Nobody wants accounting to get any more arcane, least of all commercial lenders. Untangling a small-business borrower's financials is hard enough already.

A new effort to streamline financial reporting could help credit officers make decisions without studying mountains of footnote-laden documents. The Financial Reporting Framework for Small and Medium-Sized Entities, a set of standards proposed by the American Institute of Certified Public Accountants, is touted as a simpler method to assess the health of private companies, which could have the added benefit of stimulating lending.

But as always in accounting, there are complications. The new framework has exposed decades-old divisions between accounting groups, roiling a field unaccustomed to emotional debate.

Advocates of the new framework say it could help bankers land more small-business clients, who would spend less money to prepare accurate financials that are central to credit reviews. Critics say it will just trigger new accounting headaches, by introducing a shaky set of guidelines that differ from generally accepted accounting principles, or GAAP.

"Of course a banker would like to have audited financial statements, and this may make it cheaper to get them," says Mike Gullette, vice president of accounting and financial management at the American Bankers Association. "But bankers now are going to have two different frameworks to think about, and it could take years to determine if a banker will prefer one over the next."

The AICPA, which establishes professional standards and lobbies on behalf of its members, introduced the new framework last June. It is meant to provide a detailed picture of a privately held company's finances, while avoiding the more burdensome requirements of GAAP, the most commonly used set of accounting standards.

The framework isn't a replacement for GAAP, says Dan Noll, the AICPA's director of accounting standards. It's built for traditional owner-managed companies that don't want to use GAAP but find that other accounting standards "aren't quite cutting the mustard," he says.

"This framework follows very traditional accounting principles that help put together a picture of what a company's assets and liabilities are," Noll says. "On that basis, bankers would be getting a pretty clear picture of a borrower."

For many small businesses that have used it, the simplified reporting framework is welcome.

Keith Willy, a partner at Twain Financial Partners, a small St. Louis startup that manages assets for banks, says he persuaded the company's backers to accept financials prepared under the new framework last year. The move saved around $200,000 in accounting and other costs, he says.

The new guidelines don't require the firm to consolidate its equity holdings on its balance sheet, a labor-intensive process that Willy says only serves to "clutter up your financial statement at the expense of transparency."

The new framework is not an authoritative set of rules; banks can choose to accept financial statements prepared in accordance with it or stick with GAAP. But banks that go the new route could get a leg up in small-business lending by making it easier—and cheaper—for companies to apply for loans, advocates say.

Enterprise Financial Services, parent of Enterprise Bank & Trust in St. Louis, is one of the early adopters. The $3.2 billion-asset company thinks the framework can help it land small-business customers who are reluctant to undergo a full audit, says Theresa Bible, Enterprise's senior vice president of credit.

"We look at it as a competitive advantage. If we can provide an alternative to an audit and a tax return, we would have an advantage versus a company that would want a small-business owner to do a full audit," she says.

Enterprise has begun educating the accounting firms it works with about the framework, and may hold educational sessions for potential clients—sessions that could double as marketing opportunities, Bible says.

Though it is not yet widely used, the framework "is starting to gain some traction" among companies Enterprise works with, she adds. A Thomson Reuters survey last year found that 46% of CPAs were familiar with the framework.

In the accounting community, the release of the new framework rekindled an old debate about the complexity of accounting standards, and whether some rules should be relaxed to accommodate smaller, private companies.

"There is a perception that because accounting has become too complex, it is getting too expensive to ask for an audit of financial statements.," says the ABA's Gullette, who ties the debate back to the changes ushered in by the Sarbanes-Oxley Act. That bill, a response to a wave of big accounting scandals that broke in the early 2000s, increased auditors' liability for faulty financial statements, generally making it more expensive for companies to have their financials audited.

To help ease this burden, the Financial Accounting Standards Board, which oversees changes to GAAP, has been working for the past several years to develop a less rigorous alternative—so-called Little GAAP—for small, private companies, but has not yet unveiled the new rules.

The AICPA's new framework is a separate effort apparently aimed at a similar goal. This has rankled many accountants, who see rivalry—and not good policy—as the motivation for the competing efforts. Sarbanes-Oxley established the FASB as the de facto referee of accounting rules, greatly reducing the power and responsibility of the AICPA, Gullette says.

Several of the comment letters the AICPA received on the framework say the group is spreading confusion by introducing an alternative to GAAP. Others say the framework is overly vague, leaving too many important aspects—like "small and medium-sized company," a term the AICPA does not define—up in the air.

On blogs and accounting message boards, the critics were blunt, describing the framework and its introduction as "standards anarchy;" "anything goes" financial reporting; "a race to the bottom;" like "BetaMax and Laserdisks;" and "a product looking for a market."

One blog posted a letter in which former Securities and Exchange Commission Chief Accountant Walter Schuetze calls the framework a "sack of mush."

However the debate ends, bankers would do well to educate themselves on the reporting framework, since they are likely to encounter it in dealing with small-business borrowers, Gullette says.

Something of a hybrid between a tax return and an income statement, the new model uses the accrual basis of accounting, which is often used in tax accounting, while incorporating statement disclosures required under GAAP.

Perhaps the most significant and potentially money-saving feature of the new framework is that it steers away from fair-value accounting, which is required under GAAP and can be complicated and expensive to prepare. Instead, companies can report costs when they are incurred and revenue when it is earned, rather than continuously repricing assets.

The framework also simplifies the presentation of complex assets, permitting companies to disclose derivatives transactions and leases rather than calculating their impact on the balance sheet. This simplification could reduce the need for companies to hire outside experts to appraise contracts and complex financial instruments.

It should be easier to keep current with the framework than with the GAAP standards, which are usually updated several times a year. The AICPA plans to update the framework every three or four years, after an initial tweak to address issues that arise during the rollout.

While the new framework is certainly streamlined—at about 250 pages, it is thousands of pages shorter than the full set of GAAP rules—it could give a muddier picture of a borrower's finances than GAAP. Analysts at the consulting and accounting firm Grant Thornton concluded that it was too soon to say whether the framework's simplicity comes at the cost of less transparency for lenders.

But proper underwriting depends more on a loan officer's diligence than the accounting framework a company uses, Gullette says.

"Small-business lending is all about how well the banker understands the business. And if the banker doesn't understand the business, I don't know why he would lend money anyway."


Chris Cumming covers community banks at American Banker. He is based in New York.

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