Accounting Regulations for a Private Company (Guest Commentary)

Smith Hardware Inc. is a fictitious regional closely held C corporation whose shares are all held by family members. The family gets together during the Christmas and New Year's holidays, and one of the main items of discussion is how well the company did in the last year. These discussions are only in general terms, but are fairly accurate since the employees with knowledge of operations and financial data are part of the family group.

Another issue always discussed is why the CPA firm that does their audit and prepares the corporation's financial statement costs so much and always presents information and data that seem to have very limited use in helping them run the company for the next year.

The CPA firm explains that the Generally Accepted Accounting Principles impose specific reporting standards that, for the most part, determine what is presented in the annual financial statement. Anything nonstandard requires specific disclosure, which entails extra work to determine and present. In addition, certain positions taken on the corporate income tax return are required by GAAP and always require explanation by the CPA preparing that annual return.

When Smith Hardware needs a loan to make capital improvements or a line of equity to help it through slow times, the bank always accepts the annual statement prepared by the CPA firm but also typically asks for a current cash-flow analysis and a copy of the most recent income tax return. The bank explains its actions by claiming the financial statement is very comprehensive but contains information not pertinent to making the lending decision.

Smith understands the need for the annual statement but also is frustrated by the fact that the bank requires other information to make its decision, casually reviewing the expensive report prepared by the CPAs.

This is a simplified example of a real issue that affects a large segment of the U.S. economy. About 15,000 businesses are publicly held companies for which U.S. GAAP have been developed. The principles address issues that occur in capital markets for those companies and their shareholders.

However, about 28 million private businesses have no need for all of the public company rules but must have them applied to complete their annual financial statements. This frequently results in unnecessarily complex financial statements that aren't useful to private company owners, lenders or investors. Many of these companies are small and medium-sized organizations that report to a narrow range of financial statement users, such as lenders, venture capitalists and insurers. Another result is the large number of exceptions to GAAP frequently reported on these annual statements.

This issue has been studied for nearly three decades without a definitive resolution proffered to the small-business community.

Now, however, a blue ribbon panel composed of members of the accounting profession and a cross-section of financial reporting constituencies - including lenders, investors, owners, preparers and auditors - has concluded that a systemic problem does exist. It has made two significant recommendations to solve the problem. The first recommendation is that GAAP should be changed to accommodate private company needs and, second, that a separate board should be formed to monitor the process and make those recommendations to the Financial Accounting Foundation, which oversees the Financial Accounting Standards Board and the Governmental Accounting Standards Board.

You will hear much about this issue if you pay attention to the financial news in the coming months. The FAF is expected to make proposals on the matters involved and will publish those proposals this fall and request comments.

If you are at all interested in the issue, please send your responses directly to the FAF when the proposals are unveiled. Only by making your voice heard can change come about, change that, it's hoped, will result in more relevant and useful financial data for the private company community. Please contact your CPA for more information.

(Stanley J. Kozij is a CPA with Deininger Wingfield & Corry of Little Rock. He is the president of the Arkansas Society of Certified Public Accountants. Some information for this article was supplied by the American Institute of Certified Public Accountants. Email him at SK@DWFirm.com)