Board Matters Quarterly, September 2013

Spotlight on private company financial reporting

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After adding financial reporting requirements aimed primarily at large public companies over the past several years, standard setters and regulators are focused on addressing the needs of private and smaller public companies and their stakeholders.

Several initiatives are underway at the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) that could ease the burden on these companies.

The Auditing Standards Board (ASB) and the American Institute of Certified Public Accountants (AICPA) also have projects focusing on private companies.

Whether you represent private or smaller public companies or both, change is on the horizon.

A new focus

The financial reporting landscape for all companies has changed significantly over the past decade on many fronts. The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board (PCAOB), which establishes auditing standards for public companies. These changes along with continuing calls for more disclosures and convergence with international accounting and auditing standards, have contributed to more complex and burdensome financial reporting requirements for private companies.

To promote capital formation and reduce the burden, standard setters, regulators and lawmakers are now focusing on how these changes might have hurt private and other small companies. The result is a growing number of differences between how US GAAP applies to private and public companies. Auditing standards for private companies are also diverging from that of public entities.

FASB and FAF initiatives

Improving the standard-setting process for private companies has become an area of focus on several fronts for the Financial Accounting Foundation (FAF) and the FASB.

The FASB has had efforts under way to focus on private company stakeholders. The latest actions by the FAF and the FASB reaffirm a strong commitment to that constituency.

Private Company Council

In 2012, the FAF Board of Trustees established a Private Company Council (PCC) with two primary responsibilities.

First, the PCC was asked to determine whether exceptions or modifications to existing US GAAP are necessary to address the needs of users of private company financial statements.

Second, the PCC was asked to advise the FASB on private company considerations in standard setting.

The PCC is setting its agenda in consultation with the FASB and with input from stakeholders.

All modifications or exceptions to US GAAP require FASB endorsement, and the PCC will seek public comment on its proposals, similar to the due process procedures followed by the FASB on other proposed changes to US GAAP. If endorsed by the FASB, the exceptions or modifications will become part of US GAAP.

Private company decision-making framework

This framework is intended to be a non-authoritative tool for making consistent decisions. It can help in evaluating if there is a sufficient basis for differences in recognition and measurement, disclosures, presentation, effective dates and transition methods for financial accounting standards for private companies.

The framework describes six key differences in the financial reporting considerations of private and public companies:

  • Types and number of financial statement users
  • Access to management
  • Investment strategies of equity investors
  • Ownership and capital structures
  • Accounting resources
  • Learning about new financial reporting guidance

For each area in which relief may be provided, the framework includes specific questions that the PCC and the FASB would consider when evaluating whether information is relevant to the users of private company financial statements.

Improving the standard-setting process for private companies has become an area of focus.

Simplifying accounting for private companies

Over the summer, the FASB issued four proposals from the PCC to allow private companies to apply alternatives under US GAAP for financial reporting related to the following:

  • Intangible assets in a business combination
  • Goodwill
  • Certain hedges involving interest rate swaps
  • Applying consolidation guidance to common control leasing arrangements

These proposals are intended to simplify the accounting for private companies while still providing users of their financial statements with the information they need.

Auditing

Private company auditors will see changes in the audit process as a result of the ASB’s Clarity Project. One purpose of the Clarity Project was to converge US Generally Accepted Auditing Standards (GAAS) with International Standards on Auditing. The updated auditing standards were effective for calendar year-end 2012 audits.

The primary goal of the Clarity Project was to make auditing standards easier to read, understand and apply. The project however led to some additional documentation and performance requirements for audits.

The changes that will be most apparent to private companies are changes to the auditor’s report. This includes additional discussion of management and auditor responsibilities, new headers and the re-characterization of “explanatory paragraphs” into either “emphasis-of-matter paragraphs” or “other matter paragraphs,” depending on whether the issue is something that is discussed elsewhere in the financial statements.

What’s next?

Whether you represent private or smaller public companies or both, change is on the horizon. Companies and their boards should monitor these developments and evaluate the potential effects they may have on the company’s processes, controls, financial reporting, communication with stakeholders and alternatives for access to capital. Planning early allows companies the opportunity to prepare for any uncertainties that lie ahead.