Many Gaps Between Big GAAP And Little GAAP

There is an ongoing debate about whether two sets of Generally Accepted Accounting Principles are really necessary to serve all types of companies. Some believe one set of standards should apply to small nonpublic entities; others believe a separate set is required to adequately serve larger publicly traded companies. Groups, committees and individuals always ended the debate in a stalemate.

However, there is acknowledged consensus that contrasts exist between financial reporting requirements for public and private companies. Now, two recent events might be the catalyst to finding a resolution for this longstanding Big GAAP versus Little GAAP issue.

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Two Sides of One Debate

In July 2009, the International Accounting Standards Board issued new GAAP requirements for small and medium-sized entities, also known as SMEs. Recognizing that small and medium nonpublic companies do not need as disclosures and stringent reporting requirements to the extent of larger publicly traded companies, these new requirements should help ease the process. Now, small private companies can select standards that make sense for the size and scope of their business.

The new International Financial Reporting Standards for SMEs, as this set of practices is commonly known, is less complex than those put in place by the International Financial Reporting Standards followed in the U.S. For instance, GAAP standards in the U.S. have approximately 20,000 for accounting professionals to scour through. On the other hand, reporting standards from IASB consist of only 2,500 pages; SMEs only have 250 pages of IFRS.

On the other side of the debate is a committee cosponsored by the Financial Accounting Standards Board and the American Institute of CPAs. The Private Company Financial Reporting Committee submitted recommendations to the Financial Accounting Foundation that FAF should address the issue of which standards are appropriate according to the mission of FASB.

Taking one step further, the committee also stated a preference for stand-alone accounting standards for U.S. private companies. Increased interest in settling on a more uniformed practice comes from recent trends and events including IASB standards for SMEs. Complex accounting standards that cost a lot of money and provide little usefulness in private company financial statements also prompted these recommendations.

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What to Expect from These Recommendations

Creating a set of accounting standards that are less complex for nonpublic companies appears to come from the right motivation. However, what is the appropriate balance between the costs of compliance with benefits for users of financial statements? Certainly, addressing rising compliance costs and increasingly complex standards are important to everyone involved. At a minimum, any changes should eliminate the imbalance for private companies when complying with accounting standards.

The Private Company Financial Reporting Committee has been advising FASB on issues related to private companies since its inception in 2007. Given that FASB has final endorsement over the committee’s recommendations, it is important to have clearly defined and accepted rules to which the standards apply. Private versus public is not enough to address the level of complexity or uniqueness of different entities.

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Simplifying Big GAAP and Little GAAP

While accounting boards and committees met to discuss making changes, accountants balked at the increasing complexity they were dealing with in trying to comply with U.S. GAAP standards. Many feel that a majority of the standards have very little to do with the way most businesses in the country operate. Since private companies remain important to job creation and the U.S. economy, there needs to be a simplification between Big GAAP, Little GAAP or a median that satisfies differing points of view.

There is a growing need to keep things simple in accounting and reporting standards. Keeping two different forms of GAAP is not welcomed by many in the field. However, resource constraints could keep most privately held companies from satisfying complex demands associated with GAAP. For many, the only way to comply is to outsource the responsibility to an outside accountant who has the expertise.

This does not directly solve the problem since primary users of financial statements are lenders who want to see cash-based accounting practices. In between Big GAAP and Little GAAP, some want to see differences for private companies without total abandonment of GAAP accounting.

It is worth noting that different countries are taking different approaches to resolve varying demands of companies. For example, Canada and the United Kingdom kept a slimmed-down form of GAAP for private companies after transitioning to IFRS. With the FASB establishing a committee to adjust GAAP standards for private companies and AICPA introducing a Financial Reporting Framework for small and medium enterprises, the talk could shift from Big GAAP versus Little GAAP, to Big GAAP versus Many GAAP.

For their part, private companies must deal with complex issues such as derivatives, goodwill, intangibles, good will and variable interest entities on consolidation. Simplifying the reporting process for these companies is welcomed progress. From their perspective, the question is not whether standards should be streamlined. Rather, they want to know what the final recommendations will look like. Accounting boards and committees must decide whether the same simplified GAAP standards will extend to public companies.

Right now, FASB – through its committee – is looking for standard-setting rules that can apply to both private and public companies. The organization is looking to achieve balance between relevant costs for GAAP standards based on who will use the financial statements and for what reason.

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Changes That Might Close the Gap

In addition to FASB efforts, the Private Company Council has also proposed many changes to address concerns with intangibles, certain variable interest entity situations, goodwill and certain interest rate swaps. The organization is accepting public comment on the recommendations before PCC begins deliberating and holding public discussions. In addition, the PCC is charged with looking at previous work on disclosures and perhaps implementing a Disclosure Framework.

While PCC will continue to focus on private companies, FASB will seek to span instructive changes across all nongovernmental entities. Any PCC proposal can be assessed to determine the appropriateness of extending changes to public companies, as well as nonprofit organizations.

This highlights the important benefit of having a standard-setting process that is interconnected for public, private and nonprofits. The potential of simplification for all entities is worth the effort. Each entity can appreciate a better cost-benefit balance when complying with GAAP standards.

Some are suggesting that AICPA and FASB combine their efforts with changes to accounting standards. Both organizations can draw on each other’s frameworks. This can provide accountants with a decision-making tool that will guide them through the process of applying a specific framework for private accounting.

Representatives from FASB do not rule out the possibility noting that both organizations are trying to do the same thing for private and public companies. A major concern is to avoid any potential for marketplace confusion by merging the standards. While these efforts can meet a need, there are things in comprehensive accounting systems that may differ from GAAP, yet still have many similarities. Uniformly changing a standard without this additional consideration could do more harm than good.

Very few are expecting an overnight resolution to an issue that is 40 years old in the accounting world. On one end of the spectrum, purists believe that GAAP represent the best set of standardized rules for private companies to use in financial reporting. On the other end are the private and public companies that have to differentiate what actually applies to their particular interests. For them, current standards do not adequately address how reporting needs differ between private and public financial statements.

Nevertheless, creating exceptions to GAAP remains a daunting task in which the final product must have an acceptable definition for each type of company. The expectation is that this will occur while addressing needs. Closing the gap between Big GAAP and little GAAP standards ultimately requires creating a common sense solution for a complex problem.