By Brendan Fitzgerald, CPA
2012-2013 Chair of the Executive Board
After nearly 30 years, the end of the Big-GAAP, Little-GAAP debate is near.
Then again, maybe not. I might even be committing a faux pas just by referring to it as Big-GAAP/Little GAAP instead of its current euphemistic description, “differential standards.” After this past May’s creation of the Private Company Council (PCC) by the Financial Accounting Foundation (FAF) to identify exceptions for private companies in the application of existing standards, there remains a great amount of work to complete before we can declare the debate over.
The issue has been controversial as far back as 1974, with the formation of the AICPA’s Committee on Generally Accepted Accounting Principles for Smaller and/or Closely Held Business. From purists who think generally accepted accounting principles represent one set of standardized rules used in financial reporting, to the private company stakeholders who think current standards do not adequately address the differences in reporting needs between the users of public and private company financial statements, creating generally accepted accounting principles with exceptions for private companies is daunting. Any final product must be predicated on an acceptable definition of a private, or non-public, company while addressing the needs of the users of private company financial statements. It must also provide a common sense solution for the problem it is attempting to solve.
From its inception in 2007, the Private Company Financial Reporting Committee advised FASB on private company issues. The subsequent formation of the Blue Ribbon Panel on Standard Setting for Private Companies in December 2009 was intended to provide recommendations to the FAF on the future of standard setting for private companies. The recommendations put forth in the Blue Ribbon Panel’s report issued in January 2010 included the creation of an independent standards setting board that would have direct reporting responsibility to the FAF. While that recommendation was rejected, one of the underlying arguments for the independent body was that the FASB had not exhibited much interest toward validating the issue. Given that FASB has final endorsement over recommendations advanced by the PCC, the argument will either be upheld or disproved by their decisions. As PCC recommendations are promulgated, it is imperative that there is a clear, accepted definition of the entities to which they apply. Simply using public versus private or total assets doesn’t address the complexity or uniqueness of an entity.
Is it also considered heresy to conclude that some aspect of the needs-are-different argument arises from practitioners who want relief from burdensome measurement and disclosure requirements? Many private company owners engage a CPA for financial reporting to comply with a credit agreement provision requiring them to provide financial statements prepared in accordance with GAAP. The owner is acquiescing to the provision out of necessity. Furthermore, private company owners are frequently asked to personally guarantee the debt of the entity, thus relegating the GAAP basis financial statements to being one part of the credit-decision process (albeit an important part). If a private company owner views financial reporting as merely a check mark toward satisfying a lender’s regulatory documentation requirement, their engagement in the process tends to increase only as their concern for satisfying their lender’s needs increases. While they trust us as professionals, they are not pleased when our adjustments or disclosures to bring the financial statements into compliance with GAAP lead to violating a loan covenant. Another use of GAAP basis financial statements in the marketplace is driven by transactions between owners and prospective buyers. These two examples are commonplace and can elevate our anxiety. That is not to suggest we create accounting standards to produce only happy results, but recognize that we must balance the wants and needs of the users with recommended exceptions or modifications.
We must also not lose sight of the objective to improve financial reporting for private companies. The acceptance of GAAP basis financial statements stems from their relevance, reliability, consistency and comparability. For some time now FASB has been broadening the use of fair value measurements and disclosures for statements to be GAAP compliant. In the examples illustrated in the preceding paragraph – a lender or prospective buyer – statements prepared using fair value sure seem to be a solution. Presenting assets and liabilities at fair value could be useful in either case. You can argue that such a presentation is more relevant, but it is likely to lack reliability. Once that argument begins, comparability and consistency – or lack thereof – is not far behind. Furthermore, a private company owner who, when presented with the requirement that the assets and liabilities be presented in the financial statements at fair value also receives an education on professional independence, questions why we have to make it so complicated, we’d like to have an answer.
If we cannot arrive at widespread acceptance and reasonable implementation, all we have accomplished is creating additional diversity in private company financial reporting. Additional complexity and higher cost is not a desired outcome. When the time comes for public comment of PCC recommendations, if the only respondents are CPAs, we might have no choice but to conclude that the debate will never be over.