Options available when GAAP becomes too much

Financial reporting is critical for making informed decisions and maintaining stakeholder transparency, but there’s not just one way to do it correctly.

While U.S. Generally Accepted Accounting Principles (GAAP) provide a standardized framework, the rules can be complex and costly for small and medium-sized businesses to implement. An alternative approach — commonly known as Special Purpose Framework (SPF) — offers a simpler and often more cost-effective solution for certain entities that don’t need to achieve full GAAP compliance.

Here’s an overview of alternative accounting methods, including key benefits and drawbacks of SPF reporting.

Basics of SPF

SPFs are still sometimes referred to as Other Comprehensive Bases of Accounting (OCBOA), although the term is used less commonly. Both refer to financial statements prepared using an accounting framework other than GAAP or the International Financial Reporting Standards (IFRS). Examples include:

• Cash-basis accounting, which recognizes revenue and expenses only when cash is received or paid.
• Modified-cash-basis accounting, which blends elements of both cash and accrual accounting.
• Tax-basis accounting, which aligns financial reporting with IRS regulations for simplified tax compliance.
• Regulatory-basis accounting, which follows rules set by a specific government or industry regulatory agency.

These frameworks may be tailored to meet a company’s specific needs and can simplify financial reporting while maintaining clarity for stakeholders. Generally Accepted Auditing Standards (GAAS) permit the use of SPFs for compiled, reviewed and audited financial statements when GAAP statements aren’t required.

Pros of SPF reporting

The U.S. Securities and Exchange Commission (SEC) requires U.S. publicly traded companies to file GAAP financial statements. However, privately held businesses that aren’t subject to these requirements often find SPF to be a more practical option. SPF eliminates some of the complexities associated with GAAP, making financial statements easier to prepare and understand. Cost savings can be significant, as SPF statements typically require less time and fewer resources, leading to lower accounting fees.

Private companies also have the flexibility to choose an SPF that best suits their operational and stakeholder needs. For instance, cash-basis statements may be more relevant when management’s primary concern is cash flow. Likewise, tax-basis statements may streamline tax preparation by reducing discrepancies between financial statements and federal income tax filings.

Regulatory-basis statements may be appropriate for companies that operate in heavily regulated industries, such as financial institutions, insurance companies, healthcare providers, public utilities, governmental entities and brokers and dealers. Regulatory guidelines align financial reporting with industry-specific rules and oversight requirements, often prioritizing solvency, rate-setting and compliance over general-purpose financial reporting under GAAP.

Downsides of SPF reporting

While SPFs offer advantages, there are also potential drawbacks. Some lenders and investors may prefer GAAP-compliant statements due to their consistency and comparability. Financial statements prepared under different SPFs can make it difficult to benchmark against industry peers. Stakeholders unfamiliar with SPFs may require additional explanation to understand the financial statements fully. However, some lenders and investors may accept SPF statements if they meet transparency and consistency requirements. Businesses considering SPFs should consult their financial institutions to confirm acceptability before switching accounting methods.

Choosing an alternative accounting method still requires diligence and resources. Although SPF statements require fewer disclosures than GAAP, they must still include sufficient information to ensure transparency and clarity. Additionally, SPF statements must provide footnotes explaining the accounting framework used and key differences from GAAP.

Choosing the right framework

Whether SPF or GAAP is the right choice for a private company depends on several factors, including management preferences, external stakeholder expectations and regulatory guidelines. GAAP compliance may be necessary if your business is seeking investment or financing. However, SPFs could be a viable alternative if your primary goal is cost-effective and straightforward financial reporting.