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Needed: Guidance on FASB Private Company Rules

When private firms that use the new standards are acquired by public companies, they're “going to have to undo those elections,” SEC accounting chief says.

While there have been a number of healthy and spirited debates recently over the proper approach to aiding small and mid-sized businesses, there is no disagreement over the importance of creating an environment that is conducive to their growth.

Opinion_Bug7It is in this spirit that on January 16, 2014, the Financial Accounting Standards Board (FASB) issued the first accounting standards with simplified alternatives for the way private companies account for goodwill and certain interest rate swaps. These are steps in the right direction that can help many private companies save both money and time without compromising the relevance and usefulness of the information included in their financial statements – thus lowering the cost of compliance so private companies can invest more in job creation and other activities that will spur economic growth.

Joe Adams, CEO, McGladrey

Joe Adams, CEO, McGladrey LLP

But electing those accounting alternatives may come with a catch. Going public or being acquired by a public company is a strategy for many private companies. However, a transition plan has not yet been provided for private companies that adopt these simplified alternatives and are subsequently required to file their financial statements with the Securities and Exchange Commission as a result of executing these strategies. Absent any specific transitional guidance, Paul Beswick, the SEC’s chief accountant, has said, “If you elected the alternatives under the PCC [Private Company Council] and then try to go public, from our perspective you’re going to have to undo those elections.”

This complicates the decision around whether the accounting alternatives are viable options for private companies, including family-owned businesses that may want to tap into the public markets in the future to expand operations or provide liquidity in transitioning the ownership of the business. Such companies must decide to either continue using the existing guidance with its known costs and complexity or elect the accounting alternatives, in the latter case knowing that any future filings with the SEC will come with the incurred cost of retrospectively applying the existing guidance.

Just what is that cost?

Consider the following situation. A private company elects the goodwill accounting alternative in an attempt to reduce the costs related to hiring valuation specialists. Three years later, that company is acquired by a public company with the intention of expanding sales areas and product lines. As a result of the acquisition, the acquirer must include the private company’s historical financial statements in one filing with the SEC.

Under the current provisions, those financial statements must reflect public company accounting. Therefore the private company (and, ultimately, the public company) must incur the costs of undoing the goodwill accounting alternative in its historical financial statements, even though that goodwill will not ever be recorded in the public company’s financial statements.

Worst-case scenario? The cost-savings originally achieved are erased and surpassed by the costs incurred to retrospectively adjust the financial statements for a single filing. Further, the mere potential of incurring costs to retrospectively adjust financial statements could keep other similar private companies from taking advantage of the reduced complexity and financial reporting costs provided by the accounting alternatives.

Does it make sense to require a private company that has applied the accounting alternatives to retrospectively apply the existing guidance in these situations? In the case of the goodwill alternative or the FASB’s ongoing PCC project on identifiable intangible assets in a business combination, I don’t think it does. One of the primary arguments for requiring retrospective restatement is to provide for comparability among public business entities. In such cases, there isn’t comparability under the existing standards for two otherwise identical companies, one of which grew organically and the other through acquisitions.

The United States has taken some positive steps to spur the growth of private companies, including making it easier for them to access the public markets through legislation, such as the JOBS Act. I encourage the standard-setters and regulators to provide transitional relief for private companies that adopt the new accounting alternatives to alleviate an unnecessary burden they would otherwise have to bear in trying to access the public markets in the future.

Joe Adams is CEO and Managing Partner of McGladrey LLP, a leading provider of assurance, tax and consulting services focused on the middle market.

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