Earlier this year, the Blue Ribbon Panel on Private Company Financial Reporting began considering the changes necessary to best meet the needs of U.S. users of private company financial statements. The panel is sponsored by the AICPA, the Financial Accounting Foundation (which oversees the Financial Accounting Standards Board) and the National Association of State Boards of Accountancy. At its next meeting on October 8 at the AICPA offices in New York, the panel is expected to finalize its recommendations to the FAF on the future of standard setting for private companies prior to issuing a report at year end. In this Q&A, AICPA Chairman of the Board Robert R. Harris, CPA/CFF, describes the critical issues at stake.
Why is the work of the blue ribbon panel so important to the profession?
Private companies play a vital role in our economy. There are more than 29 million private companies in the United States, including 7 million small- to medium-size businesses. CPAs who serve these companies, or who work in these companies, have been saying for a long, long time that these businesses have financial information needs that are much different from those of large public entities. Their financial statement users need straightforward, understandable information that addresses what they need to know – no more, no less. Given private companies’ key role in job creation and economic development, it’s more vital than ever that their financial statement users and other stakeholders, such as owners of those companies, have the most relevant and useful financial information we can give them.
What’s happening at the October 8 meeting that CPAs need to know?
The panel will be deciding the direction of its recommendations for both the standards model and the board structure that sets GAAP standards. This is the meeting where it all comes together – the standards and the standard-setting process are the essence of what the panel’s been working toward. The AICPA believes, regardless of the reporting model to be recommended, that a separate standard setting board is necessary for private company reporting to become a reality.
Why is a separate board critical to having private company accounting standards?
We’ve had years of studies and research, a joint advisory committee (the Private Company Financial Reporting Committee), private company constituent representation on the FASB Board and comment letters in the past, without meaningful results. It’s imperative that there be a board made up of private company oriented people who would set the different standards affecting the private company financial reporting system. This new board could be overseen by the Financial Accounting Foundation, but it would have to be separate from the FASB. The FASB would continue to set standards for public companies.
Do private company financial statement users agree that change is needed?
Yes, I can tell you that many constituents - including lenders, investors and owners - question the relevance and usefulness of a number of current GAAP standards as they relate to private companies. In fact, the panel listened to users at its very first meeting and this group is also represented on the panel. Users may not be overly engaged in how the process needs to change to get to more relevant GAAP standards, but they appreciate that certain standards need to change to bring balance to the cost-benefit equation.
Can you provide some examples of standards that aren’t appropriate for private companies?
Two come immediately to mind – and this is based on what I have heard in my many travels. The standard formerly known as FIN 48, on uncertainty in income taxes, is an excellent example, one that many CPAs and companies have wrestled with. At least one long-time lender has pointed out that he never got burned on a loan under the accounting method in use before this standard was issued. Since lenders are key users of private company financial statements, why was the change necessary? In this case, and many others, the standard was created because of issues in public company reporting and the related regulatory oversight that accompanies it.
Many CPAs also will agree that FIN 46R, on consolidation of variable interest entities, is causing numerous unnecessary challenges for private companies. It was created because some public companies found loopholes in the old standards that they were able to work to their advantage. But private companies do not have similar incentives and pressure to game the system for investors. Still, they are now forced to consolidate common controlled structures that may have been created for tax purposes. This causes so many problems in private company financial statements that we often hear about lenders accepting GAAP exception audit reports so the company can issue a more relevant statement and sidestep FIN 46R altogether. The growing use of such exceptions weakens the relevancy of GAAP.
I should also mention the rules on goodwill impairment, which force private companies to assess goodwill assets in business combinations for impairment annually, no matter what the circumstances. To comply, private companies often must perform calculations based on extensive, complicated fair value estimates. And yet, the users of private company financial statements often say they totally ignore goodwill. It’s clear that private companies are spending a great deal of time and money developing information that may never actually be used.
Is cost a factor for change, too?
I know that my fellow CPAs are aware that U.S. GAAP has become exceedingly complex and difficult to apply, especially for private companies. Too much of what’s included in current financial statements is not useful to private company owners, lenders and investors. As a result, not only is this complexity not cost beneficial, it also can stand in the way of good decision making.