The GAAP Between Public and Private Companies
A Band-Aid for Standards Setting?

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The AICPA recently announced that, along with FASB, it will be examining user needs and cost/benefit considerations for private companies’ financial reporting standards. The AICPA cited significant differences between the reporting environments for public and private companies as the impetus for initiating this project. The differences mentioned in the announcement include capital structure, owner involvement, stakeholder access to management, and the usefulness of certain reporting requirements in the private sector. The initial communication indicated that the AICPA plans to issue “a proposal that outlines the model for a special committee charged with studying existing and prospective GAAP standards to evaluate their relevance to the private company sector.” The committee is expected to comprise equal numbers of users, preparers, and auditors of private industry. The proposal was officially issued on May 22 and appears on a new website: www.PrivateCompanyFinancialReporting.org. There is a 60-day comment period.

Many in the accounting profession agree that the time has come to explore appropriate differences in financial reporting standards for public and private companies. After all, private companies have a significant impact on our economy, and the attention given to this sector by our standards setters has been largely nonexistent compared to that given to public companies, which represent only a fraction of the 22 million businesses in the United States.

Usefulness of Financial Reporting

FASB Concepts Statement 2 states that, to be useful, financial information must be both relevant and reliable. Although much has been written about the importance of the reliability of financial information following the high-profile corporate scandals of Enron, WorldCom, and others, comparably little attention has been given to the relevance of the financial information presented. Because of the litigious nature of our society, many accountants prefer to provide more information, rather than less, sometimes without considering its relevance or usefulness.

So how do we determine what information is relevant? Simply put, relevant information enhances the user’s ability to make
an informed decision. Accordingly, relevant information is not limited to numbers. For example, if a technology company hires one of the best minds in the field, would that information be an important factor in making an informed decision about the company’s future economic prospects? Or if a bioengineering company lost its most productive R&D scientist, might that information influence stakeholders’ decisions?

In our knowledge-based society, many business entities derive much of their value from intangible assets; yet many intangibles, such as human capital, ideas, and innovations, are nowhere to be found on the balance sheet. The real value of these companies may not be accurately reflected in their financial reports. Although these economic resources may be difficult to quantify, to ignore them would not fairly represent the financial and business position of the company. Furthermore, assumptions and estimates in financial reporting will never be perfect, and there will always be some companies that go to great lengths to manipulate the numbers through aggressive, misleading, or even fraudulent application of the rules. If we’re going to limit ourselves to counting beans, our value in the business reporting process won’t be worth a hill of them.

So where should accounting standards setters go from here?

Standards for the Future

The AICPA had it right some time ago, when it envisioned accountants as professionals who possess a broad-based business background and understanding. We need to change our financial reporting system to a business reporting system, with an eye toward evaluating value, not just numbers. Many accountants have become too comfortable using numbers as a crutch. I’m not suggesting throwing the baby out with the bathwater. On the contrary, standards should be flexible enough to apply to both public and private companies, yet adequately standardized to provide the consistency needed to compare companies’ performance within the same industry. And there should be an exploration of ways to include relevant information about the resources of a business that are not addressed by the existing financial reporting structure. Standards setters should seek to provide appropriate implementation guidance to accounting professionals based on a coherent conceptual framework, rather than bright-line rules. There will—and should—always be a need for accountants to exercise their professional judgment.

As always, I welcome your comments on these and other issues.

Mary-Jo Kranacher, MBA, CPA, CFE
Editor-in-Chief
mkranacher@nysscpa.org