‘Big GAAP’ and ‘little GAAP’ Featured

8:00pm EDT July 30, 2006
More than 17,000 companies are registered with the Securities & Exchange Commission (SEC), and more than 20 million are privately held.

For decades, there has been discussion and debate about the impact and benefits of applying the same set of accounting standards to publicly and privately owned companies. Many have suggested the needs of the people who refer to financial statements for say, Microsoft, are significantly different than the needs of those who must refer to a much smaller company’s statements.

After years of debate, the accounting profession is tackling the issue of creating two separate generally accepted accounting principles (GAAP) head on. Two months ago, the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA) issued a joint proposal to evaluate the creation of two standards, nicknamed “big GAAP” for publicly held companies, and “little GAAP” for private companies.

“This is a controversial issue that has the accounting world divided,” says Stephen W. Christian, managing director for Kreischer Miller, an accounting and consulting firm based in Horsham, Pa. “Proponents argue that it will save money and eliminate needless complexity in financial statements for private companies. On the other side, people question the practicality of such a plan that could render the financial statements of private companies ‘second class.’”

Smart Business spoke with Christian about the implications of creating two different accounting principles for companies, and, if the proposal is adopted, what a different GAAP could mean for privately held companies.

 

What have been the biggest issues facing issuers of private company financial statements?
Two areas of concern confront issuers of private company financial statements.

First is the applicability of many of today’s standards. As financial instruments and transactions get more complex in the public company arena, the accounting standards-setters are promulgating more pronouncements to deal with the proper accounting for such transactions. Many of these pronouncements have unintended consequences that often render private company financial statements less meaningful. One example would be the recent standards surrounding the consolidation of variable interest entities.

Second is the cost/benefit of adopting certain standards. Some standards, such as the new guidance on share-based compensation, are of little value to users of private company financial statements but require significant time and effort by issuers to comply.

 

What are the benefits of a ‘little GAAP’ for nonpublic companies?
If differential accounting standards are adopted, the time and effort that go into preparing private company financial statements will be reduced significantly. In any case, we won’t be any worse off than we are now.

 

Will differential accounting standards be accepted by users of the financial statements?
Good question. The AICPA established a task force in 2004 to assess the views of GAAP among private company financial reporting constituents and to see whether benefits justified the cost. They surveyed external stakeholders and found that more than 50 percent of creditors and investors expressed support for standards specific to private companies. Many users found statements insufficiently useful or relevant. Currently, many lenders would rather see a qualified opinion on the financial statements to GAAP conformity than a set of financial statements that conform to GAAP but portray a less-than-useful picture.

 

What is the next step in adopting differential standards?
The FASB and the AICPA issued a joint proposal in June intended to improve the financial reporting process for private company constituents. Under the proposal, the FASB would implement certain improvements to enhance its standards-setting process for private companies and consider input from private company financial statement issuers and users. Where it will end up is anybody’s guess, but there seems to be significant agreement and momentum to address this issue.

 

Do you think the proposed change is a good thing for business?
It is a controversial topic. Each accountant or financial adviser will have a different opinion.

The major argument against the proposal is the perception that a separate set of standards for private companies would be viewed as a lower, second-class set of standards; that business is business and what is good for public companies is also good for private companies.

My feeling is that many of the standards today are not relevant to private companies; it is confusing for the users of financial statements and thereby less meaningful. These standards are met at a significant cost to the private company. Creating differential accounting standards makes sense and will be an important move toward simplifying financial reporting for private companies.

 

STEPHEN W. CHRISTIAN is the managing director at Kreischer Miller, (www.kmco.com), an accounting and consulting firm based in Horsham, Pa. Reach him at (215) 441-4600 or schristian@kmco.com.