GAAP: Private Companies Need Modified Standards, Not Separate Rules


	Lynn Westergard

October 2011

Private Companies Need Modified Standards, Not Separate Rules

The recommendations of a Blue Ribbon Panel may be the first step in a long process that could dramatically improve the quality and consistency of financial reporting for private companies

Private companies have long argued that applying U.S. Generally Accepted Accounting Principles (GAAP) is too expensive and, further, the results are of marginal benefit.

In response to those arguments, in 2009 the American Institute of Certified Public Accountants (AICPA) and the Financial Accounting Foundation (FAF) created a “Blue Ribbon Panel” to analyze how existing U.S. accounting standards could be leveraged to help improve the usability of private company financial statements. The panel recently issued a report on its findings and recommendations, which are summarized below.

Private vs. Public Companies. In the U.S. there are about 28 million private companies. In contrast, there are about 14,000 public companies, which are required to file reports with the U.S. Securities and Exchange Commission (SEC). Although private companies do not need to prepare GAAP financial statements for the SEC, they commonly need them for investors, lenders, bonding companies, regulators and others.

A public company’s shareholder population typically includes a broad range of investor types with a wide variety of expectations regarding the information needed from the company’s financial statements. Alternatively, the shareholders in a private company have relatively defined needs and expectations for the company’s financial statements.

Panel Findings

As contained in its 2011 report, the Blue Ribbon Panel found that applying U.S. GAAP to private companies has resulted in a number of unintended consequences, including the following:

For private companies, applying U.S. GAAP can needlessly complicate the financial reporting process, at a considerable cost, without improving the usability of their financial statements.
Since private companies can choose to ignore GAAP, it is often difficult to compare two companies’ financial statements.
Stakeholders may not be familiar with U.S. GAAP, or they may have specific questions that are not easily answered by reviewing the company’s financial statements. As a result, stakeholders often request additional information or an ad hoc analysis in order to make sense of the financial statements.
Accounting staff members with U.S. GAAP experience can be relatively expensive to hire and retain, since they can work with both private and public companies.

Consistent with these and other findings, the panel concluded that there are “urgent and growing systemic issues that need to be addressed” in the current U.S. accounting standards.

Recommendations. The panel’s recommendations include the following:

There should not be a wholesale departure for private companies from U.S. GAAP. Rather, in the near term, “the system should focus on making exceptions and modifications to U.S. GAAP for private companies that better respond to the needs of the private company sector.”
Accordingly, a new board, overseen by the FAF, would be tasked with developing “exceptions and modifications” to U.S. GAAP to better suit the needs of private companies.
A framework should be developed to help the newly formed board determine whether a specific exception or modification to U.S. GAAP is appropriate. The framework would take into account the costs and complexity of the revisions and the overall impact on the relevance and accuracy of a private company’s financial statements.

The panel’s recommendations are not without critics. Some have suggested that the recommendations are unrealistic, in that they put forth solutions without adequately addressing the risks inherent in those solutions.

One of the key factors mentioned was “solution-implementation risk,” which refers to the risk that the solution will fail in the process of implementation. Successful implementation is not automatic and requires careful development and monitoring. For example, implementation might fail because of real-world resource constraints or because the costs of implementation could exceed the benefits gained by resolving the issue. A solution that has high implementation risk, critics contend, will probably prove useless.

The FAF Board of Trustees will consider the panel’s recommendations as it deliberates improvements to the standard-setting process, possibly finalizing the changes to private company reporting before the end of 2011.

What This Means to You

Will the users of private company financial statements welcome the exceptions and modifications produced by the newly appointed FAF board? How will the tweaking of current rules impact such important issues as fair value disclosures, derivatives, stock options and balance sheet consolidation? Time will tell. However, consider the following steps that a company can take now to prepare for the finalized changes.

Map Out a Strategy. Once you have a detailed understanding of how the upcoming changes approved by the FAF will affect your business, develop a timeline of steps and communications that your company needs to undertake prior to implementation. Taking the time to plan for the changes can dramatically increase the probability that your company will be able to quickly and effectively implement them.

Meet with Significant Stakeholders. To prepare users of your company’s financial statements for possible changes in how your company reports its performance, consider meeting with major stakeholders. While waiting until the changes are in place and your company has produced its next financial statement may not cause undue concern, remember that lenders, investors and other stakeholders rarely like surprises.

Review Lender Debt Covenants. Changes in the application of U.S. GAAP may result in the “busting” of bank imposed covenants. Once the FAF recommendations are finalized, consider engaging your accounting firm to model the impact on your company’s debt covenants. In addition, if your company is subject to government regulation, your accounting firm can implement tests to ensure that the financial metrics that are subject to review by regulators remain within an acceptable range.

Contact Your Accounting Firm for Guidance. Once the FAF recommendations have been approved, companies need to prepare for changes in personnel, processes and technology needed to produce financial statements. Discuss with your accountants how the changes may affect your company; your accountants should be able to share with you the cost/benefit of adopting the FAF-approved changes and help your company model the impact on its financial statements.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.

SERVICES | RESOURCES | ABOUT US | CAREERS | CONTACT US