MACPA Private Company Standards Whitepaper

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The time is now! An MACPA task force supports creation of private company standards board, says GAAP exceptions and modifications are essential. …

The time is now! An MACPA task force supports creation of private company standards board, says GAAP exceptions and modifications are essential.

This whitepaper was unanimously approved and adopted by the Board of Directors of the Maryland Association of CPAs on June 2, 2011.

After three months of study and debate, the MACPA task force concluded that the needs of private companies or nonpublic entites have not been considered by FASB in their standard setiing activities resulting in overly complex and costly standards that do not benefit the users of those financial statements.

This whitepaper present the research, analysis, and recommendations of the MACPA Task Force.

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  • 1. Private Company Standards: Responding to the Reporting Needs of Private Companies and the Users of Their Financial Statements Maryland Association of Certified Public Accountants, Inc. A Report from the MACPA Accounting Standards Task Force May 27, 2011 1MACPA – Copyright 2011
  • 2. Executive summaryThe suitability of Generally Accepted Accounting Principles (GAAP) for private companies hasbeen a matter of debate and study for more than 30 years. Numerous task forces, committees,and studies have been formed or undertaken over the years to address private company standardswith minimal accomplishments.The concerns of private company preparers, users, and auditors center on:  the costs of GAAP private company financial statements, which often exceed the benefits;  lack of relevance to users;  increasing complexity of standards and the pace of change; and  increasing use of “other comprehensive basis of accounting” (OCBOA), viewed as a symptom of the problem.In 2009, the Financial Accounting Foundation (FAF), the parent organization of the FASB,formed the Blue Ribbon Panel on Standard Setting for Private Companies (BRP) withrepresentatives from the AICPA and the National Association of State Boards of Accountancy(NASBA). In January 2011 the BRP issued a report calling for exceptions and modifications toGAAP to better meet the needs of private companies. In addition, the BRP report called for aseparate standards board to develop those exceptions and modifications to GAAP.The MACPA’s Accounting Standards Task Force (Task Force), created by the MACPA Board ofDirectors in October 2010, has met to review and discuss the history of private companystandards and formulate a response to the BRP’s report. The private company standards issue hasbeen reviewed and discussed with more than 1,500 MACPA members at town hall meetingsthroughout Maryland over the past year. More than 90 percent of members polled at thosemeetings believed GAAP modifications and exceptions for private companies are the bestsolution to the problem. The MACPA Task Force responded to the BRP’s report and offeredadditional suggestions and comments. The Task Force’s response to the BRP report can besummarized as follows:  The Task Force agreed that the current structure does not properly address private company standards and needs to be improved.  The Task Force agreed that the FASB has not demonstrated an ability to address the needs of private companies.  The Task Force agreed that a separate board for private companies is warranted. A majority of the Task Force wanted the separate board to have ultimate authority over standards decisions for private companies. Two dissenters felt the FASB should have “veto power” over standards changes proposed by the new committee. The principle of “distinct but linked” with a parallel and joint process to avoid unnecessary divergence was viewed as critical to the process. 2MACPA – Copyright 2011
  • 3.  The Task Force agreed that a “sunset” provision of five years, during which the new private company board would be evaluated, would be appropriate with the understanding that the five-year term begins with the formation of the new board.  The Task Force viewed the development of a differential framework for developing exceptions and modifications to extended GAAP as an essential element of the new board’s work and critical to the successful development of private company standards.  The Task Force agreed that a proper cost-benefit balance is critical to the success of the new private company standards while taking into account the relevance to the financial statement users.  The Task Force agreed that a single source of GAAP is imperative and would be codified in the same manner for private and public companies, with private company exceptions noted and contained within the respective pronouncements.History and backgroundThe Financial Accounting Standards Board (FASB) was created in 1973 to establish andimprove standards of financial accounting and reporting by non-governmental entities. Thosestandards, known as “generally accepted accounting principles” (GAAP), are the widelyaccepted set of accounting standards and rules used by non-governmental entities for reportingfinancial information.Private company accounting standards have been the topic of debate in the United States foralmost 40 years. There have been 12 separate studies, reports, or formal recommendations thathave been made, with the most recent recommendations made in January 2011.The FASB’s most recent formal research on the needs of private companies took place in 1983,with discussions by others occurring several years before. Since then business, finance, andeconomics have expanded globally and have become exponentially more complex. Accountingstandards that have developed in response to these changes have become increasingly divergentfrom the needs of users of private company financial statements, examples of which includeaccounting for variable interest entities, uncertain tax positions, fair value measurements, and thelevel of detail associated with certain disclosures.The efforts expended over the past 40 years to make private company accounting standards morerelevant to its users had varying degrees of success, and generally culminated inrecommendations or creations of advisory-level committees that lacked authoritative status.In 2004, the American Institute of Certified Public Accountants (AICPA) established the PrivateCompany Financial Reporting Task Force (PCFRTF), chaired by Jim Castellano of theaccounting firm RubinBrown. The report issued by the PCFRTF, known as the “CastellanoReport,” was completed in 2005 (see Resources for further details). The Report concluded usersof private company financial statements have different needs from users of public company 3MACPA – Copyright 2011
  • 4. financial statements; GAAP exceptions and Other Comprehensive Basis of Accounting(OCBOA) should not be the resolution to the private company financial reporting problems; andfundamental changes should be made to the current standard-setting process.Subsequently, in 2006 the FASB established the Private Company Financial ReportingCommittee (PCFRC) to further improve its current standard-setting process. The PCFRC’sprimary objective is to provide recommendations to the FASB as the FASB sets accountingstandards for privately held enterprises. In addition, PCFRC members focus on how standard-setting affects day-to-day technical activities and procedures from a cost/benefit perspective. Theestablishment of the PCFRC was significant in that, unlike prior efforts, the FASB was tospecifically address and articulate within the literature of each subsequently issued accountingstandard, whether differences should exist for private companies and state the basis for itsconclusion. Based on private company stakeholders’ comment letters, feedback from MACPAmembers and the work of this Task Force, the work of the PCFRC was viewed as not fullyachieving its intended goal due to the FASB’s unwillingness or inability to consider and approve,where appropriate, the possibility of measurement, recognition, and presentation differences forprivate company financial reporting.On Sept. 8, 2008, the Maryland Association of Certified Public Accountants (MACPA), joinedby 10 other state CPA societies, wrote to Chairman Bob Herz of the FASB and requested that theFASB accept the recommendations from the PCFRC and exempt private companies from theprovisions of the proposed Interpretation No. 48 – Accounting for Uncertainty in Income Taxes,An Interpretation of FAS Statement No. 109. The FASB acted with an extended implementationdeadline of one year for private companies and non-profits and a modification to the disclosurerequirements but declined to exempt private companies from the new interpretation. The resultwas an implementation delay and a modification to the disclosure requirements, which providedonly limited relief for private companies and non-profits.In 2009, the Financial Accounting Foundation (FAF), the parent organization of the FASB,formed the Blue Ribbon Panel on Standard Setting for Private Companies (BRP) with theAICPA and NASBA. The mission of the BRP was to address how accounting standards can bestmeet the needs of users of U.S. private company financial statements.On Aug. 5, 2010, the BRP published a list of questions requesting input from the public. Thecommon issues and concerns cited by the respondents were as follows:  Private company financial statements often lack relevance to users.  Standards have become increasingly complex.  The pace of the standard-setting process has increased.  Costs often exceed benefits.  There has been an increase in qualified opinions and use of OCBOA basis statements in order to avoid the complexities of GAAP.Our experience in Maryland is consistent with the feedback from the respondents to the BRP.Our fall 2010 town hall meetings reached approximately 1,500 CPAs, with 90.87 percentindicating support for GAAP modifications and exceptions for private companies. 4MACPA – Copyright 2011
  • 5. The BRP issued a report in January 2011 concluding that there are urgent and growing systemicproblems that need to be addressed in the current U.S. system of standard setting. The BRPrecommended that there be exceptions and modifications from extended GAAP to better meetthe needs of private companies and the users, preparers, and auditors of their financialstatements. In addition, the BRP recommended that a separate private company standards boardbe established to develop and implement those exceptions and modifications.On March 4, 2011, FAF announced “the formation of a Trustee Working Group to address theimportant topic of accounting standards for nonpublic entities.” The FAF news release stated that“the Working Group will conduct outreach to stakeholders in various ways, including roundtablemeetings, surveys, and meetings with advisory and constituent groups and others. In conjunctionwith obtaining input on the scope of the issues and concerns to be addressed, the Trustees alsowill seek input on suggested improvements, including the solutions recommended by the Blue-Ribbon Panel.”Internationally, standards setting bodies are wrestling with the same issue. Most notably, Brazil,Argentina, and Hong Kong have adopted International Financial Reporting Standards (IFRS) forSmall and Medium-sized Entities (SMEs) with the United Kingdom scheduled to implement it in2012.MACPA Accounting Standards Task ForceAt its October 2010 meeting, the Board of Directors of the MACPA recognized the need toinform members and the Maryland financial community of the need for changes in privatecompany financial reporting and approved the formation of the MACPA Accounting StandardsTask Force (Task Force). The Board directed the Task Force to study current issues inaccounting standards, inform the Maryland financial community of the issues surroundingprivate company standards, comment on the private company financial reporting standards issue,and provide input into satisfying the needs of private companies and the users of their financialstatements. The Task Force participants were selected in December 2010. The Task Forceincludes representatives of CPA firms, public and private companies, as well as representativesfrom banking, education, and government. Four Task Force meetings have been held to date inColumbia, Md.Criteria for evaluating reform proposalsWe focused our efforts on finding solutions and making recommendations that would bemeaningful to preparers, auditors, and users of private company financial statements. To evaluateour recommendations in this report, we developed and considered the following criteria:Will the recommendations and comments:  Improve the relevance of financial statements for users?  Improve the cost-benefit ratio of private company accounting standards?  Minimize complexity of financial statements for users, preparers, and auditors? 5MACPA – Copyright 2011
  • 6. Reform matters for consideration: Scope of this documentThe Task Force focused on the January 2011 Report to the Board of Trustees of the FAF by theBlue Ribbon Panel on Standard Setting for Private Companies (BRP). Our approach is tocomment on the recommendations outlined in the report, raise pertinent questions on thestructure and processes being followed, and provide suggestions from our perspectives aspreparers, auditors, and users of financial statements. This report is the work of the Task Forceand is for the use of the MACPA Board of Directors, MACPA members, and the financialcommunity in Maryland.Task Force response to the BRP recommendationsThe Task Force, in carefully reviewing and deliberating the recommendations of the BlueRibbon Panel, has made the following resolutions: 1) The Task Force agreed that the current structure does not properly address private company standards and needs to be improved. The Task Force was dismayed that a broad section of private companies, both large and small, are not using GAAP, viewing it as too complex and expensive to implement. The Task Force concluded that the use of OCBOA is not an acceptable alternative to GAAP. 2) The Task Force agreed that the FASB has not demonstrated an ability to address the needs of private companies as evidenced by the inability of the PCFRC to effect meaningful change. 3) The Task Force agreed that a separate board for private companies is warranted. The principle of “distinct but linked” with a parallel and joint process to avoid unnecessary divergence was viewed as critical to the process. A majority of the Task Force wanted the new board to have ultimate authority over private company standards decisions. Two Task Force members dissented; they stated that a separate board is needed but, concerned about excessive standards divergence, felt separate private company standards board recommendations should be subject to the final approval of the FASB, much like the Emerging Issues Task Force (EITF) is structured. 4) The Task Force agreed a “sunset” provision of five years would be appropriate, with the understanding that the five-year term begins with the formation of the new board. The sunset provision is critical to evaluate whether the new structure is adequately addressing the shortcomings of the current system and to make changes as necessary to further address the needs of private company stakeholders. One factor to use in judging the level of success will be whether usage of OCBOA diminishes after implementation of private company modifications and exclusions are implemented. 5) The Task Force viewed the development of a differential framework for developing exceptions and modifications to extended GAAP as an essential element of the new board’s work and critical to the successful development of private company standards. The Task Force felt it is important to identify in advance the attributes that will drive differences between public company and private company standards. For instance, when are differences appropriate, under what circumstances are differences allowed, if 6MACPA – Copyright 2011
  • 7. and how will private company standards interfaces with International Financial Reporting Standards (IFRS) for Small and Medium-sized Entities (SMEs)? The Task Force also agreed the differential framework should be made available for public comment and approved by the FAF. 6) The Task Force agreed a proper cost-benefit balance is critical to the success of the new private company standards while taking into account the relevance to the financial statement users. At the same time, the Task Force recognizes the level of complexity of the underlying accounting (for instance, accounting for derivatives), will have a bearing on the complexity of the standard. 7) The Task Force agreed that a single source of GAAP is imperative and would be codified in the same manner for private and public companies, with private company exceptions noted and contained within the respective pronouncements. The Task Force believes such codification is essential to allow for full understanding for preparers and auditors of financial statements.Other recommendations and concerns:In considering the issues related to private company accounting standards, the Task Force makesthe following recommendations or raises the following areas of concern:  The Task Force recommends that principles and structure be put in place to ensure collaboration between the FASB and the new private company board. The Boards need to be distinct but linked. Public company/private company divergence should be limited with both boards being compatible and collaborative.  The funding of the new board needs to be structured to ensure independence. The Task Force questioned how the new board would be funded and whether the source of that funding would have an impact on the development of private company standards.  Consideration should be given to the impact on private companies of International Financial Reporting Standards convergence and the development of IFRS for small and medium-sized entities (SME).  Concern was expressed about the disparity of interests between small, medium, and large private companies. The Task Force recommends that all entities that are eligible to use private company GAAP have the option to use extended GAAP, allowing the flexibility to respond to the needs of the users of the financial statements.  The Task Force suggested that consideration be given to the academic community when offering subscription-based standards resources to ensure the maximum number of students have inexpensive access to standards materials as these changes are implemented.  The Task Force noted a real need to inform the financial community and the broader 7MACPA – Copyright 2011
  • 8. business community about these changes to private company standards once they are implemented.ConclusionThe Task Force concludes that the time is right to establish a separate board for private companyaccounting standards that will develop exceptions and modifications to GAAP for privatecompanies. It is clear private company stakeholders see a need to improve standards for privatecompanies. The increasing use of OCBOA calls into question what is generally accepted and issymptomatic of the problems with private company standards. Any further studies should belimited to determining how the recommended changes can be implemented and not continuing tostudy whether changes are needed. The Task Force looks forward to the implementation of theserecommendations to improve private company accounting standards.ApprovalThe Task Force report was formally accepted and endorsed by the Maryland Association ofCPAs Board of Directors on June 2, 2011 in a unanimous resolution.For more information about the Task Force Report and Process:MACPA Announcement http://www.macpa.org/Content/26146.aspxContacts:Skip Falatko, CPA – MACPA Committee Liaison – skip@macpa.orgTom Hood, CPA.CITP – MACPA CEO – tom@macpa.orgDisclaimerThe opinions expressed in this document reflect the personal views of the Task Force membersand don’t necessarily reflect the viewpoint of their employers. 8MACPA – Copyright 2011
  • 9. Task Force Members  Chairman: Organization: Segment:Arthur E. Flach, CPA Grant Thornton, LLP Public AccountingMembers:Debra G. Busk, CPA DeLeon & Stang Public AccountingJames F. Canalichio DVCC, Inc. Private CompanyAllen P. DeLeon, CPA, PFS DeLeon & Stang Public AccountingJames D. Jenkins, CPA SC&H Group, LLC Public AccountingCarl Kampel, CPA Ellin & Tucker, Chartered Public AccountingKenneth A. Kelly, Jr., CPA McCormick & Co., Inc. Public CompanyMichael P. Manspeaker, CPA Smith Elliott Kearns & Co., LLC Public Accounting Hayles & Howe, Inc.Joselin R. Martin, CPA KCI Technologies, Inc. Private CompanyDonald A. McConnell, CPA University of Maryland Private CompanyJames J. McKinney, CPA Gross, Mendelsohn & Associates, EducationErnest J. Paszkiewicz, CPA P.A. Public Accounting Small Business AdministrationOliver J. Phillips Santos, Postal & Company, PC GovernmentCharles B. Postal, CPA Branch Banking & Trust Co. Public AccountingRobert L. Tuggle Branch Banking & Trust Co. BankingWilliam Ziegler, CPA BankingMACPA Staff: MACPAJacqueline E. G. Brown MACPA Non-profitFrancis J. Falatko, Jr., CPA MACPA Non-profitJ. Thomas Hood, III, CPA Non-profit 9MACPA – Copyright 2011
  • 10. ResourcesAICPA: “Private company financial reporting panel starts work”http://www.macpa.org/Content/23457.aspxAICPA Private Company Standards Resource Centerhttp://www.aicpa.org/privategaapAICPA Private Company Financial Reporting Task Force Report (known as the“Castellano Report”), Feb. 28, 2005http://www.aicpa.org/InterestAreas/AccountingAndAuditing/Resources/AcctgFinRptg/AcctgFinRptgGuidance/DownloadableDocuments/Report_Draft_Final.pdfBlue Ribbon Panel on Standard Setting for Private Companies: “Report to the Board ofTrustees of the Financial Accounting Foundation,” January 2011http://www.accountingfoundation.org/cs/ContentServer?site=Foundation&c=Document_C&pagename=Foundation%2FDocument_C%2FFAFDocumentPage&cid=1176158181336Kennard S. Brackney and R. David Mautz, Jr.: “The Private Company FinancialReporting Committee - A New Voice in FASB’s Process,” NYSSCPA, July 2008http://www.nysscpa.org/cpajournal/2008/708/infocus/p14.htmCPASuccess.com: “What is one thing almost all CPAs agree with?” Jan. 28, 2011http://www.cpasuccess.com/2011/01/this-time-its-real-private-company-standards-time-to-pay-attention.htmlCPASuccess.com: “Private company GAAP? Time to pay attention,” Dec. 7, 2010http://www.cpasuccess.com/2010/12/private-company-gaap-time-to-pay-attention.htmlGovernment Accountability Office: “A Framework for Crafting and Assessing Proposalsto Modernize the Outdated U.S. Financial Regulatory System,” January, 2009http://www.gao.gov/new.items/d09216.pdfHouse Bill 3763 (the "Oxley Bill”), United States House of Representatives, Feb. 5, 2002http://www.gpo.gov/fdsys/pkg/BILLS-107hr3763ih/pdf/BILLS-107hr3763ih.pdfMarie Leone: “A one-two accounting punch? Next year U.S. public companies will findout if they have to adopt international accounting standards – just as they areimplementing a host of new FASB rules,” CFO.com, May 18, 2010http://www.cfo.com/article.cfm/14496195MACPA: “Financial reporting committee names founding members,” March 6, 2007http://www.macpa.org/Content/23173.aspx 10MACPA – Copyright 2011
  • 11. MACPA letter to Tim Woo, FAF/FASB - “Blue-Ribbon” Panel written submissions fromconstituents, Sept. 15, 2010http://dl.dropbox.com/u/20948371/Tim%20Woo%20-%20MACPA%20Letter%20to%20FAF%20Blue%20Ribbon%20Committee.docMACPA letter to Bob Herz, chairman of FASB: “Support of PCFRC’s positions onFASB Interpretation No. 48 & FASB Interpretation No. 46(R),” Sept. 4, 2008http://dl.dropbox.com/u/20948371/FASB%20Chairman%20Bob%20Herz%20-%202008%20Comment%20letter.docEdith Orenstein: “FEI CPC-S releases working draft on private company accounting,”Financial Executives International, May 19, 2010http://www.accountingweb.com/blogs/edith-orenstein/fei/fei-cpc-s-releases-working-draft-private-co-accountingBruce Pounder: “How not to create private company GAAP: A favored approach toestablishing "little GAAP" for private U.S. companies is way off target,” CFO.com, Jan.6, 2011http://www.cfo.com/article.cfm/14548290Private Company Financial Reporting Committee (PCFRC) meeting:Judy ODell (PCFRC chair), who is a participating observer on the BRP, provided thePCFRC with an overview of the first meeting of the BRP, April, 2010http://www.pcfr.org/downloads/PCFRC_April_2010_final_meeting_highlights.pdfPrivate Company Financial Reporting Committee: Recommendations and other letters toFASBhttp://www.pcfr.org/recommendations.htmlThe Sarbanes-Oxley Act of 2002, 107th United State Congress, July 30, 2002http://www.gpo.gov/fdsys/pkg/BILLS-107hr3763enr/pdf/BILLS-107hr3763enr.pdfSenate Bill 2673 (the "Sarbanes Bill"), United States Senate, June 25, 2002http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=107_cong_bills&docid=f:s2673pcs.txt.pdfBill Sheridan: “CPAs take next step in private company debate,” ledgerlink.monster.com,Dec. 24, 2009http://ledgerlink.monster.com/training-accounting/articles/506-cpas-take-next-step-in-private-company-debateSmall Business Administration Office of Advocacy: “The impact of regulatory costs onsmall firms,” September 2010http://archive.sba.gov/advo/research/rs371tot.pdf 11MACPA – Copyright 2011