Today I am going to discuss one of the most important issues our profession is facing, not just this year but in the last 30 or so years – private company financial reporting. After decades of debate about whether U.S. GAAP, in terms of both the standards and the process that leads to those standards, adequately considers the unique needs of private companies’ owners and financial statement users including lenders, investors and other stakeholders, we’re the closest we’ve ever been to changing the financial reporting system. It may be a now or never scenario, though, and so your understanding of the issue and participation to help bring about this change is critical.
Let me set the stage for you. This is an issue that impacts vast reaches of the U.S. economy. Only about 15,000 companies are registered with the Securities and Exchange Commission, but there are 28.5 million private businesses, according to the U.S. Census Bureau (this number excludes non-profits which would not be covered by current proposed changes in private company reporting). Yet U.S. GAAP is driven by issues that occur in the capital markets to address the needs of public companies and their stockholders. So, standards developed for 15,000 companies have to be applied to many of the nation’s 28.5 million private businesses that prepare U.S. GAAP financial statements. In recent years, accounting and reporting guidelines too often have lacked relevance and have become unnecessarily complex. The result is that too much of what’s included in current financial statements is not useful to private company owners, lenders or investors. Anything that hinders small businesses has a profound impact on the U.S. economy. According to the U.S. Small Business Administration, small businesses employ more than half of all private sector workers in the United States and are responsible for 44% of the private payroll. They have generated 64% of the new jobs created during the past 15 years. Many of these companies are small and medium-sized organizations that report to a narrow range of financial statement users, such as lenders, venture capitalists and insurers.
And we’re not alone. This is a situation that exists around the world. Some countries have come up with solutions already while others are exploring various approaches.Canada adopted IFRS for public companies effective this past January 1. It decided to have a set of separate, stand-alone standards for private companies that also became effective on January 1.The UK has proposed a three-tiered financial reporting system: publicly accountable entities would follow International Financial Reporting Standards (tier 1); large and medium non-publicly accountable entities would be eligible to apply the IFRS for SMEs (tier 2); and the Financial Reporting Standard for Smaller Entities (the UK’s FRSSE) would remain available to small entities (tier 3). Japan formed a council that is looking at the issue now.The International Accounting Standards Board says its International Financial Reporting Standard for Small- and Medium-sized Entities, released in July 2009, has either been adopted or is planned for adoption within the next three years by more than 70 jurisdictions. IFRS for SMEs is specifically designed for what we would mostly consider private companies.
In 2004, the AICPA undertook a research effort to definitively assess what constituents thought about the problem after hearing concerns from CPAs and others for decades. The AICPA’s Special Task Force on Private Company Financial Reporting (also known as the “Castellano Task Force”), after getting responses from more than 3,700 lenders, investors, business owners, financial managers and public accounting practitioners, found that too many GAAP-specific requirements are not useful or relevant to private company constituents. A majority of each group who had an opinion believed it would be useful if underlying accounting in GAAP reporting were, in certain instances, different for non-public companies. The task force published its report in early 2005, underscoring the need and urgency to address private company reporting. Two examples cited as offering many private company financial statement users little benefit while costly to implement are: the interpretation formerly known as FIN 48, on uncertainty in income taxes, and FIN 46R, related to consolidation of variable interest entities. Many private company constituents say both are causing unnecessary challenges for private companies and demonstrate why private companies are spending quite a bit of their time and money complying with accounting standards that relate to information that may never actually be used by anyone reading their financial reports.
Big picture: Private company financial reporting, as it stands now, is too complex, embodies too much irrelevant information and is too costly and time-consuming given its benefits. This is because the current system cannot adequately understand and consider the needs of the private-company sector.Public company users are most often focused on understanding the financial statements for investment analysis purposes. Private company users, however, are typically using financial statements to assess cash flow sufficient to repay a loan, complete a project or perform under a contract. Another major difference is that private company users, unlike their public company counterparts, have access to company management and to additional financial information beyond that provided in the financial statements. The accounting standard-setting process should take these differences into account.
The panel concluded that indeed a systemic problem does exist where private company financial reporting is concerned. As a result, it had two significant recommendations agreed to by a supermajority of its members. It proposed that FAF accept:- Changes and modifications in existing U.S. GAAP for private companies, where appropriate. There would continue to be one GAAP codification but with differences within standards as necessary to recognize the needs of private companies, thereby fixing the standards dilemma. - A new, separate standard-setting board reporting into FAF and consisting of people with private company constituent experience, addressing the process component. The new board would work closely with the FASB throughout the standard-setting process. The new board would have the authority to change or modify underlying accounting differences, such as recognition and measurement requirements as well as disclosures for private companies.
The report had other recommendations as well: To determine when there should be differences for private companies in the standards, the panel recommended that a framework with decision criteria be developed against which standards would be compared. It also outlined a process for exposure of proposed standards. Another recommendation is that the new standard-setting structure and process be reviewed after 3 to 5 years to determine if it is working as effectively and efficiently as it should. The FAF would at that point determine if the changes are performing as intended, and whether additional structural modifications are necessary.The number of board members of the new board was proposed for between 5 and 7.The panel’s staff estimated the cost of the new board at approximately $4-5 million annually and suggested ways of funding it.
The AICPA believes change in financial reporting for private companies is long overdue and that a separate standard-setting board is crucial for meaningful private company reporting to become a reality.At its October 2010 meeting, the AICPA governing Council adopted a resolution supporting the panel’s work, including its main recommendations which were pending at the time. “The CPA profession stands ready to help implement a differential GAAP model for private companies, as determined by a separate private company accounting standards board,” according to the resolution which passed by an overwhelming voice vote.In October 2009, Council had expressed overwhelming support for having GAAP recognition, measurement and disclosure differences for private companies where appropriate.
A board consisting of people with private company constituent experience is necessary to make the changes that will ensure useful information for private company users, owners and others. History tells us something very different needs to be tried. We’ve had years of studies and research, private company constituent representation on the FASB Board and comment letters in the past, without meaningful results. Here are some other past efforts intended to bring private company issues to the fore that have not resulted in necessary changes in standards: AICPA Private Companies Practice Section created the PCPS Technical Issues Committee in 1980 to ensure that standard setters were aware of the private company perspective.- The FASB formed a Small Business Advisory Committee in 2004 to gain more insight into this segment.- The Private Company Financial Reporting Committee, a joint effort of the AICPA and the FASB, launched in 2007 to inform the board about the consequences that proposals will have for private companies. It seems clear at this point that the only way that the needs of private company constituents will be truly addressed is through the creation of a separate board with standard-setting authority.
FAF discussed the panel’s recommendations in closed session on February 15. Panel chairman Rick Anderson presented the final report to FAF’s Trustees.In early March, FAF formed a working group to address accounting standards for nonpublic entities – private companies and nonprofits. The working group will conduct outreach to stakeholders in various ways, including roundtable meetings, surveys, and meetings with advisory and constituent groups and others. The Trustees will seek input on suggested improvements, including the solutions recommended by the Blue-Ribbon Panel. An action plan is expected in the September-November timeframe.
Whenever there’s possible major change to something that has been familiar for years, there are always challenges. It’s important that people are aware of this initiative and understand why it’s so important – and that the opportunity to do this may never arise again. In terms of understanding, CPAs and stakeholders should be aware that we are talking about starting with existing U.S. GAAP and making private company modifications to it where warranted. The FASB’s GAAP Codification would remain the source for authoritative accounting standards.In addition, changes would not be made just for the sake of making changes. That is exactly what the decision criteria framework is meant to prevent. It is changes where appropriate.Yes, if this goes through some standards will be different and may take some adjustment and getting used to. But CPAs are in a profession that embraces lifelong learning. After a transition period, the new way of the standards will become routine. Let’s not fear change.
We’re closer than ever but still need to have that push over the finish line that can only be brought about by a critical mass.To do that, we need you to comment on the FAF proposals when they come out and write in support of the Blue Ribbon Panel’s recommendations, even if they are not included in FAF’s proposals. Just as important, we’d like CPAs to serve as ambassadors on this effort. It’s critical that FAF hear from users and the other constituencies involved in private company reporting. Lenders, in particular bank presidents who can speak on behalf of their financial institutions, are essential to demonstrating the value of differences in accounting standards for private companies. They can discuss the relevancy issue – the information they need and what they don’t need. Small business clients and private business employers are other necessary audiences. FAF wants input from these stakeholders and likely will make decisions based on their feedback. CPAs are the linchpin to get these groups engaged.
Specifically, this is how you can participate in the process to finally make financial reporting relevant for private companies. Find out what you can about this issue; educate private company stakeholders and tell them why you support the changes and that they should too; prepare CPA firms, private companies, users and others to get informed and respond to FAF’s proposals; and be sure to comment to FAF or attend one of the roundtable discussions.
The AICPA has created a webpage dedicated to the private company financial reporting effort. There you’ll find articles on the panel’s meetings and its recommendations, videos of members and AICPA leadership discussing the issue and their support for change, a comprehensive FAQ, the final report that went to FAF and more. The site will be updated with additional resources after FAF’s proposal is released, including a toolkit to use for outreach to businesses and users and information on commenting on the proposal.
What's Happening with Private Company Standards - Blue Ribbon Panel - Chuck Landes - Thursday - Regionals 2011
Private Company Financial Reporting<br />Historic Changes to Benefit the Marketplace<br />Charles E. Landes<br />NASBA Regional Meetings - June 2011<br />
Problem Exists Outside of U.S. Too<br />Canadian Accounting Standards Board decided one size does not fit all and published Accounting Standards for Private Enterprises in Dec. 2009<br />UK Accounting Standards Board proposing three-tier system of financial reporting<br />Council on Accounting for Unlisted Companies formed in Japan to determine if changes should be made to standard-setting process for unlisted companies<br />IFRS for SMEs – being used in many areas of the world and being considered in some others<br />
What U.S. Constituents Say about GAAP for Private Company Financial Reporting<br />Too many GAAP-specific requirements not useful or relevant for private companies’ financial statement users<br />Greater FASB emphasis on equity/public company investors<br />Most important problem: relevance<br />Increased complexity burdensome, time-consuming<br />Based on 2004 AICPA task force research among constituents with 3,709 responses <br />
Panel’s Conclusions Consistent with AICPA Council and Board of Directors<br />Structure is the most critical piece – need new standard setting board under FAF oversight<br />Support needed for significant GAAP differences, where warranted<br />Modified GAAP will mean cost savings for preparers and practitioners<br />
Reasons for Separate Board<br />Board with private company constituent experience would set different standards affecting private company financial reporting system<br />Years of studies and research since 1970s did not yield meaningful results <br />Other efforts that did not bring necessary change:<br /><ul><li>Joint advisory committee with FASB