Is There A New GAAP On The Horizon?

“It is the belief of the committee that there is strong support within the profession as a whole for reconsideration of present practices with respect to the application of generally accepted accounting principles to the financial statements of smaller and/or closely held businesses and with respect to standards for reports of CPAs on such statements.”

The preceding quote is an excerpt from a report issued by the American Institute of Certified Public Accountants (AICPA) prior to Jimmy Carter being elected the 39 th President of the United States; August of 1976 to be precise. Well, it has been nearly thirty years and we have yet to balance the needs of “Big GAAP and Little GAAP.”

For those of us involved in financial reporting and the application of accounting standards, the idea of “Big GAAP versus Little GAAP” is nothing new. “GAAP,” being generally accepted accounting principles, “big” representing publicly traded companies, and “little” representing non-public and/or closely held companies. This author takes exception to “little,” as 99.7% of the nation’s incorporated businesses are private companies. For those who have not keyed in to this debate, the idea is quite simple.

The FASB, the AICPA, the SEC, and now the Public Company Accounting Oversight Board (PCAOB), have essentially one overarching goal when it comes to financial reporting: to make the process and the product as simple and transparent as possible, while ensuring that the data being presented is an accurate portrayal of a company’s operations. Unfortunately, like so many goals, this has proven incredibly difficult to achieve.

For many years now, executives of publicly traded companies have had their livelihood wrapped up in the price of their company’s stock. It should come as no surprise then, there has been constant focus on increasing share price with or without truly enhancing the performance of the company’s operations. The broad use of employee stock options in the past decade or so has exacerbated this focus. It is probably not a coincidence that Bernie Ebbers and Ken Lay were among the highest paid executives in the world shortly before their companies were found to have committed massive amounts of accounting fraud. Without those stock options being “in the money” how was Dennis Kozlowski going to fly Jimmy Buffet to Sardinia to perform at his wife’s birthday party?

So, what does all of this really mean? As companies create new complexities within the accounting arena in order to report a healthier balance sheet, the various organizations responsible for creating financial standards are hard at work trying to keep pace. Currently all companies, regardless of size or structure, which issue financial statements in accordance with GAAP are forced to maintain an understanding of all newly issued pronouncements, which pronouncements have been superseded, and how to properly apply the current authoritative literature to their company.

If revenue was the only item that separated “big” companies from “little” companies, then forcing all companies to ascribe to the same GAAP may make sense; however, it is quite clear that this is not the case. Another fundamental difference when it comes to financial reporting is who the stakeholders are. Publicly traded companies issue financial reports that are read by CPAs, lenders, investors and sureties, and also by stock analysts, the general public and a variety of other entities. To put it simply, there are issues that public companies must deal with and disclose that have no relevance to 99.7% of the incorporated businesses in our country, yet regulation related to the minute minority is being forced upon the vast majority. Essentially, the big GAAP versus little GAAP debate takes a regulation like accounting for stock-based compensation and asks if it makes sense that private companies should have to incur the time and cost to make ample disclosure regarding an issue in which none of their stakeholders has an interest. In response both the FASB and the AICPA have formed committees to investigate the issue.

The FASB was up first, creating the Small Business Advisory Committee (SBAC), comprised of about 20 individuals from a variety of industries. The SBAC has met twice since inception and has primarily focused on the effects of Equity Based Compensation on non-public companies and the creation of a framework to be utilized in the development of future accounting standards. To date, it is uncertain what effect, if any, these meetings will have upon future pronouncements, so we must remain patient until further action is taken.

Next up was the AICPA, who created the Private Company Financial Reporting Task Force, whose job it was to issue a report after the completion and analysis of a comprehensive survey regarding reporting by non-public companies. The survey took a two-pronged approach at gathering data. First, there was a random survey of 301 external stakeholders (lenders, investors, and sureties), 300 business owners and 407 public accounting practitioners. Second, there was a broad outreach survey in which anyone was able to go online and answer questions regarding these issues.

The results of the survey were issued on February 28, 2005. The first findings related to the overall value of financial statements issued in conformity with GAAP and the accountants’ report that accompanies those statements. All three groups felt the comparability between periods and companies provided by financial statements issued in accordance with GAAP accompanied by an independent accountants’ report was of moderate to high value. External stakeholders rated financial statements in accordance with GAAP and a corresponding accountants’ report as the single most valuable aspect of financial reporting. The second portion of the survey related to specific GAAP requirements and their relevance to non-public companies. Out of 12 listed, those requirements deemed most relevant were financials issued on an accrual basis, the statement of cash flows, the classifications of liabilities and equity, and the fair value basis of measuring assets and liabilities. Among those requirements considered least relevant were variable interest entities, intangibles, and guarantees. Finally, the survey attempted to determine if the three groups felt there should be a difference in the underlying accounting for public and non-public companies. The overall conclusion of the task force was that it would be useful if there were differences in the underlying accounting used by public and non-public companies, with an overwhelming majority of practitioners concurring with this opinion. A key factor related to this opinion is the difficulty in keeping up with new pronouncements. A significant percentage of all three groups reported that it was extremely difficult to keep up-to-date on and implement all of the new standards.

After taking the information into consideration, the Private Company Financial Reporting Task Force concluded that “GAAP for private companies should be developed based on concepts and accounting that are appropriate for the distinctly different needs of constituents of that financial reporting.” The report went on to state it was the inherent differences between public and private companies such as capital structure, income and estate tax considerations, and the presence of multiple entities with common private ownership that truly created a need for a distinct set of accounting principles.

The battle between “Big” GAAP and “Little” GAAP rages on, however a potential end is in sight. Admittedly, the creation of a separate set of GAAP standards would mark a huge paradigm shift in financial reporting. However, having the SBAC and the AICPA on the same team is accounting’s version of the New York Yankees. With the support of the FASB and the AICPA, it appears inevitable that private companies may have their own set of accounting regulations in the years to follow.

Sean Avant, CPA, MAcc
Assurance Services Department