The Case for Private Company GAAP

May 1, 2005

SPECIAL REPORT

GAAP has high value—for the most part—say a growing number of external users of private company financial reports, CPAs and other financial professionals working in or serving private companies, which represent more than 99% of the nation’s incorporated businesses. But while a recent AICPA-sponsored survey revealed the prevalence of this opinion, respondents also said certain GAAP standards aren’t relevant and useful enough to help private companies make management, credit and investment decisions.

Following its research, the task force recommended that a cooperative effort including representatives of the key constituents of private company financial reporting be undertaken to

Determine who should establish private company GAAP.

Determine how best to effect change in the GAAP standard-setting process to meet the financial reporting needs of private company constituents.

Develop and oversee the implementation process on a timely basis.

This article explains why the topic of private company GAAP is important to the profession and those it serves, and it provides details on how current GAAP in some cases does—and in others does not—meet the needs of private company financial reporting constituents.

Survey Methodology
A survey was sponsored by the Private Company Financial Reporting Task Force, which the AICPA established in 2004 to assess views of GAAP among private company financial reporting constituents and to see whether the benefits derived from GAAP financial statements justify the cost of producing them. Independent market research firm the MSR Group of Omaha, Nebraska, surveyed 3,700 practitioners, private company owners and managers who prepare financial statements and external stakeholders, such as lenders, who use them.

A FRESH START
Drawing on its research, the task force concluded that a customized version of GAAP should be developed based on concepts and accounting that better meet the needs of private company financial reporting constituents, whose information requirements are different in certain instances than those of groups using public company reports. This can be accomplished, the report said, by fundamentally changing the current GAAP standard-setting process in a manner to be determined by further discussion.

The report also noted that although private company financial statement preparers sometimes use GAAP exceptions and other bases of accounting, such usage is not always appropriate—even when there is no current alternative—because it erodes GAAP’s consistency while failing to truly satisfy private company financial report users.

INSIDE VIEWS
To find out more, the JofA spoke with three of the task force’s 15 members ( www.aicpa.org/members/div/ ). For information on the roles these and other constituents play in the private company marketplace, see “ Who Does—and Needs—What, ” below.

Who Does—and Needs—What
Practitioners often perform multiple roles in serving clients and may be instrumental in helping prepare or providing assurance on financial statements. Practitioners also may act as liaisons between their clients and external capital providers.

Owners and managers may prepare their companies’ financial statements. Private companies provide financial statements to external stakeholders to raise capital, obtain credit, qualify to bid on contracts and obtain licenses.

External stakeholders often are the primary users of private companies’ general-purpose financial statements. In the survey a majority valued GAAP financial statements, saying they made it easy to compare company performance over time, employ standardized terminology and were useful in making investment or credit decisions.

A practitioner. James G. Castellano, CPA, the group’s head and a former AICPA chairman, is the chairman of Rubin, Brown, Gornstein & Co. LLP in St. Louis, an accounting and business consulting firm serving private company clients.

“Because I’ve worked in this market segment for many years, I knew it was time for a fresh assessment of GAAP’s value to constituents of private company financial reporting,” Castellano said. From 1983 to 1985 Castellano chaired the AICPA Technical Issues Committee, and he served on a FASB task force on private and small public companies. The results of FASB’s research on the accounting standards for private companies were published in 1983 ( www.aicpa.org/members/div/acctstd/pvtco_fincl_reprt/download/FASSUM81.pdf ). They revealed that fewer than 10% of external stakeholders saw a need for differences in the underlying accounting for public and private companies.

“Since then, though, there’s been a fundamental shift in the thinking of key constituents,” Castellano said. “Our current research reflects much greater support for standards specific to private companies, as stated by more than 50% of creditors and investors among those expressing an opinion.” (See “ External Stakeholders .”)

A private company manager. Financial consultant Gary M. Cademartori, CPA, of Tatum Partners LLP, has more than 20 years’ experience as chief financial or operating officer of public companies. In recent years, while serving as CFO or strategic financial consultant to six private companies, he realized GAAP required much information that those businesses, their lenders, creditors and investors felt had little value. “Since joining the task force, I’ve learned firsthand how widespread this problem is,” he said. “Our research showed that although respondents valued GAAP highly overall, they—as my clients do—found certain GAAP principles insufficiently useful or relevant. The survey gave us a general sense of where GAAP meets private company constituents’ needs and where it doesn’t.”

For example, owners and managers of private companies of all sizes considered certain GAAP requirements pertaining to leases, guarantees, intangibles, variable interest entities and share-based payments not very relevant or useful to their businesses, the survey found. Practitioners from larger firms were less critical of these requirements than were those from smaller ones. External stakeholders’ opinions varied by their area of specialization; for instance, lenders and sureties found GAAP’s guarantee requirements more useful than did investors and venture capitalists.

Because the 2004 survey was the first systematic exploration of this topic in years, its aim was to identify any issues or problems with GAAP rather than to propose specific solutions—which subsequent reform efforts should address as necessary. “The requirements of a private company version of GAAP would be determined by the body that assumes the task of formulating private company standards,” Cademartori said. “It’s not useful to speculate what such standards would require or cost to develop and implement, although I think it’s safe to say most of the cost would relate to initial standard-setting activities, rather than to their implementation.”

A bank lender. David L. Maraman, senior vice-president and chief credit officer of First Indiana Bank in Indianapolis, said, “Taking part in the research quickly removed my initial uncertainty about the importance of private company GAAP to CPAs and especially to their clients. The question is not whether to act; it’s how to accomplish what’s absolutely necessary.”

Maraman said future efforts must be committed to ongoing communication with private company bankers, investors, sureties, owners and regulators to ensure any new standards provide the information each needs. He doubts that private company standards would undermine public company GAAP, which he believes will remain viable and useful because of its critical role in fostering the uniform, high-quality corporate financial information essential to a stable economy.

THE MARKETPLACE RESPONSE
“We on the task force expect that the creation and implementation of private company standards will produce financial statements whose high quality equals that of their public company counterparts,” Castellano said. “Of course some private companies—for example, those planning to go public or to be acquired by an SEC registrant—still will want to follow public company GAAP. But private company GAAP will be a success if it meets the requirements of those who need it. That’s the bottom line.”

NEXT STEPS
Barry C. Melancon, CPA, AICPA president and CEO said, “The Institute’s board of directors, subject to the approval of its governing council, supports the task force’s findings and conclusions and will, with the Financial Accounting Standards Board and the Financial Accounting Foundation, explore an appropriate course of action to improve the usefulness of private company financial reporting.”

More information is available at the AICPA Private Company Financial Reporting Web site ( www.aicpa.org/members/div/acctstd/pvtco_fincl_reprt/index.htm ).

—Robert Tie

Support Is Growing
Would it be useful if the underlying accounting in GAAP reporting were different, in certain instances, for public vs. nonpublic companies?

PRACTITIONERS

OWNERS AND MANAGERS

EXTERNAL STAKEHOLDERS

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