Private-Company GAAP: Can We Get a Do-Over?

Private U.S. companies need a much better solution for their financial-reporting problems than one recently proposed by a blue-ribbon panel.

In the United States, generally accepted accounting principles (GAAP) are increasingly burdensome for private companies to apply. At the same time, private-company stakeholders find U.S. GAAP to be decreasingly relevant to their information needs.

A blue-ribbon panel recently proposed a solution to these problems. The upshot of the panel’s solution is that GAAP for private U.S. companies should be defined by a standard-setting body other than the Financial Accounting Standards Board (FASB), which currently sets authoritative GAAP for all nongovernmental entities in the United States. Furthermore, the new body would define private-company standards by specifying extensive exceptions to FASB standards.

As I have explained in previous columns, the panel has disregarded four specific, significant risks in arriving at its solution. In this column, I’ll focus on the last of the four: solution-implementation risk. The lack of attention paid to this and the other risks makes the panel’s proposed solution a nonstarter.

What Is Solution-Implementation Risk?

Solution-implementation risk is a type of process risk. Specifically, it’s the risk that the process of implementing a particular solution will fail. As such, it’s distinct from problem-solving risks that arise prior to implementation, such as the risk of choosing an inherently ineffective solution to a problem.

In general, solution-implementation risk exists because the successful implementation of a solution is never automatic. Even for solutions that are problem-appropriate, well developed, and widely accepted by stakeholders, implementation isn’t effortless or free. Successful implementation invariably requires scarce economic resources as well as competent stakeholders, neither of which can be taken for granted.

Solution-implementation risk can manifest itself in several different ways. For example, it may simply not be possible to implement a particular solution due to real-world resource constraints. Or the costs of implementation might exceed the benefits of solving the problem. In any case, it’s important to recognize that a solution that carries high implementation risk is likely to be useless.

Pounder 2-24-11

Three Risk Factors

There are three major factors that contribute to the solution-implementation risk associated with the blue-ribbon panel’s proposed solution. First, the panel has left the details of implementation up to others. Without the discipline of thinking through the implementation process, problem-solving exercises such as the panel undertook often produce “perfect-world” solutions that are impossible or imprudent to implement in the real world.

The second risk factor stems from the fact that financial-statement users were severely underrepresented in the panel’s composition and deliberations. But successfully implementing a solution to the problems of private-company financial reporting will require not only the participation of this key stakeholder group but also leadership from them. Unfortunately, most users of private-company financial statements aren’t even aware of the existence of the panel or its proposed solution.

The third risk factor is that the successful implementation of the panel’s solution would require the coordinated efforts of millions of stakeholders who have conflicting interests as well as diverse levels of motivation and ability. The phrase “Good luck with that” jumps to mind.

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