Separate Private Company Financial Reporting: A Word of Caution
The Financial Accounting Standards Board (FASB) recently initiated a project to create separate private company accounting standards. Meanwhile the Private Company Council (PCC) — formed to advise FASB on private company standards — is charged with identifying areas within existing U.S. generally accepted accounting principles (GAAP) to adjust reporting requirements for private companies. The goal, according to FASB, is to “reduce the complexity and cost of preparing private company financial statements.”
Separate private company reporting would reduce comparability between the financial statements of U.S. public and private companies. Comparability is essential to those who invest across both private and public companies. Creating differences in the financial reporting requirements of private and public companies hinders investors’ financial analysis and investment decision-making process. Therefore, we urge the PCC to consider any relief from U.S. GAAP both cautiously and in limited circumstances.
Modifications Shouldn’t Create Differences in Recognition, Measurement, and Presentation
In July 2012 the FASB issued an invitation to comment (Private Company Decision-Making Framework) to determine whether, and in what circumstances, exceptions or modifications should be made to U.S. GAAP for private companies. The invitation to comment suggests that there may be occasions when an item included (i.e., recognized) in public company financial statements may not be recognized in private company financial statements. It further suggests that similar items may be measured differently in public and private company financial statements.
An asset is an asset and a liability is a liability. The underlying assets and liabilities of an entity do not change based upon the type of entity or its legal structure. Therefore, similar items should be accounted for — recognized and measured — similarly across all entities. There is no basis for any change in recognition and measurement that would make financial information less useful for investors.
The invitation to comment suggests that in order to simplify private company financial statements, private companies should not have to provide all the information provided by public companies. The argument is that private company investors have greater access to management and can simply ask management for any additional information they want. But if an item does not appear in the financial statements, investors may not know to ask for information because they’re not aware of its existence.
The invitation to comment then turns to the presentation of the financial statements. It appears to suggest that the presentation of an item in the main financial statements could be substituted by its disclosure in the footnotes. The invitation to comment does not explain what the basis for this could be or clarify who would benefit. In reality, it would benefit no one. There is no cost savings for preparers as they need to generate the information whether it is presented on the face of the financial statements or in the disclosures. And placing information in the disclosures only makes the information harder for investors to see.
Modifications in the aforementioned areas would raise some interesting questions, such as what happens when a company goes from being private to public, or vice versa, as in the case of Dell. Would the company change its accounting?
Possible Areas for Relief: Disclosures and Effective Dates
Private companies differ greatly in size, complexity of activities that they undertake, and the accounting personnel they retain. If the PCC 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, and only in the areas of disclosure requirements and effective dates of new accounting requirements. With respect to disclosures, the PCC could provide some relief to private companies by not the requiring the narrative that accompanies tables, charts, reconciliations, and roll forwards. Secondly, the PCC could consider allowing private companies extra time to adopt new accounting requirements.
7 thoughts on “Separate Private Company Financial Reporting: A Word of Caution”
Refreshingly direct language, Ms. Singh, you have very logically and thoroughly explained the essential points and potential outcomes of this issue, with great clarity and brevity. I completely agree. Well said!
All private companies eventually grow in size or become public someday. If from the start they are required to make disclosures like public companies it always better and will bring down fraud/adjustments which companies normally hide inorder to grow. I feel your concerns are more from the point of view of investors only rather you should take into account all stakeholders including govt, employees, buyers, supplier, etc. A company cannot work in isolation hence a clear picture for all stakeholders is necessary. Eventually a private company, equally as a public company, is a potential for investment may be in the form of raw material, pure bank loan, PE fund, etc. All I mean is a private company has or can have as many potential stakeholders as a public company so a differrence for a particular stake holder for private vs public company stakeholder should not exists. From cost point of even public companies will claim to reduce cost by reducing disclosures as it will increase their profitibilty which will eventually benefit the shareholders.
Also I fogot to mention any stakeholder including analyst of PE funds, minority shareholders, etc of private company will require all the information for their analysis & when that time they ask the private company, the company will incurr cost for providing them the same. Hence cost incurred whether for one stakeholder or many stakeholder will not be materially different. So I mean is private companies should be at par with public companies
Thank you for your comments, Rahul. We believe that the financial reporting requirements of public and private companies should be the same. However, if the Private Company Council is going to consider any differences we urge them to do so in very limited circumstances.
While I agree with the issue of being able to compare the results of public and private companies, one has to consider the cost of this exercise and overall benefits. The IFAC published its comprehensive financial reporting standards earlier this century with the introduction of IFRS. This standard is comprehensive was all companies were required to implement it. However, by 2009 IFAC recognized that this was not the most sensible approach for non-public reporting companies and introduced the modified standard for Small and Medium Sized enterprises (IFRS-SME). This new standard did not change the method of measuring income, assets, expense or liabilities but it did reduce the level of disclosure required. Most private companies cannot invest in the resources required to complete address the disclosure requirements as well as the additional costs of completing audits that review the disclosure requirement. I would have to agree with the FASB approach with is consistent with IFAC and Canadian approach to dealing with non-public reporting companies.
Thank you for your comments, Colin. We have some concerns. The proposed standards will apply to private companies yet the FASB has not finalized its definition of a private company. Secondly, the FASB is considering differences in recognition, measurement and presentation, which we find conceptually very difficult. We agree with you that if relief is to be provided, it should be in the disclosures.