Auditing Special Purpose Frameworks—Part 5

As auditors prepare to audit special purpose frameworks, knowledge of underlying principles in commonly used frameworks is a prerequisite.  Previous articles presented basic principles for the income tax basis of accounting and began a comparison of the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) with U.S. GAAP.  This and several future articles will continue this comparison.  The AICPA has provided various Toolkits for the FRF for the FRF for SMEs on its website. http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/pages/frf-smes-cpas.aspx

Accounting principles for these topics are discussed below:

·      Investments

·      Fair Value Accounting

·      Derivatives

Investments

U.S. GAAP:

Financial assets and liabilities are classified in the balance sheet based on managements intentions, i.e., to trade, hold for sale or retain until maturity.  Trading securities and available-for-sale securities are valued at fair value.  Unrealized appreciation or depreciation for trading securities is recorded in operating income; for available-for-sale securities such amounts are recorded in comprehensive income.  Held-to-maturity securities are carried at amortized cost.

FRF for SMEs:

Investments in entities over which a company has significant influence are accounted for under the equity method.  All other investments are accounted for based on historical cost, except for securities held for sale which are valued at market value (changes are included income). Income from investments should be presented separately or disclosed in the footnotes.  Equity method investees should follow the same method of accounting as the as the investor.  An entity’s share of any discontinued operations, changes in accounting policies or corrections of errors and capital transactions of an equity method investee should be presented and disclosed separately.  General disclosures are:

·      Accounting basis for all classes of investments.

·      Events and transactions occurring between different reporting periods for the entity and equity-method investees should be disclosed or recorded by the investor.

·      Name, description, carrying amount and ownership percentage for each significant investment.

Fair Value Accounting

U.S. GAAP:

The definition of fair value in the accounting standards is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”  The standards provide guidance on valuation techniques (market approach, income approach, cost approach) and the hierarchy of inputs (levels one, two, three) for determining fair value.

FRF for SMEs:

The term “market value” is used instead of fair value.  The definition is: “The amount of the considerations that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act.”  Since the FRF for SMEs uses a cost approach primarily, measurement using market values is limited to business combinations, some non-monetary transactions and marketable equity and debt securities that are available for sale.

Derivatives

U.S.GAAP:

Generally, derivatives are accounted for as assets or liabilities and are measured at their fair values; changes in fair values are accounted for based on the use of the derivative. An entity is permitted to use hedge accounting.

FRF for SMEs:

This framework requires a disclosure approach only with recognition at settlement on a cash basis.  Disclosures include:

·      The face, contract or notional principal amount (upon which payments are calculated).

·      The nature, terms, cash requirements and credit and market risks

·      The entity’s purposes in holding the derivatives.

·      At the reporting date, the net settlement amounts of the derivatives.

Hedge accounting is not permitted.

For more information about the FRF for SMEs, and to register for a series of my webcasts on this topic, click the appropriate box on the left side of my home page, www.cpafirmsupport.com.