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.

Managing Solution-Implementation Risk

It’s especially important to manage solution-implementation risk in the case of private-company financial reporting because partial success at implementing the panel’s solution would actually be worse than complete failure. As I have pointed out previously (see “The Big Risks of Little GAAP”), successful implementation among only some private U.S. companies and only some stakeholders would increase the diversity of standards used by private U.S. companies. This would in turn reduce comparability across reporting entities while increasing the complexity and cost of financial-statement preparation, auditing, and analysis.

So how can solution-implementation risk be minimized? Primarily by taking a realistic look at who must do what when, and why. Doing so may lead to the realization that we can’t solve the problems of private-company financial reporting through an alternative set of private-company standards for general-purpose financial reporting. For example, to implement the panel’s proposed solution, users of private-company financial statements would have to be ready, willing, and able to accept general-purpose financial statements prepared in accordance with standards other than existing GAAP. This would in turn require user education, IT system changes, other business-process changes, reviews of contractual provisions that are based on accounting metrics, and changes to state accountancy laws and regulations, among many other daunting-and potentially prohibitive-tasks.

Conclusion

The risk-blind solution the blue-ribbon panel has proposed has no realistic chance of solving the problems of private-company financial reporting in the United States. We need to try problem-solving again, this time paying attention to risk management from the start. Only by doing so will we have a chance of producing a much better solution than what the panel has proposed.

Contributor Bruce Pounder is vice president, accounting programs, for SmartPros Ltd. and is the immediate past chair of the Small Business Financial and Regulatory Affairs Committee of the Institute of Management Accountants (IMA). He will be a featured speaker at the 18th annual CFO Rising Conference & Expo in March. Bruce is also the lead developer and presenter for the Webcast series “This Week in Accounting.”

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