name a few, do not meet their reporting needs.
If the effects of non-application of these standards have a material effect on the financial statements, management should disclose the non-application in the footnotes. The auditor should prepare an opinion on the financial statements that is qualified because of the GAAP departure.
If non-application effects are not material, no footnote disclosure or audit report modification would be necessary. Some reporting entities, however, do disclose the immaterial non-application of certain standards to eliminate questions knowledgeable financial statement users may raise about possible non-compliance. In such cases, management and the auditor would have to develop sufficient evidence to support the conclusion that the effects of non-application would not be material.
Applying Rule 203-1 of the AICPA Code of Professional Conduct:
Rule 203 instructs an accountant or auditor reporting on financial statements to apply all principles of the applicable reporting framework. However, Interpretation 203-1 states that when the application of a principle or standard causes the financial statements to be misleading, management and the accountant or auditor can justify a departure.
In the mid-1980s for example, SFAS No. 15 was issued to guide the accounting treatment of troubled-debt restructurings. Among other things, this statement required loan modifications on the financial statements of debtors to be treated as gains in the income statement. For reporting entities that had sustained years of losses, the deterioration of retained earnings and, in some cases, the elimination of stockholder’s equity, large gains from debt modification had significant “psychological” affects on the income statement.
In other words, entities that had losses from operations and were facing immediate threats to the continuance of their businesses were now showing large amounts of net income. Some auditors believed the effects of SFAS No. 15 caused the financial statements of certain entities to be misleading and included a middle departure paragraph in their report justified under Interpretation 203-1. Due to current economic times, similar situations may arise today.
Using IFRS for SMEs:
Finally, since the issuance of IFRS for Small and Medium-size Entities by the IASB, some entities are considering utilizing these principles-based standards for their reporting framework. Both FASB and the AICPA have recognized these standards as GAAP. With increased opportunities for reducing the content of required disclosures as a motivator, this framework offers some entities a more efficient method of financial statements and footnotes preparation. As users grow more knowledgable of of IFRS for SMEs, their use will likely increase.
The Bottom Line:
Deciding on the appropriate reporting framework depends on the needs of users of financial statements, the nature size and complexity of an entity and the ability of its employees to facilitate changes to alternative frameworks. Changes in reporting frameworks take time. Decisions to not apply certain pronouncements must be well thought out. All of this decision making must be done early in an entity's fiscal year to be accomplished properly. The bottom line is that accountants and auditors can minimize the costly effects of new and future accounting and reporting standards by using an alternative reporting framework. The time to plan for the future is now!