PCSIC Comment Letter No. 261
Accounting Standard Setting for Private Companies: Response to the Financial Accounting Foundation’s Plan to Establish the Private Company Standards Improvement Council1 The Financial Reporting Policy Committee of the Financial Accounting and Reporting Section of the American Accounting Association Mark Bradshaw, Chair; Daniel Bens (principal co-author); Carol Ann Frost (principal co-author); Elizabeth Gordon; Sarah McVay; Gregory Miller; Ray Pfeiffer; Marlene Plumlee; Catherine Shakespeare; Wayne Thomas; Franco Wong (principal co-author)
January 14, 2012
NOTE FROM COMMITTEE CHAIRMAN: The Financial Reporting Policy Committee of the American Accounting Association is comprised of eleven members with different skills and perspectives. Subsets of the Committee respond to various regulatory proposals, and the draft response is circulated among Committee members for feedback. Occasionally, disagreements occur that are not able to be reconciled by the due date of a call for comment, which has occurred in this case. Committee members Mark Bradshaw, Elizabeth Gordon, Gregory Miller, Ray Pfeiffer, Marlene Plumlee, and Catherine Shakespeare dissent from the views expressed in this comment letter based on various grounds. These Committee members wish to express, by reference, alternative views reflected in a thoughtful dissent by Teri Yohn to the Blue Ribbon Panel on Private Company Financial Reporting,2 which we understand is being submitted by her under separate cover as a response to the Financial Accounting Foundation Board of Trustees.
1
We gratefully acknowledge helpful information provided by Robert Durak (AICPA), Kevin Catalano (FASB), and Lynn Rees (FASB), and benefited from presentations on Private Company Standard Setting made by Daryl Buck (FASB) and Gavin Cassar (The Wharton School) at Financial Accounting Standards Research Initiative (FASRI) Roundtables (November 1 and 8, 2011, respectively). 2 See Blue-Ribbon Panel on Standards Setting for Private Companies (2010).
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INTRODUCTION The Financial Reporting Policy Committee (hereafter, the Committee or AAA FRPC) of the Financial Accounting and Reporting Section (FARS) of the of the American Accounting Association (AAA) is charged with responding to discussion papers and exposure drafts related to financial accounting and reporting issues. The Committee is pleased to respond to an invitation to comment on Request for Comment: Plan to Establish the Private Company Standards Improvement Council (hereafter, the FAF proposal) issued by the Financial Accounting Foundation Board of Trustees (hereafter, the Financial Accounting Foundation, or FAF) on October 4, 2011. Our response addresses two issues: (1) Should there be different accounting standards for public and private companies? (2) If there should be separate standards for private companies, should the system of setting accounting standards for private companies be changed? In 2006, the Financial Accounting Standards Board (FASB) established the Private Company Financial Reporting Committee (PCFRC).3 By creating the PCFRC, FASB sought to become more responsive to views of private company constituents in its standard-setting process. Concerns about the PCFRC’s ineffectiveness prompted the FAF, the American Institute of Certified Public Accountants (AICPA), and the National Association of State Boards of Accountancy (NASBA) to form the Blue-Ribbon Panel on Standards Setting for Private Companies (BRP). The BRP’s charge was to study the needs of private company financial statement users and to make recommendations concerning how the standard-setting process can best meet those needs. The BRP submitted its report to FAF in January 2011 (BRP 2011). In March 2011, the FAF created a Working Group to consider standard setting for nonpublic entities, and in October 2011 the FAF issued its plan to establish a Private Company 3
For further discussion, see FAF (2011a).
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Standards Improvement Council (PCSIC) (FAF 2011a). The FAF proposal recommends adoption of all but one of the BRP proposals. Whereas the BRP’s plan calls for a new, separate, and authoritative standard-setting board (under FAF oversight), the FAF’s plan retains the FASB’s authority over private company standard setting through a ratification process. Preparation of our analysis of the FAF proposal has included group consultations and reviews of academic research and practitioner articles. We also reviewed comment letters and other feedback prepared in response to the FAF proposal. The opinions expressed in this paper are ours, and do not necessarily represent the AAA or FARS memberships. Very little academic research is relevant to the issues addressed in this analysis.4 Our main conclusions are as follows. 1. We agree with the FAF that different accounting standards for private companies (or, at a minimum, modifications and scope exceptions to public company GAAP for private companies) are appropriate given the specific informational needs of the users of their financial statements. 2. We would like to see a more detailed description of how the new standard setting process (with the PCSIC replacing the PCFRC) will work than the FAF proposal currently gives. Our concern is that having FASB retain oversight of private company accounting standards setting, given its disappointing record in this area, might fail to produce much-needed improvements. 3. We agree with the FAF that complexity is a pervasive problem in financial reporting standards. We believe that assessments of complexity and benefit-cost analysis should be added to the standard setting process.
BACKGROUND During the past few years, regulators increasingly have acknowledged that separate GAAP for private companies might be appropriate. In 2005, an AICPA task force produced a study on private company accounting (referred to as the Castellano Report). The Castellano
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Our view is that attempts to distinguish between discussion of academic research and other expressions of carefully researched and reasoned opinion are lacking in merit.
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Report concluded that many GAAP requirements lacked usefulness and relevance for private companies, and recommended changes in GAAP for private companies (AICPA 2005).5 This report contributed to the creation of the PCFRC (BRP 2010) in 2007. The PCFRC’s chair is a part-time FASB employee. The committee also includes four users of private company financial statements, four preparers of private company financial statements, and four practicing CPAs from small to mid-size firms. The PCFRC makes recommendations to the FASB, usually requesting either exceptions or differential accounting for private companies.6 The PCFRC chair has expressed concern that many stakeholders in the private company sector have viewed the work of the PCFRC as not being completely successful, since the FASB has not been willing to consider carefully and approve appropriate measurement, recognition, or presentation differences for private companies (BRP 2011). In November 2009, the PCRFC issued a letter that asked the FAF trustees to study the issue at a high level, and also recommended that separate accounting standards be set for private companies in the U.S. (BRP 2010). In December 2009, the AICPA, FAF, and NASBA formed the BRP to address how accounting standards can best meet the needs of preparers and users of U.S. private company financial statements. The BRP issued its report in January 2011. A key BRP recommendation was that an independent private company accounting standards board under FAF supervision be established (BRP 2011).7 The Blue-Ribbon Panel report also recommended that a decision5
Refer to the Blue-Ribbon Panel report (BRP 2011) and Blue-Ribbon Panel Meeting Minutes (BRP 2010) for information on studies and reports (dating back to the early 1970s) concerning private company standard setting in the U.S. 6 Further details about the PCFRC are presented in the Blue-Ribbon Panel report (BRP 2011), the Blue-Ribbon Panel Meeting Minutes (BRP 2010), and at the PCFRC website (www.PCFRC.org). 7 In contrast, the FAF proposal (published in October 2011), calls for a new body – the PCSIC -- whose proposed exceptions or modifications would be submitted to the FASB for final ratification.
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making framework for private company standard setting be developed. In response, the FASB made an initial assessment of the differences between users of private company financial statements and users of public company financial statements, and other factors relevant for the development of private company standards (PCFRC 2011).8 The FASB published information about its work on a new differential framework for private company standard setting in July 2011 (FASB 2011).9 Other countries have moved in recent years to accommodate the needs of private company financial statement preparers and users. As one example, the Canadian Accounting Standards Board (AcSB) decided to adopt IFRS for public companies and develop a separate GAAP for private enterprises, after recognizing that “one financial reporting framework does not fit all entities (Canadian Institute of Chartered Accountants [CICA] 2010).”10 As a second example, other countries have adopted International Financial Reporting Standards (IFRS) for small and medium-sized enterprises (SMEs) (BRP 2010).11 Market forces and private negotiation can generate the exceptions to GAAP required for individual cases. However, as the Canadian and IFRS for SME examples suggest, it might be more economical to have a single body generate a uniform set of GAAP exceptions and modifications for private businesses. If specific GAAP exceptions and modifications for private companies are developed, private companies may choose to use “GAAP” or “GAAP with 8
The FASB’s initial analysis has identified six factors that distinguish the financial reporting considerations of private companies from public companies: (1) types of users; (2) access to management; (3) investment strategies; (4) ownership structures; (5) accounting resources; and (6) education. 9 The framework is not meant to be a new conceptual framework that would result in fundamentally different financial statements for private companies and public companies. Rather, its goal is to facilitate consideration of less complex accounting and reporting alternatives that are more cost effective for preparers of private company financial statements, and that also meet the needs of private company financial statement users. 10 Bloomfield et al. (2009) supported the AcSB’s proposed GAAP, which is based on historical cost, requires minimal disclosures, and is principles-based. Canadian private companies can opt to follow IFRS. 11 Refer to IASB (2009) for details about IFRS for SMEs. The European Commission (EC) recognizes an enterprise as medium-sized if its headcount is less than 250, and if it is below either a turnover ceiling or a balance sheet ceiling. Entities qualify for the small (micro) enterprise categories if their headcounts are less than 50 (10), and if they are below turnover or balance sheet ceilings. (EC 2011).
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exceptions” depending on their individual circumstances. We discuss this further (in the context of U.S. GAAP) in the next section.
DO PRIVATE COMPANIES NEED SEPARATE ACCOUNTING STANDARDS? Overview In this section we first discuss the different information needs of users of financial statements for public and privately held companies, and highlight some recent academic research on the value of high quality reporting for private companies. Then, after reviewing recent changes in financial reporting, we conclude that private companies would benefit from a set of standards that are allowed to differ from those that apply to public corporations. We thus agree with the FAF proposal on this issue. Multiple roles of financial accounting information Financial accounting information has several roles; contracting and valuation are the most important. However, the accounting attributes needed for contracting and valuation purposes differ significantly (Watts and Zimmerman 1986; Kothari et al. 2010). For contracting purposes, creditors and lenders require conservative accounting information (e.g., timely recognition of losses) to protect themselves, because their main concern is whether or not the borrowers will default (Watts 2003). In contrast, for valuation purposes equity investors demand unbiased accounting information. The objective of general purpose financial reporting for public companies is to meet the needs of both contracting and valuation.12
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From paragraph OB2 of the SFAC No. 8 (FASB 2010), the objective of general purpose financial reports “is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.”
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Because of differences in types of users and ownership structure, we expect that the informational needs of the stakeholders of public and private companies differ.13 The outside equity ownership aspect of publicly held companies heightens the informational needs of their shareholders to properly value the companies. In contrast, privately held companies are typically financed by debt, and owned by a few less-diversified owners (e.g., founders or family firms). As a result, the valuation needs are greatly reduced for private companies and therefore the contracting needs of their stakeholders are more important. Existing research on private company financial reporting We argue above that private company stakeholders have different financial statement needs than stakeholders of public companies. Even so, private as well as public companies may benefit from high quality financial reporting. Two recent lines of research have examined aspects of financial reporting for private companies: the first investigates the financial reporting practices of private companies and the corresponding economic consequences; the second focuses on the quality of private company financial statements. In the first line of research, Allee and Yohn (2009) find that company age, complexity, and organizational form significantly affect whether private companies use professional accountants to prepare or audit the financial statements and whether the companies use accrualbasis accounting. They further document that companies with audited financial statements have greater access to credit markets and those that used accrual-basis accounting have a borrowing rate about 70 basis points lower. Using a larger sample of private companies, Minnis (2011) shows that lenders put more weight on audited than on unaudited financial statements when pricing their loans and that companies with audited financial statements have a borrowing cost about 25 to 105 basis points lower than those without audited financial statements. Moreover, he 13
Also see FASB (2011).
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shows that audited earnings/accruals are better than unaudited earnings/accruals in predicting future cash flows from operations, thereby explaining his first two results. Hope et al. (2011b) find that firms with annual financial statements reviewed by an external auditor experience fewer perceived problems in accessing external finance, thereby adding to Minnis’ (2011) finding. In the second line of research, Beatty et al. (2002) document that private banks exhibit higher earnings quality than public banks in that they are less likely to manipulate earnings. In contrast, Hope et al. (2011a) find that relative to public firms, private firms exhibit lower financial reporting quality (FRQ) (as proxied for by several commonly used FRQ measures). Katz (2009) shows that private companies that are backed by private equity investors (PE-backed companies) engage in less earnings management and report more conservatively than do non-PEbacked companies around the years they went public. These two lines of research suggest that there are tangible benefits when private companies prepare audited accrual-based financial statements. Since private companies in the U.S. are not required to prepare financial statements, they will produce audited financial statements voluntarily only if they believe the statements will give them a net benefit. The availability of standardized GAAP exceptions and modifications that consider the specific informational needs of the users of private company financial statements and reduce the cost of producing the financial statements may increase the net benefits of audited financial statements, thereby encouraging more private companies to prepare them.14 Recent Changes in Financial Reporting and Their Implication for Private Companies The financial reporting environment in the U.S. has changed considerably in the past decade. Perhaps most important has been the convergence of U.S. GAAP and IFRS. Along with
14
A counterargument is that audited financial statements based on relatively “weak” accounting principles should not necessarily be preferred to those based on high quality GAAP that receive a qualified opinion or are not audited.
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this trend, the FASB has removed conservatism from the Statement of Financial Accounting Concepts No. 8, instead emphasizing “neutrality” of information (FASB 2010, paragraphs BC3.27–3.29), coupled with a movement towards fair value reporting.15 Kothari et al. (2010) argue that as GAAP moves towards fair value reporting it has become less useful for contracting. Given that lenders who demand verifiable and conservative accounting information are the main users of private company financial statements, the shift toward fair value-based accounting will offer less benefit to private company lenders than to equity investors in publicly held companies.16 In addition to implementation issues with fair value accounting for private companies, our reading of many other comment letters to the FAF (see next section) suggests that significant increases in GAAP disclosures over the past 10 to 20 years are also a problem for privately held concerns. Here again, with concentrated ownership and lending, formal financial statement disclosures are less relevant to meeting information needs for private company lenders than for public company investors. While the arguments above might favor separate rules for private companies, we acknowledge that contracting parties can simply adjust GAAP numbers used in their contracts. Leftwich (1983), Beatty et al. (2008), and Li (2010) document this behavior.17 Beatty et al. (2008) show that lenders make conservative adjustments to accounting numbers used in debt covenants. Li (2010) documents a large variation among debt covenants in the items excluded from the computation of earnings and net worth. His evidence is consistent with the hypothesis
15
As Barth (2007, 30) points out, “[i]n almost every standard-setting project of the FASB and IAS, the boards consider fair value as a possible measurement attribute.” 16 Some people question the extent to which FASB wishes to implement fair value-based accounting. 17 Also see Botosan et al. (2006).
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that parties to debt covenants adjust accounting numbers in a manner consistent with efficient contracting. However, if GAAP continues to move toward fair value reporting and increased required disclosures, contracting parties will find it necessary to make more and more accounting adjustments to meet their informational needs. In such a case, users, preparers, and auditors may find it more cost effective to have a standard set of GAAP exceptions and modifications or separate GAAP for private companies than to determine the form and content of the relevant financial information transaction-by-transaction. Given the ongoing FASB and IASB trends towards accounting principles and mandated disclosures that seem to be tailored to the needs of equity investors in publicly held companies, along with other developed nations’ moves towards distinct standards for privately held enterprises, we agree with the FAF proposal that there should be an increased effort to identify U.S. GAAP standards that should be reviewed for exceptions or modifications for privately held companies. The next section presents our concerns with the FAF’s proposal for how this process would be implemented.
SHOULD THE SYSTEM OF SETTING ACCOUNTING STANDARDS FOR PRIVATE COMPANIES BE CHANGED? Current proposal The FAF’s proposed plan is a revised version of the current structure in which the FASB retains authority for setting private company accounting standards through a ratification process. The new structure is meant to be viewed as an enhanced version of the existing structure which includes deeper involvement of the FASB members and staff, more resources committed, and the
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FASB giving a much higher priority generally in the standards setting process to the needs of private companies. The FAF recommends that a Private Company Standards Improvement Council (PCSIC) be established (FAF 2011a). The PCSIC would be comprised of 11 to 15 members that would include users, preparers, and practitioners with significant private company financial reporting (and/or auditing) experience. The PCSIC would be chaired by a FASB member with substantial experience and exposure to private companies. FASB staff would be assigned to work with the PCSIC on outreach and research, with the goal of making efficient use of FASB’s resources and avoiding duplication of efforts. The PCSIC would meet four to six times per year at the FASB’s offices with FASB members in attendance. FASB would ratify or veto all proposed changes applicable to privatelyheld companies.
Responses to the FAF Proposal Responses to the FAF proposal have been varied and at times emotionally charged. The AICPA Governing Council passed a strong resolution protesting the proposal immediately after its publication (AICPA 2011b). The AICPA asserted that an autonomous board with standardsetting authority is needed, and that the proposed structure, where the FASB retains a veto over the proposed PCSIC’s decisions, is unacceptable (AICPA 2011a, 2011b). In response, the Securities and Exchange Commission’s Chief Accountant argued that that the AICIPA’s resolution was “egregious” and that it threatened the independence of the FAF (Cohn 2011). Comment letters provide information on which arguments various individuals and groups find convincing, and the intensity with which some of the individuals and groups hold their opinions. We read approximately 145 comment letters posted on the FAF web site as of
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December 25, 2011 (FAF 2011b).18 According to our discussions with FASB staff, these responses may not be representative of the expected responses, since the more detailed comment letters (such as those prepared by the largest CPA firms) typically are received near the comment period deadline. The comment letters were prepared overwhelmingly by CPA practitioners who primarily serve small private companies. Nearly 80% (112) of the letters opposed the FAF proposed structure. About 71% (103) of the respondents stated that an independent body should do standard setting for private companies, and 58% (84) stated that private and public company reporting needs differ. Forty-two per cent (61) respondents stated that the FASB is too focused on public companies and large CPA firms, and ignores private company needs. Among those who submitted comment letters opposed to the FAF proposal are chairs or other leaders at the following state CPA societies and/or boards: (1) Texas (society); (2) New York (society); (4) Montana (society and board); (5) California (society); (6) Tennessee (society); (7) Rhode Island (society); and the (8) Florida (institute). The National Association of Black Accountants, and an AICPA board member also oppose the FAF proposal. About 14% (21) respondents supported the FAF proposal. Among the supporters are: (1) The National Association of State Boards of Accountancy; (2) the Association for Financial Professionals; (3) the Conference of State Bank Supervisors; (4) the National Venture Capital Association; (5) the Institute of Management Accountants; and (6) PricewaterhouseCoopers LLP. Three state boards – Louisiana, Mississippi, and New Hampshire -- also support the proposal.
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This count does not include a very large number of identical or nearly identical letters critical of the FAF proposal.
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Our review of comment letters supports one clear conclusion: There is strong opposition to the FAF proposal from CPA practitioners whose practices mainly serve small and mediumsized private companies and from many state CPA societies.
Evaluation of proposed standard-setting structure The FAF asserts that continuing FASB’s control of the standard-setting process will ensure that GAAP modifications and exceptions for private companies will be of the same high quality as FASB’s standards. It also argues that the revised standards will not diverge excessively from the existing standards; that is, there will be no incentive to create new standards for the sake of creating new standards as might result if a new standards-setting body were created. However, the proposed structure does not remedy one of the greatest concerns expressed by constituents – that the FASB is not the appropriate body to set private company standards due to its widely-perceived bias toward large, public companies and its reluctance to make recognition and measurement accommodations for private companies.19 At the very least, we have the following concerns about the proposed structure. 1. The proposed structure may not represent significant change. There is urgent need for private-company concerns to be addressed in the accounting standards setting process. However, the FAF’s proposed structure closely resembles a longstanding process that up to the present has not yielded significant results. Constituents have expressed concern over what they perceive as a big-company bias and lack of sensitivity to
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Ultimately the success of any new standards setting structure is an empirical question that cannot be resolved in the abstract. One can create plausible scenarios for both failure and success of a FASB-controlled standards setter.
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private-company needs. As a result, there is much skepticism that the proposal would result in any significant change in accounting standards for private companies. The FAF Trustees’ Report presents ample evidence that the FASB has been increasing its activities in the following areas: (a) soliciting information from private entity stakeholders such as creditors and investors; (b) obtaining active involvement of the small business community in the development of financial accounting and reporting standards; and (c) initiating projects directly in response to feedback received from private companies. From the initial reaction to this proposal, it is clear that these actions have not been enough to inform or convince private company constituencies that significant changes have been made and will make a real difference going forward in addressing their needs. As caretakers of a self-governing profession, the FAF needs to act in the best interests of all participants (constituents) in both appearance and fact. It is not enough for FAF to pay more attention to the accounting and auditing needs of private companies – it must do so in a way that accountants and auditors of private companies will consider appropriate and effective. If the FAF does not do so, the AICPA and its members will continue to reject the FAF proposal and may break from the FAF altogether. 2. The current FAF proposal should be expanded substantially. The Blue-Ribbon Panel seriously considered and its Report comprehensively discusses many different alternatives, presenting advantages and disadvantages of each in detail. In contrast, the FAF’s responses to points made by the Blue-Ribbon Panel are less focused and complete, and provide little evidence that a wide range of options was seriously considered. The FAF report contains many gaps in critical information and incomplete discussion of key arguments. For example:
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The Blue-Ribbon Panel’s report was submitted in January 2011. Two months later, the FAF formed a “ ‘Working Group’ to further consider standard setting for nonpublic entities.” How and why the FAF decided to respond to the Blue-Ribbon Panel in this way is not discussed.
Who were the members of the FAF’s Working Group and what were their affiliations?
The FAF Report states that the Working Group received “significant input from users, practitioners, and preparers of private company and not-for-profit financial statements.” The Working Group also conducted meetings with stakeholders. More information should be provided on the input received and the meetings that were held: where were the meetings held, when were the meetings held, how were the meetings conducted, who were the participants, what was specifically discussed at each meeting, and so on.
The Working Group “met with leading members of the academic community.” Who were these individuals? Which specific research studies (if any) provided relevant evidence?
The FAF Report does not analyze why the Blue-Ribbon Panel’s recommendation for the creation of a separate and authoritative standards-setting board was rejected. They support their position, but do not respond to the rejected BlueRibbon Panel recommendations comprehensively.
We urge the FAF Board of Trustees to provide a clearer and more comprehensive discussion of their arguments and reasoning. This is particularly important since they have rejected the Blue-Ribbon Panel’s recommendation, a recommendation based on well-
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documented input from many individuals and groups and supported by detailed point-by-point reasoning. 3. The “Big GAAP/Little GAAP” argument should be expressed more clearly. The FAF report argues that the proposed PCSIC structure will prevent the development of a so-called “Big GAAP-Little GAAP” split. This argument needs to be made in much greater detail. The FAF Trustees clearly want there to be as little difference between public company and private company accounting standards as practicable. However, many have argued that the FASB has consistently refused to accommodate even the most urgent private company needs and therefore only a separate standards-setting body for private companies will provide a workable set of accounting standards for this group. How FASB involvement would contribute to the creation of private company accounting standards that would meet their needs without differing excessively from public company accounting standards needs to be spelled out and supported.
THE ROLE OF GAAP COMPLEXITY While the debate over whether to establish separate private company GAAP has at times been heated, there is agreement that the complexity of newly emerging standards creates much of the difficulty. For example, Accounting Today reported these comments of FASB Chair Leslie Seidman at a conference hosted by Standard & Poor’s: “At the heart of the matter is complexity,” [Seidman] said. She pointed out that many of the comments that FASB receives on standards such as revenue recognition are about complexity issues faced by both public and private companies. (Cohn 2011) Also, the FAF’s summary of written submissions from the public mentions “complex” or “complexity” 19 times in 15 pages (FAF 2010). Complexity and compliance costs have been shown elsewhere to have real effects on firm organizational form and structure. For example, several studies concluded that the Sarbanes16
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Oxley Act of 2002 (SOX) significantly increased compliance costs and forced many firms off of public stock exchanges (Engel, Hayes and Wang 2007; Bushee and Leuz 2005; and Leuz, Triantis and Wang 2008). Thus evidence suggests that financial reporting complexity causes real operational changes. We observe that there is widespread agreement that accounting complexity affects both privately held and publicly traded firms. However, the FAF’s proposal does not address this issue. We recommend that the FAF and FASB consider serious improvement of the cost-benefit analyses (CBA) that are done for new accounting standards during their development. There is ample evidence that, compared to other regulatory fields, finance and accounting regulators conduct relatively few CBA when proposing rules. Sherwin (2006) claims that “the nation’s financial regulators have largely failed to perform the rigorous analysis required of most other government agencies, especially those in the fields of health, safety, and environmental regulation” (p. 2). While Sherwin (2006) deals mostly with SEC rulemaking, Schipper (2010) focuses exclusively on financial reporting standards and concludes that “[accounting] standard setters do not, in fact, apply a conventional cost-benefit analysis” (p. 311). There will be limits to any CBA. As one example, most financial professionals and academics agree that a strong financial reporting system lowers the cost of capital. Therefore, one could argue that any “benefit” analysis of a proposed standard ought to include a cost of capital effect. Unfortunately, there is no consensus on how to measure equity cost of capital using historical data, and some authors claim that all of the models currently used are unreliable (Easton and Monahan 2005). Thus we have no illusions that a true cost-benefit analysis could fully analyze the economic effects of a proposed rule.20
20
See Schipper (2010) for a more complete discussion of this debate.
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We recommend that the FAF and the FASB consider workable models to evaluate the costs and benefits of every new standard. We recognize that this will take time, and caution against assuming this would be limited to a few areas; the problem appears pervasive.21 Yet a well-conceived CBA framework would create a less politicized standard setting process.
CONCLUDING REMARKS The issues considered in the FAF proposal are controversial. After careful review and consideration of both the academic and practitioner literatures, we agree with the FAF proposal that separate standards for private companies should be implemented in limited situations. However, we urge the FAF to provide more information about its recommended standard-setting structure for private company GAAP. In particular, we hope to see a more comprehensive and convincing analysis to support the recommendation that FASB continue to control private company standard setting. Further, we recommend that a more formal structure for performing cost-benefit analyses of proposed reporting rules be utilized for standards that apply to all companies, be they public or private.
21
For example, the FAF proposal states, in reference to the finding of its Working Group, that “[t]here is consensus that between six and ten current standards cause most, if not all, of the problems for private companies” (p. 11). Yet when reviewing the detailed comment letters that the Blue Ribbon Panel received, the topical areas, while perhaps numbering six to ten, were vast in their impact on firms: income taxes, variable interest entities, fair value, derivatives and other financial instruments, stock compensation, comprehensive income, business combinations, and proposed lease and revenue recognitions standards (BRP 2011, p. G-12).
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REFERENCES Allee, K.D. and T.L. Yohn. 2009. The demand for financial statements in an unregulated environment: An examination of the production and use of financial statements by privately held small business. The Accounting Review 84(1): 1-25. American Institute of Certified Public Accountants (AICPA). 2005. Private Company Financial Reporting Task Force Report Issued February 28, 2005. (The Castellano Report). New York: AICPA. ________. 2011a. Independent Board is Needed for PCGAAP. Blog posted on Oct 17, 2011 by Barry C. Melancon, President and CEO, AICPA. Available at http://blog.aicpa.org/2011/10/aicpa-tells-faf-independent-board-is-needed-for-private-companyreporting.html. ________. 2011b. AICPA Council Votes Overwhelmingly to Send a Strong Message to FAF: Adopt the Blue Ribbon Panel Recommendations for an Independent Board. Press release dated Oct 18. Available at http://www.aicpa.org/Press/PressReleases/2011/Pages/Adopt-Blue-RibbonPanel-Recommendations.aspx. Barth, M.E. 2007. Research, Standard Setting, and Global Finanical Reporting. Foundations and Treads in Accounting. Beatty, A., B. Ke, and K. Petroni. 2002. Earnings management to avoid earnings declines across publicly and privately held banks. The Accounting Review 77(3): 547-570. Beatty, A., J. Weber, and J.J Yu. 2008. Conservatism and Debt. Journal of Accounting and Economics 45: 154-174. Bloomfield, R., T.E. Christensen,, R.H. Colson, K. Jamal, S. Moehrle, J. Ohlson, S. Penman, G. Previts, T. Stober, S. Sunder, and R.L. Watts. 2009. Comments on Canadian Accounting Standards Board Exposure Draft on Generally Accepted Accounting Principles for Private Enterprises. Unpublished manuscript, Financial Accounting Standards Committee of the American Accounting Association. Blue-Ribbon Panel on Standards Setting for Private Companies (BRP). 2010. Meeting Minutes – Open Session -- April 12, 2010. AICPA, FAF, and NASBA. ________. 2011. Report to the Board of Trustees of the Financial Accounting Foundation. January. Available at http://www.accountingfoundation.org/cs/ContentServer?site=Foundation&c=Document_C&pag ename=Foundation%2FDocument_C%2FFAFDocumentPage&cid=1176158181336. Botosan, C.A., H. Ashbaugh-Skaife, A.L. Beatty, P.Y. Davis-Friday, P.E. Hopkins, K.K. Nelson, K. Ramesh, R. Uhl, M. Venkatachalam, and G. Vrana. 2006. Financial accounting and reporting standards for private entities. Accounting Horizons 20(2): 179-194.
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