Wednesday, March 17, 2010

Grant Thornton, Others Release Papers, Articles On Private Co. Accounting

Earlier today, Grant Thornton LLC released a paper on Private Company Financial Reporting. The paper, available at, authored by GT partners John Hepp and Gary Illiano, discusses the age-old question of whether it is time to develop a separate set of Generally Accepted Accounting Principles for private vs. public companies, a concept known as 'differential GAAP,' or 'Big GAAP/Little GAAP.' This is the central question to be considered by the new Blue Ribbon Panel on Private Company Accounting, cosponsored by the Financial Accounting Foundation (which oversees FASB), the American Institute of Certified Public Accountants, and the National Association of State Boards of Accountancy. As previously reported, the Blue Ribbon Panel is set to hold its first meeting on April 12.

What's Different About Differential GAAP Now?
With the question of Big GAAP/Little GAAP having a long history, GT's Hepp and Illiano discuss what's different now, including their view that there has been a shift in the fundamental financial accounting model - as evidenced by changes and proposed changes in the FASB and IASB's Conceptual Framework, and through relatively recent accounting standard-setting activities - from "one based on the traditional accounting model" to "one based on financial economics and capital markets research." Hepp and Illiano say this has created 'dueling paradigms.'

In my view, (I remind you of the disclaimer which appears on the right side of this blog), a crucial point in the GT paper relates to changing definitions of critical terms in the world of accounting standard-setting, and the fact that the definition of some terms has shifted over time toward the 'financial economics' or 'capital markets' model, as so described by Hepp and Illiano. This point is detailed in footnote 9 in the paper:

One characteristic of the shift to a different financial reporting paradigm is changes in the definitions of terms. In many cases the terminology remains the same, but with different meanings. The definitions of key terms such as general purpose financial reporting, investor, creditor, operating cash flows and fair value have all changed, sometimes in subtle ways. The term “professional judgment” is also changing to reflect more emphasis on evaluating future cash flows rather than judgment in terms of the meaning of contractual rights and obligations and realization. The FASB and IASB also plan to change the definitions of assets and liabilities to remove references to past transactions. This can be a source of confusion for accountants educated in earlier years.

But, it is not just a question of how current one's education is, in terms of how one may view the the pros and cons of the newer school of thought, or the 'financial economics' model; there are other issues as well, as described on pg. 7 of GT's paper:

The shift to a financial economic paradigm, while not complete, has increased concern among all preparers, but especially those in private companies, about the relevance of the information used in their financial statements. The declining relevance of earnings is not the only concern. There are also reservations about reliability, training and education, and the relative costs and benefits of applying new accounting standards.

Hepp and Illiano note that in November, 2009 the Private Company Financial Reporting Committee (PCFRC)- formed jointly by the Financial Accounting Standards Board and the AICPA - issued the following recommendation:

The Committee believes that a separate, stand-alone set of accounting standards for U.S. private companies tailored to the needs of the users of those statements is the preferred approach. However the Committee realizes there could be other major alternatives for private company accounting that should be explored. In establishing standards for private company financial reporting, the needs of financial statement users balanced against the costs of complying with the standards must be an overriding principle.

The PCFRC's recommendation, addressed to the Financial Accounting Foundation, led to the formation of the Blue Ribbon Panel.

Here are the conclusions in GT's paper (verbatim; reformatted into bullets):

  • On the issue of separate accounting for private companies, Grant Thornton LLP and Grant Thornton International Ltd agree with the FASB and the IASB that the objective of general purpose external financial reporting should be the same for all entities, but has expressed concerns that overemphasis of the needs of investors and creditors for capital allocation is not consistent with that determination.
  • In the 2006 response to the Preliminary Views, Grant Thornton LLP and Grant Thornton International Ltd commented that the proposed changes in the objective of financial reporting would encourage calls for a separate financial reporting framework for non-publicly accountable entities and that “on balance we believe that the proposed financial reporting objective is unsuitable for smaller, privately held entities.”
  • The objective of capital allocation could be viewed as a special case that is a subset of a more general objective of financial reporting that is common to public entities, private entities, not-for-profit organizations and government.
  • A different approach, therefore, to developing an objective of financial reporting would be to look first at the general case and the objectives held in common and then address the specific information needs of investors and creditors. As the FASB and the IASB have acknowledged, those needs may extend beyond the boundaries of financial reporting.
  • Therefore, Grant Thornton LLP welcomes the establishment of the blue-ribbon panel to study the issues facing private companies and urges that the scope be expanded, if possible, to include the interests of not-forprofit organizations.
  • While the best outcome perhaps would be a single objective and a single set of standards for all entities, the unique needs of the global capital markets and their importance may indicate that a different set of standards for investors and creditors in those markets may be the best solution to meet their needs.
  • Other standards, more reflective of accountability and local legal considerations, may better address the needs of private companies and not-for-profit organizations.

The fascinating thing about GT's conclusions, in my view (once again, I remind you of the disclaimer posted in the right margin of this blog), is that the question of "differential reporting" - a terms usually associated with a call from private companies for lessinging their burden of financial reporting, and providing their users with more relevant information - a call that is sometimes viewed by some parties in a negative light - may equally if not moreso relate to the fact that the traditional accounting model has morphed (or undergone a 'paradigm shift' to use Hepp and Illiano's terminology) to a model driven by the needs of certain (I would say, 'sophisticated') users of public company financial reporting, such as analysts (referred to by Hepp and Illiano as the "financial economics/capital markets' driven approach). That is, although we started out with a single set of general purpose accounting standards designed to be applicable to public and private companies, the 'financial economics/capital markets' view, as described by Hepp and Illiano, influenced a paradigm shift toward what amounts to, in substance, a 'different' set of standards or a 'different' paradigm than that of the original single set of standards.

Thrower, Rabin Weigh In
Further on the subject of private company accounting, this month's edition of Financial Executive Magazine, published by FEI, includes an article by Andy Thrower, "Should It Be Big GAAP or Little GAAP For Private Companies?" (FEI members, enter your member login info to open the article; nonmembers can register for a free login account to read articles online from Financial Executive Magazine.)

Thrower is past-chair of FEI's Committee on Private Companies-Standards, is a member of the FASB Small Business Advisory Committee, and previously served as a member of the Financial Accounting Standards Advisory Committee (FASAC). I remember interviewing Andy for an article which appeared in the December, 2005 issue of Financial Executive Magazine, and being struck by how steeped in the theory and history of accounting he is, as well as the current standards and practical aspects.

Separately, FEI member Steve Rabin authored an article published recently in The Value Examiner, entitled: "The Fair Value Compromise - A Proposed Solution."

Thrower's and Rabin's articles, as well as the Grant Thornton paper, make for very timely reading, as we await the upcoming deliberations of the Blue Ribbon Panel on Private Company Accounting.

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Jim Haefner said...

Changing the approach to the Big GAAP/Little GAAP question from why private companies should be exempt from some requirements to instead saying only public companaies have specific additional requirements (including more than just disclosures) makes the view of the issue very different. That would be a truly helpful paradigm shift.

FCAblog said...

The Grant Thornton link doesn't seem to work, nor can I search for it on their site (404 errors, both times). Is the report available elsewhere?

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