American accounting contains an awkward contradiction. Though 99.7 percent of the country's 4.9 million corporations are privately held, a good deal of the country's generally accepted accounting principles are primarily relevant to the financial conditions of public companies traded on equities markets.
Meeting GAAP requirements can mean a lot of time, trouble and expense with little meaningful purpose. For years there has been a call for some kind of "Big GAAP-Little GAAP" system that would ease requirements for companies of a certain kind or size.
Last year, the American Institute of CPAs formed a private company financial reporting task force, which has just completed its report. Its conclusions may have significant long-term repercussions for American business.
"We've been addressing this issue for decades," said Bill Balhoff, CPA, a partner with Postlethwaite & Netterville in Baton Rouge, La., and a member of the task force charged with exploring private company financial reporting standards.
The task force, established last year and headed by former AICPA chairman James Castellano, made its determinations based on the input of some 3,700 business owners, public practitioners, financial managers, lenders, investors and sureties.
The task force made every effort to conduct nonpartisan research. An independent market research organization, MSR Group, conducted random and open surveys.
The report found that financial statements of private companies prepared in accordance with GAAP have moderately high to high value to the users of those reports, especially with respect to the characteristics of consistency and comparability.
Users also said, however, that many GAAP requirements lack relevance or decision-usefulness. All constituent group respondents who participated in the report's survey rated certain GAAP requirements as being of low relevance or usefulness. A very high percentage of lenders, investors and analysts said that they had accepted and used non-GAAP financial reports.
Does the widespread acceptance of non-GAAP reports mean that the market has essentially resolved the issue?
That was one of those questions that didn't get asked, because the task force hadn't seen it coming.
"What struck me is that we had no preconceived notion of the results," said task force member Arthur V. Neis, vice president, chief financial officer, treasurer and major owner (along with the company's other employees) of Des Moines-based Life Care Services LLC. "After the results were in front of us, all we could say was, 'If we'd known all this beforehand, we would have asked a dozen more questions.' So we have definitely set up the next group's work."
Among the GAAP requirements most widely perceived as irrelevant or not useful - and the findings varied by type of constituent and size of company - were comprehensive income measurement, post-retirement plans, variable interest entities, intangibles, and share-based payments.
The report also found that most constituents who expressed an opinion on the issue believed that it would be useful if the underlying accounting in GAAP reporting were different, in certain instances, for public versus non-public companies.
Fundamental differences
During the research, the task force realized that one of the biggest fundamental differences between public and private companies is in the nature and intentions of their owners. While public company owners can easily sell off their shares on the equities market, and often tend to do so, the owners of private companies tend to own their companies for a long time, seeing themselves as long-term stewards rather than investors looking for short-term valuation.
"Everyone I talked with outside of the task force said that that one point summarizes it all," Neis said. That fundamental difference between types of companies, he said, is what calls for fundamentally different financial reporting with fundamentally different purposes.
Castellano, who is chairman of Rubin, Brown, Gornstein & Co. LLP, said that GAAP for private companies could have a beneficial impact on the economy as a whole. "To the extent that GAAP for private companies provides information that is relevant for the distinctly different needs of private company constituents, I believe it will facilitate the flow of capital to those companies and, therefore, help the economy," he said. "Investors are one of the key constituents of private company financial reporting and will likewise benefit from improvement in the relevance of this reporting."
The members of the task force combined the research findings with their own experience as preparers, auditors, investors, creditors and other users of information to produce a set of conclusions with which they unanimously agreed.
Among the conclusions were:
* That GAAP for private companies should be developed to serve the distinctly different needs of those who use their financial reports;
* That the common practice of using GAAP with exceptions not only fails to solve the problem, but erodes the very purpose of accounting under GAAP; and,
* That fundamental changes should be made to the standard-setting process that produces GAAP.
The task force did not specify how the standard-setting process should be modified, but it recommended that the users, preparers and auditors of private company financial information cooperate to determine how the process should be changed and who should change it. It also recommended that constituents work with the Financial Accounting Standards Board to devise a better means of producing more relevant and cost-effective standards for private companies.
FASB Chairman Robert Herz said that his board is open to exploring possible changes. "FASB is committed to establishing and improving standards of financial accounting and reporting for the public, including issuers, auditors and users of financial information, and to do so through an open and thorough due process," he said. "Exploring the creation of a process to evaluate potential changes to GAAP in an effort to improve the usefulness of private company reporting is consistent with that commitment."
The economy as a whole
Even before the report was made public, representatives from FASB and the AICPA met to discuss the possibility of developing a process to follow the recommendations of the report. Bill Balhoff will be meeting with FASB's Financial Accounting Standards Advisory Group in late March.
FASB's new Small Business Advisory Committee is likely to become involved in the process. Its next meeting will be in June, and it is likely that GAAP for private companies will end up on the agenda.
Francis Jumonville, secretary and treasurer of Airtrol Inc., a mechanical contracting company in Baton Rouge, hopes that it will be. "I certainly understand FASB's concern about the bigger issues, but the things that apply to the large businesses may not apply to me," Jumonville said. "The fair value concept, for example, is something that would not interest me, as a preparer."
Jumonville also cited Financial Accounting Standard 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, as a problem. It was expensive for Airtrol to comply, and after it did so, its bonding company recognized its irrelevance and simply changed Airtrol's financial report so that it presented more meaningful information.
Balhoff said that he does not have the ultimate solution to the problem other than to, for now, create a process that will work toward a solution. Among the possible solutions, he said, are a new set of standards developed by FASB or some other organization, or a new conceptual framework that takes into account the differences between public and private companies. He was unable to foresee a timeline, but hoped to see a process defined within six months to a year.
"I hope the AICPA, FASB and other stakeholders can get together and start working out the details of how this fundamental change will be implemented," Balhoff said. "I hope they can do this without debating the results of the study and just move forward."
Castellano foresees a difficult process that will be worth the effort. "I expect it will be quite difficult, but definitely worth achieving," he said. "Other countries have addressed the issue in various ways, so there are models to study. The subject also is high on the agenda of the International Federation of Accountants, which is studying the issue of separate accounting for 'non-publicly accountable entities.' By working with all key constituents of private company financial reporting, I am confident that a workable solution will be developed."
