Standards Overseer to Consider Proposal for Private Company Financial Reporting

BY ALEXANDRA DEFELICE
February 1, 2011

FASB’s parent organization, the Financial Accounting Foundation (FAF), this month is expected to discuss a report recommending a new standard-setting board to establish exceptions and modifications to U.S. GAAP for private companies.

 

This discussion follows the culmination of a year’s worth of work by a blue-ribbon panel, formed in December 2009 as part of a joint effort by the AICPA, FAF and the National Association of State Boards of Accountancy, to examine private company financial reporting.

 

At the panel’s final meeting in December 2010, a more detailed outline of its recommendations began to take shape. As proposed, a new standard-setting board, under FAF’s oversight, could have five members with private company financial reporting experience and an estimated $4 million annual budget. It could also face a sunset provision of five years or less to allow an evaluation of the overall process, under the panel’s draft plan. The panel planned to deliver its final report to FAF by Jan. 20, panel Chairman Rick Anderson said in December.

 

The mission of the proposed new board would be “to establish exceptions and modifications to U.S. GAAP for private companies, while ensuring that such exceptions and modifications provide decision-useful information to lenders and other users of private company financial reports,” not to issue new standards, according to the draft report. “That mission is accomplished through a comprehensive and independent process that encourages broad participation, objectively considers all stakeholder views, and is subject to oversight by the FAF’s Board of Trustees.”

 

Although this is consistent with FASB’s mission, panel members emphasized the word “lenders” to demonstrate how this board would be different from FASB, saying that lenders constitute the largest user base of private company financial reports.

 

As proposed, the new board would have the authority to modify existing and future GAAP for private entities, and FASB would consider input from all entities during the standard-setting process. The panel envisions both boards working closely in their endeavors.

 

There was some debate at the December meeting as to whether FASB should be able to identify potential exceptions and delayed implementation time for private companies—as it does currently—or whether that task should be left to the new board alone. Many panel members expressed interest in having an advisory group or groups similar to the Private Company Financial Reporting Committee to express that constituency’s opinions to both FASB and the new board.

 

All panel members supported a “sunset period” after which the new processes that are adopted could be revisited. The staff’s initial suggestion was five years, but many members favored a shorter time—some suggested three years—to encourage faster progress.

One of the largest remaining unanswered questions is how the new board would be funded. Panel members agreed that revenue from FAF publications could provide part, but not all, of the funding. They reasoned that there are companies and firms that would be willing to subsidize the process, but did not decide how to secure the funding.

 

Regardless of what the panel, and ultimately FAF, recommends, the staff did not recommend returning to a system where standard-setting bodies would have to rely on year-to-year voluntary contributions, due to potential independence issues that could arise.

 

Anderson emphasized that FAF must still consider the panel’s recommendations and that whatever the foundation decides will be exposed for public comment. A comment period plus the time it takes to create a new board and the accompanying infrastructure and policies could take “a good portion” of 2011, according to panel staff.

 

One of the top transitional recommendations is to fill one or both of the two FASB board positions created in August with individuals who have primarily private company experience.

 

The draft proposal also suggested that FASB start work on the creation of a broad set of criteria that articulates what differences private companies have from public companies. Panel members agreed this decision criteria would be of critical importance and be the basis for making appropriate modifications and exceptions for private companies. Some members cited the criteria used by the International Accounting Standards Board in its IFRS for Small and Medium-sized Entities.

 

Alexandra DeFelice is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact her at adefelice@aicpa.org or 212-596-6122.

 

 

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Panel Chairman Discusses Recommendations

 

Rick Anderson spent much of 2010 chairing the blue-ribbon panel examining private company financial reporting. He is the chairman and CEO of the CPA firm Moss Adams LLP and is an outgoing member of the Financial Accounting Foundation (FAF) Board of Trustees.

 

Anderson’s FAF colleagues will soon begin digesting the panel’s recommendations, which include the creation of a new standard-setting board for private companies—something none of the previous groups examining the issue over the years has proposed.

 

Anderson spoke with the JofA about potential next steps in the process.

 

JofA: What opportunities may come from these recommendations?

 

Anderson: The things we’ve heard the most often would be reduced cost to the preparer in the form of dealing with the irrelevant complexities and hiring outside parties to do valuations or assist with preparation. That could have a negative impact on the practitioners, because maybe there will be less work for them. We’re hopeful the outcome of the recommendations is that more companies would choose to prepare GAAP-based statements vs. qualified opinions or OCBOA statements because it would be more affordable.

 

JofA: What would you say to those who disagree with the decision to recommend a separate board?

 

Anderson: I am part of the supermajority supporting the recommendation. A separate board is an integral part of dealing with a fairly diverse set of needs for private vs. public companies. The most common concern is that a second board creates additional complexity and potentially some differing views. Unfortunately, we are talking about a complex situation. I don’t think you can remove the complexity.

 

JofA: It looks like FASB is trying to be more responsive toward private companies recently with round-table meetings and other actions. Do you think that’s a change of attitude or a defensive move to try not to relinquish control of the standard-setting process to a separate board?

 

Anderson: I don’t believe some of the more responsiveness is a defensive move. While there certainly could be some of that on the part of one or more people, the real issue is FAF and FASB, through their own processes, have heard more clearly through the last year or so the discomfort by the private company sector about the lack of listening and understanding by FASB about the needs and differences of private companies. FAF and FASB have been more responsive to what they’ve heard, but there’s a lot of work to be done, and the panel’s recommendations are a crucial part of that work. The needs are so different and so significant that no one small group of people can cover all those needs.

 

JofA: Once the panel report goes to FAF, what do you expect the process to be? What happens to the panel after that?

 

Anderson: I think FAF is clearly committed to taking the recommendations under consideration and moving forward at an appropriately brisk pace, recognizing the importance of having public input in whatever they’re suggesting. The whole process can’t happen in less than four to six months, and it could take even longer.

 

I believe the panel has an end to its life at the time it issues its report because it doesn’t have any authority after that. It’s the opportunity and responsibility of the members of the public to ascertain that FAF is in fact monitoring [private company needs].

 

JofA: Is the panel’s recommendation to expose new proposed standards that incorporate the private company exceptions and modifications (seek comments on the public and private company versions of a new standard at the same time)?

 

Anderson: Our objective all along is to have as much commonality and as few differences in process and timing as possible, so we’re hoping input from private and public companies can be analyzed simultaneously, or close.

 

 

CPAs Envision Opportunities

 

by Alexandra DeFelice

 

The JofA spoke with CPAs about the proposed recommendations for the creation of U.S. GAAP with exceptions and modifications for private companies and how such a shift might affect accounting firms and private companies.

 

Several CPAs pointed to a potential for reduced costs because of the complexities associated with GAAP that private companies must comply with—and that many lenders and other financial statement users don’t seem to find relevant.

 

While many of them could not quantify the money spent addressing these issues, almost all cited a “significant” amount of time that often cannot be billed to clients because of a lack of “perceived value.”

 

John R. Burzenski, president of Burzenski & Co. and a member of the Private Company Financial Reporting Committee (PCFRC), an advisory group to FASB, elaborated on the issues his local Connecticut firm faces.

 

“All of these standard issues fall in our firm’s lap as our clients do not have staff that can handle or understand the current or revised standards,” he said. “We incur additional hours in our engagements, most of which the client does not understand and does not want to pay for.”

 

Examples include explaining changes related to revenue recognition, leases, fair value measurement and financial instruments, he said. Some practitioners and financial statement preparers hope to see modifications and exceptions for private companies in these areas.

 

Matt Chavez, audit partner at Armanino McKenna in northern California, named share-based payments, preferred stock and convertible debt among the issues on which he spends an “inordinate” amount of time, especially in his work with many startup companies in Silicon Valley.

 

“When I look at the actual cost of my audits, often 40% of the audit budget is devoted to these areas that, frankly, the users of my clients’ financial statements don’t seem to be interested in or understand,” he said.

 

Some CPAs expressed concerns about advising companies that are preparing for an IPO or that want to sell themselves to public companies about whether those companies should follow U.S. GAAP as used for public companies or U.S. GAAP with exceptions and modifications for private companies.

 

But Chavez said that it provides more opportunities to consult with companies and their boards in the future.

 

“It would allow me to explain what would be required if [or] when they go public,” Chavez said. “I believe this would be viewed as more of a value-added discussion, and it would allow us to consult with companies [about] when it is the right time to start evaluating when the conversion would take place as well as what specific transactions might look like under [U.S. GAAP as used for public companies].”

 

END-USER VALUE

Private company clients are unlike public companies in that generally they have more direct relationships with their bankers, bonding companies or other entities requesting the financial statements. As a result, the end-users already know what is going on with the company, said Christopher A. Roush, principal at Ohio CPA firm Rea & Associates Inc.

 

“The disclosure information on the interest- rate swap, or variable-interest entities or tax positions doesn’t provide them with anything they want or can use,” he said.

 

Users of statements for private companies are generally concerned with cash flows, said Tom Groskopf, director (owner) at the Cincinnati-based CPA firm Barnes, Dennig & Co. Ltd. and a PCFRC member.

 

Certain accounting standards FASB has issued, including FIN 48 (Accounting for Uncertainty in Income Taxes, now codified in Accounting Standards Codification (ASC) Topic 740) and FIN 46(R) (Consolidation of Variable Interest Entities, now in ASC Topic 810), have been costly for private companies to implement while providing little useful information on current cash flows, according to Groskopf.

 

“Fair value information can provide useful information on future cash flows for financial instruments,” he said. “However, for nonfinancial instruments, the amounts recognized in the financial statements can be too subjective to be useful to users on future cash flows.”

 

He provided the following example:

 

The annual testing for impairment required by former FASB Statement no. 142, Goodwill and Other Intangible Assets, (now incorporated into ASC Topic 350) requires a private company to determine the fair value of its equity. Given the lack of Level 1 inputs on the fair value of a private company’s equity, this is a costly annual exercise. In his practice, the annual cost in terms of client’s time and the firm’s fees for a midsize company is at least several thousand dollars.

 

Though the future economic consequences of any changes are difficult to predict, those that lessen the standards’ compliance burden could permit CPA firms to be more efficient, he said.

 

Some CFOs said U.S. GAAP with exceptions and modifications for private companies could provide more useful information to third-party users of their financial statements in the future.

 

“The growing trend toward more complex standards and disclosures under existing GAAP can be misleading or distracting to users of private company standards,” said Ron Box, CFO of Joe Money Machinery Co., an Alabama-based heavy equipment distributor. “A more condensed and relevant set of standards for private companies should ultimately prove much more useful and less costly for the company when producing their financial statements and for practitioners performing their services.”

 

NEED FOR TRAINING

Box’s primary concern is training his company’s third-party users.

 

“Banks, in particular, must be able to determine how to make best use of the financial statements and related disclosures. Failure on the part of a bank to interpret new standards correctly can be very detrimental to credit decisions,” he said. “I believe that this [issue] can ultimately be resolved, but I believe that banks will adopt appropriate training at various times and with differing levels of success.

 

“I could estimate time savings for interim and year-end statements at least 100 to 150 hours per year after training [those third parties],” Box said.

 

Alexandra DeFelice is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact her at adefelice@aicpa.org or 212-596-6122.

 

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