RSM Resources

Citing divergent financial reporting needs for public and private companies, the American Institute of Certified Public Accountants (AICPA) recently announced it will work with the Financial Accounting Standards Board (FASB) to create a second set of generally accepted accounting principles (GAAP) for privately held companies. But experts caution that two sets of standards could do more harm than good for privately held midsized companies.

The AICPA announcement culminates an extensive institute-sponsored study.An AICPA-appointed task force surveyed more than 3,700 lenders, investors, sureties, business owners, financial managers and public accountants. The task force aimed to determine whether private companies are meeting the needs of their constituents by preparing general purpose financial statements in accordance with GAAP and whether the cost of providing GAAP financial statements outweighs the benefits they provide to private companies.

"Overall, the response from those surveyed rated the value of GAAP financial statements of private companies quite highly on consistency, providing comparability among companies, and on their use as a tool in credit and investment decisions," says James G. Castellano, former chair of AICPA and head of the task force. "However, through our discussions, focus groups and research, we learned that constituents rated certain GAAP requirements as providing relatively low relevance and decision usefulness to constituents of private company financial reporting."

The research regarding GAAP reporting shortfalls ultimately led AICPA, which represents 350,000 members, to urge separate standards for public and private companies, Castellano says. Without making any specific change recommendations, the group passed a resolution to work with the Financial Accounting Foundation (FAF) and FASB to identify and implement a process that would evaluate, where appropriate, potential changes in recognition, measurement and disclosure from current GAAP as applied by public companies.

The GAAP standard
According to a 2003 report by Accounting Today, only 17,000 of the nation’s 4.9 million corporations are publicly held. That means approximately 99.7 percent of the nation’s incorporated businesses are privately held. Although only public companies are legally bound to adhere to GAAP reporting standards, many private company officials feel obligated to comply with the increasingly complex and time-consuming requirements in order to provide a consistent basis of comparison for lenders and investors.

While the FASB-developed GAAP is not the only recognized financial reporting standard, it is the most widely accepted. Some lenders accept other standards such as "tax-basis accounting" and"other comprehensive basis of accounting," but financial statements prepared in compliance with GAAP are almost universally accepted and understood.

According to AICPA, current GAAP requirements dictate several aspects of business financial reporting, including these examples:

• Recognition. Assets, liabilities, equity, revenue and gains, expenses and losses, and other comprehensive income.
• Measurement. Historical cost, fair value, or lower of cost or market, and the measurement methodology used.
• Presentation. Balance-sheet display.
• Disclosure. Notes to financial statements.

As part of their study, researchers asked survey respondents to rate 12 GAAP reporting requirements on a scale of 1 (low) to 3 (high) in terms of relevance and usefulness to their companies. Items such as share-based payments and variable-interest entities scored among the lowest across the board, but respondents also gave low scores to many other reporting requirements.

The study states that the "lower relevance ratings of many of the 12 GAAP-specific requirements mean that they are not adequately meeting the needs of the private company constituents. Based upon its collective experiences, the task force members believe that these lower relevance ratings reflect the distinctly different needs of constituents of private company financial reporting."

Big GAAP vs. Little GAAP
The case for developing one set of GAAP requirements for public companies and another for private — nicknamed "Big GAAP" and "Little GAAP," respectively — is controversial.

Proponents argue private midsized companies and others would benefit from Little GAAP, because they would be able to decrease the complexity of their financial statements, reduce preparation costs and provide better information for their constituents. Others question the practicality of such a plan.

"I don’t want to be a doomsayer, but I really question whether the business community would accept such statements,"says James Schmutte, an accounting professor at Ball State University in Indiana."It’s going to take a tremendous amount of acceptance by the lending community to recognize that Little GAAP is good GAAP. I’m not sure the lending community is always in the position to understand the subtleties between the reporting methods, so they will figure bigger is best."

Schmutte says he doubts that creating a second GAAP standard would be a boon for midsized companies and echoes other experts in questioning how such a project could be successfully implemented.

"How do you create this thing?" he asks."Do you start out with Big GAAP and eliminate the parts you don’t like or the parts that you think are too costly to prepare? I see this as something that sounds good in theory, but the implementation of it is going to be extremely difficult."

Many predict the FASB will stop short of creating two separate standards but may modify the existing GAAP requirements to better distinguish between the needs of public and private companies. For example, private companies might be exempt from some requirements or need not apply all aspects of others. Until any changes take effect, there’s no reason to change your current financial reporting strategy, experts say. Instead, they say, officials at midsized companies should keep an ear to the debate, lend their voices to the discussion, if necessary, and wait for a final ruling to act.