This article was first published in the April 2012 International edition of Accounting and Business magazine.
Last October, the Financial Accounting Foundation (FAF) released its plan for modifying generally accepted accounting principles (GAAP) in the US for private companies.
The FAF is an independent body that oversees and administers the Financial Accounting Standards Board (FASB) in the US. Its plan would create a new organisation, the Private Company Standards Improvement Council (PCSIC), to identify US GAAP standards that need modifying. The PCSIC would then propose changes that would be subject to ratification by the FASB.
The rationale here is that the FASB is not responsive to private company needs, and a new entity with more muscle than the existing Private Company Financial Reporting Committee (PCFRC) should be created to represent private companies. More specifically, the new council would:
- jointly develop with the FASB a set of criteria to determine whether and when exceptions or modifications to US GAAP are warranted for private companies
- identify aspects of existing US GAAP that members of the council believe require exceptions or modifications for private companies
- obtain input from a broad array of constituents, and deliberate and vote on specific changes to ensure they meet the needs of users of private company financial instruments
- publicly discuss its proposed exceptions or modifications at meetings attended by the FASB members and then vote on final changes. Changes approved by at least two-thirds of council members would be forwarded to the FASB for final ratification
- serve as the primary source of advice on appropriate treatment for private companies for items under active consideration on the FASB’s technical agenda
- have the ability to take a position on the appropriate treatment for private companies related to issues under active consideration by the FASB, including all joint projects with the International Accounting Standards Board (IASB)
Although the proposal seems innocuous enough, mainly addressing improvements in the process for modifying US GAAP to offer better support to private companies, many have not seen it in this light.
There is concern that the proposal dilutes the power and relevance of the FASB in modifying US GAAP for private companies. Some fear that it will result in the creation of a ‘big GAAP/little GAAP’ system in the US.
Ultimately, the worry is that the evolution of a second private company GAAP would not only diminish comparability between the financial statements of private and public companies in the US but also internationally.
On the other side of the spectrum, the concern is that the proposal hasn’t gone far enough, and that the FASB will have too much control over the new council, essentially leaving the process for implementing any changes to GAAP for private companies unchanged, and therefore, according to private company proponents, unsatisfactory.
The proposal served to raise the ire of the US Senate Committee on Homeland Security and Governmental Affairs – a group not often thought of in conjunction with the setting of accounting standards. At the heart of the matter, according to the committee, is that the creation of the new council with distinct voting rights ‘represents an unprecedented approach to US accounting standards that would weaken GAAP, reduce transparency, and conflict with international accounting standards while producing few benefits for financial statement users’.
Essentially, the committee feels that although the FAF denies that its intention is to encourage the creation of two different versions of GAAP, ‘that is the inevitable consequence of the proposal’. Furthermore, it points out that, once approved, any special exceptions and rules would apply to the 22 million private companies in the US, ‘inherently undermining the justification for the tougher GAAP standards applicable to publicly traded corporations’. In time, it says, ‘the exceptions could swallow the rules which, by then, would apply to a minority of US corporations’.
Others calling for minimal divergence between the reporting standards of private and public companies include the Association for Financial Professionals, which represents 16,000 finance and treasury professionals in the US. The AFP maintains that the FASB should have firm control over the council. ‘The authority of the PCSIC should be subordinate to the FASB,’ the AFP declares.
Similarly, in a joint letter to the FAF, staff of the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation, the National Credit Union Administration and the Office of the Comptroller of the Currency all offer their support to the FAF as long as ‘any changes to the standard-setting process do not impinge on the independence of the FASB and its authority to issue accounting standards’. They say that they would ‘not support a process in which the PCSIC recommends or the FASB promulgates modifications to or exceptions from US GAAP that would result in divergent accounting frameworks based on an entity’s status as private or public’.
In contrast, many large US-based public companies support the FAF’s proposal. For example, Metlife, a global provider of insurance, annuities and employee benefits programmes, takes the view that ‘in certain instances, the financial information needs of private company investors may differ from the financial information needs of interest holders in public companies’. Moreover, says Peter Carlson, executive vice president and CFO of Metlife, ‘disclosure requirements for private companies should be based on a cost-benefit analysis’.
Similarly, accountancy firm Grant Thornton offers a rationale for the evolution of a two-GAAP system. ‘It is not evident that private companies and listed companies always face the same issues,’ it says.
It goes on to note: ‘While all companies are concerned about reporting economic resources, obligations and performance, the recent focus of the conceptual framework for financial reporting on information for resource allocation decisions and future cashflows may lead to demands for different standards for private companies.
‘The nature and frequency of resource allocation decisions are different for private companies, and therefore it would seem reasonable that the information needs of their users can differ from the information needs of the users of the financial statements of listed companies who make equity capital resource allocation decisions on a continuous basis.
‘Therefore, we believe that one cannot preclude the possibility that different information needs could lead to different standards’.
Others have called for the council to be given more autonomy. Deloitte & Touche, for example, proposes that the FASB-PCSIC relationship be monitored to ensure that the FASB ‘doesn’t exert too much control’.
The firm believes that the PCSIC would be effective only ‘if the FAF maintains active direct oversight of the council. This oversight would mitigate any potential for the FASB to have too much influence over the PCSIC agenda and to misuse its ultimate authority to ratify proposed changes to accounting standards.’
Deloitte adds that in order to maintain the PCSIC’s autonomy from the FASB ‘we do not believe that the FASB should have the ultimate authority over the PCSIC’s agenda’.
In identifying agenda items that should take priority, the firm suggests the council should address disclosure requirements for variable interest entities, share-based payments, income taxes and revenue recognition.
At the same time, Deloitte alludes to the potential for diversity in reporting between private and public companies, by pointing to the added complexity of first defining a private company in the US. Private companies in the US are currently defined in a variety of ways throughout the FASB accounting standards codification. Deloitte therefore calls for the first task of the council to be the identification of which private companies would be subject to the modifications and exceptions developed by it.
Further questioning the oversight and governance process of the new group, Richard Dinkel, controller and CFO of Koch Industries, one of the largest private companies in the US, has called for increased autonomy for the council, and wants the FAF to further examine the independence issue between the two bodies prior to finalising any decisions.
‘We don’t believe the plan goes far enough to establish a separate group with enough autonomy over the FASB,’ Dinkel says. ‘We do not believe the FASB should have the authority to direct the council’s agenda or determine the framework.’
Dinkel also suggests that given the potential scope of work of the new council, the current timeframe will prove ineffectual. ‘As it relates to the agenda,’ he says, ‘and the number of meetings required for the council, we doubt that significant progress could be made under the proposed meeting dates of four to six times per year.
‘While we agree the immediate focus should be on a relatively few number of accounting standards, you should not underestimate the amount of time it will likely take to develop a framework and then evaluate even a relatively small number of standards for exceptions.’
The FAF is currently reviewing the comment letters submitted in response to its October proposal, as well as conducting roundtables on the topic across the country. It is expected to make a decision on the process for modifying/improving US GAAP for private companies, including the creation of the PCSIC, once deliberations have been completed, probably later this Spring.
Ramona Dzinkowski is a Canadian economist and award-winning journalist