From the President’s Desk
October 2011Improving Standard Setting for Private Companies
Since it was created in 1972, the Financial Accounting Foundation (FAF) has been committed to balancing two critical, but sometimes conflicting, objectives.
The first goal is to ensure that financial accounting standards provide investors, lenders, and other users of financial statements with clear and comparable financial information about a wide variety of companies, not-for-profit organizations, and state and local governments.
The second is to make certain that those standards also take into account the individual needs and circumstances of the disparate companies and other entities that issue financial statements under US Generally Accepted Accounting Principles (US GAAP).
Striking a fair and reasoned balance between these two objectives is one of the most important elements of the FAF’s stewardship of financial accounting standard setting in the United States.
Over the years, one of the greatest challenges has involved private companies. To address the financial reporting needs of lenders, investors, and other users of private company financial statements, as well as the concerns of private company preparers and auditors, the FAF Board of Trustees recently released for public comment its “Plan to Establish the Private Company Standards Improvement Council" (PCSIC).
The plan would ensure that the issues associated with standard setting for private companies, especially those related to complexity and cost, get the attention that they deserve. The Council would identify, propose, deliberate, and formally vote on specific exceptions or modifications to US GAAP for private companies. These deliberations would be conducted in meetings attended by members of the Financial Accounting Standards Board (FASB), which ultimately would be called on to ratify any changes approved by a two-thirds vote of the new Council. Any changes approved by the Council and ratified by the FASB would become final following public comment, further deliberation by the PCSIC and final ratification by the FASB. The Trustees believe that FASB participation, and ratification is important because it will make the deliberative process more efficient and effective, and prevent the development of a “two-GAAP” system.
Creation of the new Council would represent a major step forward in the standard-setting process for private companies, and will build on the work of the Private Company Financial Reporting Committee (PCFRC), an advisory-only group that was created in 2006. While the PCFRC made important progress in representing the interests of users, preparers, and auditors of private company financial statements, the Trustees believe the effort was not wholly successful in two respects. First, the PCFRC and the FASB did not develop a criteria for considering exceptions or modifications to US GAAP for private companies; and second, the two organizations did not optimize their administrative and operational processes to support their common objective. The plan would directly address both of those issues.
The Trustees believe that establishing a new group with the power to deliberate and vote on accounting changes—subject to FASB ratification—is the best way to significantly strengthen the standard-setting process for private companies. The effect would be to create a new body with substantially increased authority and scope that will shape the agenda for the FASB’s consideration of private company issues.
This approach reflects not only the judgment of the Trustees, but the views of a broad cross-section of constituents from whom the Trustees heard during their extensive outreach effort.
As part of that effort, Trustees and their representatives met with scores of stakeholders, including representatives of large, mid-market, and small CPA firms, all with significant practices serving private companies and not-for-profit organizations.
They also spoke with leading members of the academic community who have reviewed and, in some cases, undertaken significant research on issues relating to private company financial reporting. In addition, they participated in discussions with the FASB’s advisory groups, including the Financial Accounting Standards Advisory Council (FASAC), the PCFRC, the Not-for-Profit Advisory Committee (NAC), and the Small Business Advisory Committee (SBAC). Lenders, investors, regulators, and preparers also provided their perspectives. The views expressed to the Trustees were remarkably varied and diverse.
Another key input to the Trustees’ deliberations came from the work done last year by the Blue-Ribbon Panel on Standard Setting for Private Companies, organized by the FAF in conjunction with the American Institute of Certified Public Accountants (AICPA) and the National Association of State Boards of Accountancy (NASBA).
A side-by-side comparison of the recommendations submitted by the Blue-Ribbon Panel and the plan proposed by the Trustees shows that the Trustees incorporated nearly all of the Panel’s recommendations into their plan.
For example, the Blue-Ribbon Panel called for creation of a new body, under the supervision of the Trustees, which would ensure that appropriate and sufficient exceptions and modifications are made to US GAAP for private companies. The Blue-Ribbon Panel recommended development of decision-making criteria to enable standard setters to determine whether and when exceptions or modifications of US GAAP for private companies are warranted. The Blue-Ribbon Panel called for a comprehensive review of the new board’s work in three to five years. And the Blue-Ribbon Panel called on the Trustees to include issues related to private companies in its new post-implementation review process. Each of these recommendations was included in the plan issued by the Trustees.
The one area where the judgments of the Blue-Ribbon Panel and the Trustees diverge involves the role of the FASB as the final arbiter of accounting standards.
The Blue-Ribbon Panel recommended that the FAF create a new, authoritative standard-setting body for private companies, independent of the FASB. However, the Trustees believe that setting up such a board could, over time, lead to a two-GAAP system—“little GAAP” for private companies and “big GAAP” for public companies. Such a system could create confusion, increase costs, and potentially lower the quality of accounting standards—and the quality of financial reporting. Further, the Trustees believe that some of the concerns raised by private companies about the complexity of GAAP are shared by public companies and nonprofit organizations.
Instead, the Trustees chose to strike a balance and adopted an approach that would: 1) create a strong body with agenda-setting authority and voting rights to actively represent the interests of private company stakeholders in the standard-setting process and 2) prevent development of a “two-GAAP” system by creating a deliberative process through which the FASB would integrate into US GAAP specific exceptions or modifications for private companies identified by the Council. The Trustees anticipate that integrating the Council with the FASB’s activities would allow cross-fertilization of the Council’s findings that could ultimately benefit all reporting entities and potentially minimize the resulting differences.
In settling on that approach, the Trustees noted the receipt of more than 2,800 letters in support of the Blue-Ribbon Panel’s recommendations. Many of those letters expressed the view that only a separate board, independent of the FASB, can properly represent the interest of private company stakeholders. The Trustees carefully considered that perspective.
After weighing all of the divergent views, the Trustees determined that the needs and concerns of all constituents—as well as the best interests of the US financial reporting system—would be better served by an approach that at once focuses greater attention on private company issues, preserves a unified US GAAP, and provides the greatest opportunity to reduce complexity for all constituents.
The Trustees recognize that no single approach will attract universal support—even from the varied private company constituencies. For example, a poll published recently by a leading accounting journal found that 50 percent of respondents (from a sample of 418 accounting industry opinion leaders) believe that the FASB should continue to set standards for private companies and integrate those standards into existing US GAAP.
Twenty-nine percent of respondents favored a version of US GAAP tailored by a separate standard-setting board; nine percent wanted a separate GAAP developed by a separate board; eight percent favored adoption of IFRS for Small and Medium-sized Entities (SMEs); and three percent wanted a separate GAAP developed by FASB.
In an article about the poll, the publication noted: “Perhaps the most interesting finding was that, of those who think that the U.S. needs separate accounting standards for private companies, fully half think that the best form for those standards to take would be a version of GAAP tailored by the Financial Accounting Standards Board—somewhat contradicting claims that the profession overwhelmingly supports a separate standard-setter.”
In the end, the Trustees believe the outcome of the process to strengthen standard setting for private companies should be based on what is best for the financial reporting system and its constituents. The outcome should be determined in a manner that is deliberative and thoughtful, and that directly addresses the root cause of the need for change.
To achieve that outcome, it is important that the Trustees have the benefit of comment letters that address in detail and with specificity the complex issues surrounding private company accounting standards and financial reporting. That’s why explaining the “why” of the views expressed is so important to the process.
As the Trustees review your comments on this plan in the coming weeks, they will consider a wide range of critical and sometimes conflicting views, with the goal of reaching a balanced decision that will take into account the needs of all of the beneficiaries of private company financial reporting.
The comment period extends to January 14, 2012. You may forward your comments to the FAF by sending an email to: PrivateCompanyPlan@f-a-f.org.
FAF President and Chief Executive Officer
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