Private Company Financial Reporting: Need for Clear Definition of Private Company

In a blog post earlier this year, CFA Institute discussed the Financial Accounting Standards Board (FASB) initiative to establish separate financial reporting standards for private companies. We expressed our concern that the FASB was marching ahead with this initiative without actually finalizing the definition of a private company.

Without a definition it is unclear to which entities separate private company guidance might apply. Indeed there may be entities to whom such guidance may apply that are currently unaware of these possible new standards being applicable to them.

In August, after considering how accounting in four areas (including goodwill) should be differentiated for private companies, the FASB finally issued a proposed accounting standards update that provides a single definition of a public business entity (PBE). Essentially, this provides a de facto definition of a private company that helps identify the types of business entities that would be eligible to use private company financial reporting standards.

Inconsistent Definitions of Nonpublic and Public Entities Creates Confusion

The proposed update was issued in response to inquiries by stakeholders “about the inconsistency and complexity of having multiple definitions of a nonpublic entity and public entity within U.S. GAAP” and acknowledges that “eliminating the multiple definitions of a nonpublic entity and public entity in the Accounting Standards Codification [accounting literature] could reduce confusion among stakeholders and simplify the definition, which could help reduce complexity in financial reporting.”

The proposed update, however, does not resolve the differences between all the definitions of a public entity contained within accounting literature. In fact, the literature would continue to include numerous definitions of a public entity (and related terms such as “publicly traded company”) with the new definition of a public business entity being used to distinguish between different types of entities in future standard setting. As we note in our comment letter, CFA Institute believes that the FASB needs to resolve the differences between and consolidate all the definitions of a public entity. Otherwise, complexity and confusion for investors remains and may increase with the inclusion of yet another definition for a PBE.

Few Truly Private Entities

As mentioned above, the de facto definition of a private company would be used to identify those entities that fall within the scope of private company guidance. The proposed update goes further, stating that “the FASB … aim[s] to achieve an appropriate cost-benefit balance by providing accounting and reporting alternatives to entities that are within the scope of the guide (which is not based on the notion of public accountability).” We, however, disagree with the notion of basing the scope of private company guidance primarily upon compliance costs for private companies.

Private companies differ greatly in size, the complexity of activities they undertake, and the accounting personnel they retain. We have stated before that the issue of cost or limited resources does not pertain to large (and sometimes widely held) private companies such as Cargill, Mars, and Koch Industries. The 2012 Forbes listing of America’s largest private companies notes there are a significant number of private companies with substantial revenues, employees, and resources, and they will be subject to these private company exceptions.

Furthermore, it is our view that it is almost impossible to draw the line between public and private companies as there are many investors in private entities and many users of their financial statements. Our view is that there are few truly private companies, and the only truly private companies are those with a single owner/manager and no external financing. A single owner/manager can choose to have financial statements prepared in whatever form he or she finds useful. All other enterprises have either investors or creditors who need financial statements to evaluate their investing or lending decisions.

Relief Should Be Provided Only for Small Private Companies

We, therefore, believe that if the FASB were to consider providing some relief for private companies, such relief should only be considered for private companies that are truly small with limited resources. We also believe there is a need for a single, logical definition of a public entity rather than the multiple definitions that are currently in place.

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