A blue-ribbon panel has recommended that a new set of accounting standards be drawn up for private companies based on U.S. generally accepted accounting principles. The panel also recommended that a private-company rulemaking board be established, separate from the Financial Accounting Standards Board, which currently writes and revises U.S. GAAP.
The details of how the rules will be developed — and how FASB and its parent organization, the Financial Accounting Foundation (FAF), will be involved in the process — will be outlined in a report issued in December, said panel chair Rick Anderson, chairman and CEO of accounting firm Moss Adams, during the panel’s fourth and final public meeting on Friday. The final product, often dubbed “little GAAP,” will be a pared-down version of the full set of rules, requiring fewer disclosures and less-detailed measurements of some assets and liabilities.
The panel was established in December 2009 by FAF, the American Institute of Certified Public Accountants, and the National Association of State Boards of Accountancy to explore the need for separate accounting standards for nonpublic companies. The discussion among the 18 panelists and official observers at Friday’s meeting did not yield a definitive vote count, as most members preferred a hybrid of the models being offered up to a vote. However, the majority of panelists favored a separate set of rules, governed by a separate board, while a handful of others voted for separate rules and a reconstituted FASB, that includes more representation from private-company constituents.
The overarching argument for carving out a private-company version of GAAP is to make accounting rules “relevant” to private companies by excising unnecessary measurement requirements and transaction disclosures. In particular, proponents say the complex rules for measuring the fair value of assets and liabilities should be trimmed. “Fair value is the elephant in the room,” quipped Judith O’Dell, a panel observer and chair of FASB’s Private Company Financial Reporting Committee.
O’Dell, a valuation and business consultant, pointed out that under full GAAP, most private-company assets and liabilities would have to be measured using unobservable, or “Level 3,” inputs, because their values cannot be estimated using actively traded prices. She contended that valuing Level 3 assets would not only pose a major expense for smaller companies but also fail to provide pertinent information for private-company investors.
For many years, preparers and auditors of private-company financial statements have sought a private-company GAAP, insisting that the full set of rules is too complex, and therefore costly and burdensome, for smaller nonpublic companies to apply. Although private companies are not required to file financial results using GAAP, many have followed the rules at the request of investors and lenders who are more comfortable assessing GAAP-prepared statements. Others use GAAP because they intend to go public, and investment banks that handle initial public offerings prefer consistency in reporting.
Nevertheless, proponents of little GAAP say private-company investors and lenders don’t need the same level of detail that the Securities and Exchange Commission requires from publicly held companies. (The SEC has final approval over GAAP.) And if they do want more details about a company’s finances, they will demand it, noted Anderson.
Indeed, private-company investors and lenders often request information not required by full GAAP, commented panel member Dev Strischek, a former CFO and current senior credit policy officer for SunTrust Banks. Strischek said that as a lender, for example, he wants to know whether a company has sufficient cash flow to service debt, and often asks for breakdowns of inventory and receivables to verify inflows.
Panel member Steve Feilmeier, CFO of Koch Industries, uses GAAP to report his company’s results, but doesn’t think the rules are always appropriate for private companies. Koch is one of the nation’s largest private companies, with more than $100 billion in revenues. The company’s latest annual report contains about 200 pages worth of disclosures, which probably could have been reduced to about “10 pages and been more meaningful to users” if little GAAP were in place, said Feilmeier. He added that while Koch can absorb the cost imposed by conforming to full GAAP, “smaller companies can’t.”
Bill Knese, vice president of finance for Angus Industries and a panel member, said it was likely his company’s banker would accept a version of GAAP that was “appropriate to my business,” such as little GAAP. Knese, who served as the panel’s representative from the Institute of Management Accountants, noted a “dramatic rise” in qualified audit opinions given to private companies that don’t apply GAAP to all transactions, and suggested that a little GAAP could reverse the trend.
Although Knese voted for a separate GAAP, he expressed concern that having two sets of rules “might cause confusion in the market.” But, he added, “as a practical matter, I recognize the need for some change for private companies.”