The CPA profession has been debating the concept of separate accounting standards for closely held businesses for over 40 years. In the December 1972 Journal of Accountancy, two CPAs expressed frustration with small organizations being required to comply with GAAP requirements. In 1974, CPA Journaleditor Max Block stated, “The accounting standards should not have been made mandatory to public and private companies without exception. In some instances, later exemplified, they should have been made optional to private companies.” In 1989, The CPA Journal reported that the Private Company Practice Section (PCPS) had promoted non-GAAP Other Comprehensive Bases of Accounting (OCBOA) as an alternative.
This article will examine the use of two alternatives not available in the past: the Private Company Council’s (PCC) alternative reporting framework within GAAP, and the non-authoritative alternative developed by the AICPA, the Financial Reporting Framework for Small and Medium Entities (FRF for SMEs).
Background
In January 2011, a Blue Ribbon panel consisting of NASBA and AICPA representatives, bankers, and private company executives was formed to consider the accounting needs of private companies. The panel was tasked with defining the problems that private companies face with the current GAAP framework and developing models to solve the problem. The issues of relevance and consistency for private companies were identified, and the panel’s recommendation was for a separate standards-setting board for private companies. The panel issued the following statement:
One major enhancement, supported by a supermajority of Panel members, is to establish, under the FAF’s [Financial Accounting Foundation] oversight, a separate private company standards board to help ensure that appropriate and sufficient exceptions and modifications are made, for both new and existing standards. That new board would work closely with the FASB to achieve a coordinated and efficient standard-setting process but would have final authority over such exceptions and modifications.
The FAF did not adopt this proposal, but instead established the PCC to work with FASB to determine whether and when to modify GAAP for private companies. The PCC’s decisions would be subject to endorsement by FASB.
In the meantime, the AICPA, unhappy with the FAF’s decision to not adopt a separate standards setting board, formed one of its own, albeit without any authority. It released a full set of standards for small and medium-sized entities, the FRF for SMEs. The FRF for SMEs has several differences from GAAP and many alternatives built into the framework that impair comparability among companies.
The authors, with the cooperation and resources of the CPA Journal and NYSSCPA, developed a survey to determine to what extent that the AICPA’s FRF for SMEs and the alternatives developed by the PCC have impacted the financial reporting of private companies. NYSSCPA members were contacted via email and asked to complete the survey. Four hundred eighty-four individuals were contacted, and 57 responses were received; 81% of respondents were in firms with 25 or fewer professionals.
Impact of the FRF for SMEs
Survey participants were asked the general question of whether their clients had submitted financial statements prepared using the FRF for SMEs; only 16% (7 respondents) had, and 84% (36 respondents) had not. The remaining 14 respondents did not answer the question. Thus, in general, based on this survey, this framework has seen only limited adoption. Several areas where the FRF for SMEs differ from GAAP were subject to separate questions, as detailed below.
Defined benefit pension plans.
FRF for SMEs allows the option of using just current contributions as an expense, while GAAP uses a projected benefit obligation model recognizing projected obligations, including service costs, interest on liabilities, estimated return on assets, amortization of prior service costs, and any gain or losses resulting in the year’s pension expense. No respondent had a client with defined benefit plans that used the FRF for SMEs.
Business consolidations.
For parent subsidiary arrangements where the parent owns 50% or more of the subsidiary, the FRF for SMEs allows use of the equity method, where just the net results would be shown, while GAAP requires consolidated financial statements. No respondent had a client with this type of parent subsidiary relationship that used the FRF for SMEs.
Over three years after its issuance, the FRF for SMEs has not had a significant impact on private company financial statements and has not been widely embraced by the profession.
Income taxes.
For tax expense and liabilities, the FRF for SMEs allows recognition of only current income tax assets and liabilities, while GAAP requires the deferred income tax method. No respondent had a client with deferred taxes that used the FRF for SMEs.
Intangible assets.
For research and development expenditures, the FRF for SMEs allows the option for certain development costs to be capitalized, while GAAP requires expensing all internally developed costs. No respondent had a client with R&D expenditures that used the FRF for SMEs.
Derivatives.
GAAP requires the recognition of derivatives as either assets or liabilities. The FRF for SMEs does not provide for recognition of derivatives; derivatives are accounted for by recognizing the net cash paid or received at settlement. No respondent had a client with derivatives that used the FRF for SMEs.
Stock-based compensation.
GAAP requires the recognition of stock-based compensation as either a liability or equity and is fair-value based. The FRF for SMEs does not provide for recognition of stock-based compensation other than disclosure. No respondent had a client with stock-based compensation that used the FRF for SMEs.
Other comprehensive income (OCI).
GAAP provides for OCI and recognizes fair value for available for sale and trading securities, with changes in fair value for available-for-sale securities reported in OCI. The FRF for SMEs does not provide for OCI and records all investment securities at historical cost unless they are being held for sale. Only one respondent had clients with OCI that had adopted the FRF for SMEs and therefore did not recognize the OCI. This respondent indicated that less than 25% of those clients that who could have adopted this framework did.
Respondents were also asked if they had encouraged privately held clients to use of FRF for SMEs, discouraged its use, discussed the option without encouraging or discouraging, or not discussed the option. None had encouraged the option or discussed it without encouraging or discouraging, half discouraged the use of FRF for SMEs, and half had not discussed the option.
The survey results also indicate that the use of FRF for SMEs was with clients that had owner’s equity of under $1 million and whose financial statements were mostly compilations (as opposed to reviews, audits, or an equal mix of compilations and reviews). Given the small size of these businesses, it is not surprising that they would rarely engage in these other reports and thus not use the provisions for these transactions in the FRF for SMEs. In addition, no company with over $1 million in equity used the FRF for SMEs.
The authors believe it is clear from the survey results that, over three years after its issuance, the FRF for SMEs has not had a significant impact on private company financial statements and has not been widely embraced by the profession.
Use of PCC’s Alternative GAAP
Since its inception, the PCC has had only four projects that have been adopted as Accounting Standards Codification (ASC) topics by FASB, thus modifying GAAP for private companies:
- Topic 350: Intangibles—Goodwill and Other Intangibles. This allowed private companies to elect to amortize goodwill over 10 years and to elect a one-step impairment test.
- Topic 805: Business Combinations. This allowed private companies in a business combination to elect to no longer recognize separately from goodwill noncompetition agreements or customer-related intangible assets that cannot be sold or licensed separately.
- Topic 810: Consolidations—Interests Held through Related Parties That Are under Common Control. This permitted a private company lessee to elect not to apply variable interest entity (VIE) guidance to a lessor under common control under specific circumstances.
- Topic 815: Derivatives and Hedging. This allowed private companies to use a simplified hedge accounting approach to account for swaps converting variable rate borrowing into fixed-rate borrowing, essentially making the treatment the same as if they had originally used a fixed-rate loan.
The PCC was also instrumental in the issuance of ASC Topic 915, “Development Stage Entities,” which eliminated some financial reporting requirements for development stage entities both public and private.
The survey asked respondents about the use of these GAAP alternatives, posing the general question of whether their clients have used any of the alternatives provided. Only three (5%) responded that they had; 54 respondents (92%) said they had not. For Topic 350, no respondent had clients using this alternative; when asked if they had any clients who could have used it, one respondent said under 25%, while the other two said over 50%. For Topic 805, no respondent had clients using this alternative. For Topic 810, one said no clients used it, and the other two indicated that, when available, over 50% adopted the alternative. For Topic 815, one respondent said none of their clients used it, while one said under 50% had adopted and one said over 50% had. Thus, even the PCC’s GAAP alternatives for private companies do not appear to have been widely adopted.
The FAF believes that the current process is working and should not be significantly modified either by establishing a different set of standards or eliminating private company alternatives.
FAF’s Lookback on the PCC
In February 2015, issued an invitation to comment on the PCC as part of a three-year review, some of the responses to which are relevant to this article. Some commenters advocated the establishment of another Blue Ribbon panel; however, there was also a small group of commenters that said there should be no difference between public and private companies. Overall, the answers to the question, “Since the establishment of the PCC, do you believe the FASB has been appropriately responsive to the needs of private companies and the recommendations from the PCC?” were generally positive; 27 said yes, two said no, and one said, “Fair at best.” A few respondents also commented on the low number of PCC-suggested alternatives, attributing it to concern regarding restatements if the alternatives were adopted and the company went public in the future. There was also concern over the lack of guidance on how to adopt or unadopt the standards, as well as regarding the makeup of the PCC and the lack of representatives from small and medium companies or their accountants.
The request for comment also asked, “Do you believe the PCC review of existing GAAP that requires reconsideration for private companies (lookback) is complete or almost complete?” This question spurred a great deal of comment; 12 respondents said yes, while 26 said no. Interestingly, of the 12 who said yes, one was a former FASB board member, four were non-accounting membership associations, one was a state society member, and six were CPA firms. Of the six CPA firms, four of the top five thought the lookback should be over, as did two large national firms. None of the other 18 CPA firms or preparers thought the lookback should end. There were also many comments on transparency, communications between FASB and the PCC, outreach to private company users, and the lack of staff support for PCC.
The FAF’s response to these comments has been that the PCC’s focus should increasingly be on providing FASB with private company perspectives on active technical agenda projects. In addition, there should be a PCC Technical Agenda Consultation Group, and mechanisms should be developed to increase the transparency of the PCC’s discussions and views. Not surprisingly, the FAF believes that the current process is working and should not be significantly modified either by establishing a different set of standards or eliminating private company alternatives. Nevertheless, the FAF decided to include the lookback aspects by stating, “The PCC’s principal responsibility remains unchanged—to advise the FASB on the appropriate accounting treatment for items under active consideration by the FASB and on possible alternatives within GAAP to address the needs of private company financial statements.” Thus, the PCC maintains the ability to develop proposed accounting alternatives; however, its advisory role is expected to consume a greater percentage of the PCC’s time. The FAF also stated that the PCC should refrain from adding a topic to its agenda that is already being actively considered by FASB and confirmed that private company stakeholders should be kept informed in a timely and transparent manner of related PCC and FASB activities.
Too Much or Too Little
From the results of the survey, it appears that any company using the FRF for SMEs is probably very small, with a simple accounting system. In particular, the very few companies that have adopted it have little need to address the complex matters—defined benefit plans, stock-based compensation, derivatives, deferred taxes, and R&D—addressed in the framework. On the other hand, with minimal suggestions for alternative options for private companies, the FAF seems to want to put a stop to the PCC’s examination of current GAAP. The request for comments provided myriad suggestions, including many from the NYSSCPA. Topics suggested included leases, revenue recognition, fair value, debt versus equity, derivative and hedge accounting rules, accounting for transfers and securitizations, accounting for income taxes, accounting for stock options and other equity-based, defined benefit plan disclosures, available-for-sale securities, uncertain income tax positions, and related-party debt.
It appears that any company using the FRF for SMEs is probably very small, with a simple accounting system.
Perhaps comments regarding the makeup of the PCC and the suggestion that it have more small firm representation would result in more of these topics being considered as additional options. The survey showed that some of these options are in the FRF for SMEs, but have not been adopted by companies; however, the same might not be true if the alternatives came from the PCC, since PCC adoptions are still within GAAP.
During the initial development process, an appeal was made for the AICPA not to release the FRF for SMEs until the PCC had a chance to be active. The PCC failed to seize that chance, given the limited number of its projects adopted by FASB and the interest in ending its lookback. The AICPA’s FRF for SMEs does address many of the topics listed above; however, the FRF for SMEs is not GAAP, and is not appealing to most companies.
In the Blue Ribbon panel’s report to FAF in January 2011, it concluded that “the current U.S. accounting standard-setting process has systemic issues, involving (a) an insufficient understanding of the needs of users of private company financial statements and (b) an insufficient weighing of the costs and benefits of GAAP for use in private company financial reporting.” The panel went on to propose that “the current accounting standard-setting system needs to be improved to better address the needs of users of private company financial statements in a cost-effective manner.” Six years after this report, however, the idea of an acceptable comprehensive private company framework has yet to meet this mandate.
