Audit, Compliance and Risk Blog

For the foreseeable future, the accounting standard setter in the United States, also known as the Financial Accounting Standards Board (FASB), will continue to set generally accepted accounting principles (GAAP) for private companies. The trustees of the Financial Accounting Foundation (FAF), the oversight body of the FASB, recently rejected the concept of establishing a separate accounting board that would prescribe GAAP for private companies, sometimes termed “baby GAAP.” They concluded that the FASB should continue to set GAAP for all companies that report financial results in the United States.

Impetus for Developing Baby GAAP

Over the years, private companies have been periodically clamoring for a less-complicated GAAP that doesn’t require multiple CPAs to figure out how to apply the FASB rules. This “clamoring,” like the sea, comes and goes depending on the tide at the time.

Probably the latest impetus for establishing a less complicated GAAP or “baby GAAP” was the complexity the FASB created in its rules for derivative accounting (issued in form of FASB Statement 133) and uncertain tax positions (in FASB Interpretation 48), together with the uniqueness of the concept of accounting for variable interest entities or VIEs as originally described in FASB Interpretation 46. Each of these sets of FASB rules has been amended, revised or interpreted numerous times by the FASB or by such groups as the Derivatives Implementation Group or the Emerging Issues Task Force (EITF). At times, it is hard to decipher what the FASB had in mind (or did not consider) when prescribing its rules.

Key Events Since 2009

In 2009, a “blue-ribbon” panel was created to “address how accounting standards can best meet the needs of users of U.S. private company financial statements.” This panel included representatives of the FAF, the American Institute of Certified Public Accountants (AICPA) and the National Association of State Boards of Accountancy.

In 2011, the trustees of the FAF received the report of the blue-ribbon panel and decided that a working group should be formed to consider the report’s findings. And one major conclusion of that report was that private companies should have their own standard-setting body, apart from the FASB but under the oversight of the FAF—effectively a two-tier GAAP scenario.

In October 2011, after receiving input from the working group, the FAF proposed a solution that stopped short of having a separate board to establish GAAP for privately held companies; rather, it proposed having a separate body to recommend changes that would eventually require FASB “ratification.”

The FAF solicited feedback on its proposed solution and received 7,367 comment letters, of which 7,069 were “form letters generally following a template provided by the [AICPA]....”[1]  After considering these letters, the FAF decided that a new group, termed the “Private Company Council” should be formed that would eventually replace the existing “Private Company Financial Reporting Committee” that currently provides feedback to the FASB on its rules affecting private companies.

The New Private Company Council

As elaborated in the report by the trustees of the FAF on May 30, 2012, the new Private Company Council will have two responsibilities. First, it will determine whether exceptions or modifications to existing GAAP are required to address the needs of users of private company financial statements. Second, the new Council will serve as the primary advisory body to the FASB as it considers new accounting rules on its agenda. The Council will have 9 to 12 members and, unlike in the original FAF proposal, the chair cannot be a FASB member.

For some, the result appears to be status quo—no separate accounting board, no baby GAAP, and the FASB can decide whether or not to “endorse” a decision of the new Council. This time, however, the FAF is giving the new Council dedicated support from the FASB staff and expects that each of the seven FASB members attend the deliberations of the Council. The FAF believes this will help ensure that FASB members consider the views and perspectives of private companies when voting whether to “endorse” an exception to GAAP that the Council believes should be granted to private companies.

A major proponent of having a separate board was the AICPA, which now supports the FAF’s revised “endorsement” approach by the FASB for establishing GAAP for private companies. Similarly, the FAF supports an effort by the AICPA “to develop a financial reporting framework for smaller private entities, which would be used as form of OCBOA [other comprehensive basis of accounting] reporting where appropriate ….”[2]

Questions Expected to Arise

Over time, the following questions will undoubtedly arise regarding the new concept approved by the FAF:

• Will the Private Company Council be effective if it meets only 5 times per year (the minimum) or will more frequent meetings be required, and will Council members have the time to devote to more frequent meetings?
• Will the Council attract the right talent since Council positions are unpaid, unlike the full-time paid positions of the seven FASB members?
• The FAF changed its original plan to have the FASB “ratify” decisions of the Council and will now have it “endorse” decisions of the Council. As a result of this change and certain procedural changes, the revised Council seems to have more support from constituents, but is there any difference between the two concepts?
• With all of the activities that the FASB must support, including its current process to converge its standards with those issued by the International Accounting Standards Board (IASB), does it have time to properly support another “drain” on its resources?
• Will private companies shift to OCBOA financial reporting and will users of OCBOA financial statements (e.g., lenders) accept them?

Separately, the U.S. Securities and Exchange Commission (SEC) is evaluating whether to permit or require public companies in the United States to follow accounting principles set by the IASB. The question will be whether this decision will affect how the FASB sets GAAP for private companies.