On Wednesday, January 26, 2011, the Blue-Ribbon Panel (BRP or Panel) issued a much anticipated report on recommendations to the Financial Accounting Foundation (FAF), the parent organization of the Financial Accounting Standards Board (FASB), regarding the future of accounting standards for private companies i ii.
The BRP was a joint effort commissioned in 2009 by the AICPA (American Institute of Certified Public Accountants), the FAF, and NASBA (National Association of State Boards of Accountancy). The Panel recommended that accounting standards for private companies be based on existing Generally Accepted Accounting Principles (GAAP), but with exceptions and modifications for private companies.
These exceptions and modifications, contained in GAAP, would be promulgated by a newly created authoritative board, overseen by the FAF but separate from the FASB. An important distinction to make is that the Panel has recommended that GAAP consist of a single source of authoritative literature embedded with exceptions and modifications for private company financial reporting; and not a separately issued set of accounting rules for private companies.
The Panel’s conclusions were based on its belief that the current system for promulgating accounting standards in the United States has not sufficiently:
- Considered the information that users of private company financial statements consider decision-useful and how those information needs differ from those of users of public company financial statements, and
- Weighed the costs and benefits of GAAP for use in private company financial reporting.
History of Differential Private Company Accounting Efforts
Differential private company accounting standards is a long-debated topic. In fact, 12 separate studies, reports, or formal recommendations have been commissioned over the past 40 years. The FASB’s most recent formal research on the needs of private companies occurred in 1983.
Since that date business, finance, and economics has become global and exponentially complex resulting in the development of accounting standards that have become increasingly divergent from the needs of users of private company financial statements, examples of which include accounting for variable interest entities, uncertain tax positions, fair value measurements, and impairment.
The efforts expended over the past 40 years to differentiate private company accounting had varying degrees of success, and generally culminated in recommendations or creations of advisory-level committees that lacked authoritative status.
The most significant development in these efforts was the 2007 creation of the Private Company Financial Reporting Committee (PCFRC) which was the by-product of the Private Company Financial Reporting Task Force chaired by RubinBrown’s Chairman, Jim Castellano. This development was significant in that, unlike prior efforts, the FASB was to specifically address and articulate within the literature of each subsequently issued accounting standard, the basis for its decision on whether differences should exist for private companies.
The PCFRC has met with some success on achieving differential private company disclosure requirements and accounting standards’ effective dates but has concerns over the ability to experience that same level of success in private company differences relating to:
- Recognition (what events get recorded in the financial statements)
- Measurement (in what amounts are those events recorded)
- Presentation (how are those events and amounts presented in the financial statements)
The BRP’s recommendations are significantly incremental to similar historical events due to the recommendation of an authoritative standard setting body whose mission is to determine exceptions and modifications to FASB promulgated standards.
The Value of GAAP at Risk
Unlike many other countries, the U.S. has no statutory requirement for most private companies to prepare financial statements in accordance with GAAP. A major concern of the BRP is the growing use of GAAP exceptions used in private company financial reporting. One example of an exception is an election to amortize goodwill instead of the GAAP-required impairment model.
Another concern is the increasing popularity of an election by many private companies to report under a basis of accounting other than GAAP, such as a cash basis or the basis in which the company reports transactions on its federal income tax return.
Private company lenders are becoming accustomed to these types of reports and may at times, find them to present information that is more decision-useful than their GAAP-compliant counterparts. The frequency of such reporting options could undermine the value of GAAP in the marketplace and eventually call into question what is “generally accepted”.
The BRP believes that GAAP, complete with the appropriate exceptions and modifications for the users of private company financial statements, is a preferable solution to these other reporting options.
A critical element to the BRP’s proposed model is the recommended development of a differential conceptual framework. The FASB uses an existing conceptual framework in its standard setting activities. A conceptual framework is an important standard setting tool in that it serves as a “ground zero” for developing standards level pronouncements and helps insulate standard setting from the influence of personal opinion and the economic cycles that may exist at the time.
The development of a private company conceptual framework would help ensure that private company exceptions and modifications are made in the best interest of the stakeholders of those financial statements and not made simply for the sake of creating differences.
On August 5, 2010, the BRP published a list of questions requesting input from the public. The common issues and concerns cited by the respondents were:
- 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 other comprehensive bases of accounting, where possible
Click here to see the full text of the Blue-Ribbon Panel’s report.
At this time it is unknown when or how the FAF will consider and address the recommendations of the Blue-Ribbon Panel. However, it is likely that the FAF will ask for public comment on any action plans they develop. Because it is expected that a large respondent group will be CPAs in public practice, it is commonly thought that such a response period will occur after the spring tax filing season.
The recommendations of the BRP are monumental and, if enacted in any resemblance of their original form, would spell significant relief for the financial reporting requirements of many small businesses in the U.S. As a result, we encourage those who have a stake in such developments to watch for and take advantage of the potential comment opportunity.
i In the context of the BRP report, the term “private companies” is used to refer to nonpublic companies and therefore is inclusive of organizations that are generally not referred to as “companies” such as non-profit organizations and employee benefit plans, to the extent that these organizations do not file periodic reports with the Securities and Exchange Commission.
ii Estimates of the number of private companies in the United States approximate 28 million, whereas the number of public companies with SEC reporting requirements approximate 14,000
Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.
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