Big GAAP vs. Little GAAP

Big GAAP and Little GAAP

Private companies need modified standards, not separate rules — private companies have long argued that U.S. Generally Accepted Accounting Principles (GAAP) are too expensive to apply and that the results are often of marginal benefit to end users.

In December 2009, the American Institute of Certified Public Accountants and the Financial Accounting Foundation (FAF) created a “Blue Ribbon Panel“ to analyze how existing U.S. accounting standards could be changed to help improve the usability of private company financial statements. The panel is made up of 18 members who are senior leaders representing a cross-section of financial reporting constituencies, including lenders, investors, and owners, as well as preparers and auditors. The panel is charged with exploring possible changes necessary to best meet the needs of users of private company financial statements. The panel limited its work to private for-profit companies, and did not include private-sector not-for-profit entities.

There are approximately 29 million private and not-for-profit companies in the United States, including 7 million small-to-medium size businesses. In contrast, there are about 15,000-17,000 public companies that have reporting requirements with the U.S. Securities and Exchange Commission (SEC). However, U.S. GAAP continues to be driven by issues affecting international reporting convergence. Although private companies may not need to prepare GAAP financial statements for the SEC, they might need them for lenders, bonding companies, regulators, and others.

Depending on the size of a public company, the number of shareholders can reach well into the hundreds of thousands. A public company’s shareholder population typically includes a broad range of investor types with a wide variety of expectations regarding the information needed from the company’s financial statements. Alternatively, the shareholder population of a private company is generally far smaller with relatively defined needs and expectations for the company’s financial statements.

What both public and private shareholders do expect is accurate, reliable, and comparable financial statements that paint a clear picture of the company’s financial performance over time.

Applying U.S. GAAP to private companies has resulted in a number of unintended consequences including the following:

• Private companies often incur considerable costs to apply GAAP. These costs usually do not improve the usability of their financial statements. In many cases, it can actually complicate the financial reporting process.
• A large number of GAAP-specific requirements are not useful to private company owners, lenders or private company investors.
• Since private companies can choose GAAP exception audit reports, it is often difficult to compare financial statements for private companies with other entities. Further, the growing use of such exceptions weakens the relevancy of GAAP.
• Stakeholders may not be familiar with GAAP or they may have specific questions that are not easily answered by reviewing the company’s financial statements. As a result, stakeholders often request additional information in order to make sense of the financial statements.

The Blue Ribbon Panel issued a report in January 2011, which includes the following recommendations:

• The panel concluded there are “urgent and growing systemic issues that need to be addressed in the current system of U.S. accounting standard setting.”
• The panel did NOT recommend a wholesale departure for private companies from U.S. GAAP. In the near term, the report stated, “The system should focus on making exceptions and modifications to U.S. GAAP for private companies that better respond to the needs of the private company sector.”
• A new, separate standard setting board should be formed consisting of people with private company experience that would report directly to the FAF The board would be tasked with developing exceptions and modifications to U.S. GAAP to better suit the  needs of users of private company financial statements.
• A framework should be developed that the newly formed board could use to determine whether a specific exception or modification to GAAP is appropriate. The framework would take into account costs, complexity of the revisions, and the overall impact on the relevance and accuracy of private company financial statements.

In March 2011, the FAF formed a working group on private company reporting. The FAF currently is gathering public input on the panel’s recommendations and expects to issue an action plan by this fall.

The changes proposed by the Blue Ribbon Panel may be the first step in a long process that has the potential to dramatically improve the overall quality and consistency of private company financial reporting.