Accounting & Auditing

Considering Private Company Alternatives

February 2014

Private company initiatives are moving quickly. The definitions of "public business entity" and "private company" have been established and added to the Master Glossary. In January 2014, the Financial Accounting Standards Board (FASB) issued two standards offering private companies financial accounting and reporting alternatives to U.S. generally accepted accounting principles (GAAP). Both standards are effective for the first annual period beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015, with early adoption permitted. This means qualifying companies could adopt and apply the standards to calendar year 2013 financial statements. This article focuses on items for companies not meeting one of the five criteria of a public business entity (and, by default, meeting the definition of a private company) to consider before adopting an accounting alternative. Additional considerations are provided for financial institutions.

Public Business Entity

Overview

In December 2013, FASB issued its last accounting standard of the year, Accounting Standards Update (ASU) 2013-12, Definition of a Public Business Entity. The standard defined a public business entity for U.S. GAAP financial reporting purposes and amended the Master Glossary. The definition was issued to determine which entities would be within the scope of future Private Company Council (PCC) and FASB simplification projects. In general, entities meeting the definition of a public business entity will not be considered, at least initially, when FASB and PCC discuss U.S. GAAP financial accounting and reporting alternatives.

In January 2014, FASB issued ASU 2014-02, Intangibles – Goodwill and Other (Topic 350), and 2014-03, Derivatives and Hedging (Topic 850):  Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps – Simplified Hedge Accounting Approach. Both updates were issued upon consensus of the PCC and only apply to private companies.  FASB defined a private company in ASU 2014-02 and added this definition to the Master Glossary. 

FASB defines a private company as a company other than a public business entity, not-for-profit (NFP) entity or employee benefit plan (EBP). The next step is to understand FASB’s definition of a public business entity. Before moving on, note a couple of items.  First, current accounting standards include multiple definitions of “nonpublic entity” and “public entity,” as do regulators such as the SEC, PCAOB and industry-specific regulators. All these definitions remain intact. “Public business entity” applies to U.S. GAAP accounting standards, and the definition became effective upon its addition to the Master Glossary in December 2013. It applies to the alternatives for private companies, beginning with ASU 2014-02 in January 2014. Secondly, the definitions of public business entity and private company cannot be applied carte blanche. For example, FASB determined financial institutions are ineligible to apply ASU 2014-03 on interest rate swaps even if the financial institution meets the definition of a private company. Similarly, FASB will decide on a standard-by-standard basis which NFPs and EBPs should be permitted to apply financial accounting and reporting alternatives within U.S. GAAP. 

Criteria

As for the definition of a public business entity, if any of the criteria below are met, an entity is a public business entity for purposes of U.S. GAAP. 

Criteria Classification

Definition of U.S. GAAP “Public Business Entity”

(a)

SEC Requirement

The entity is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements or does file or furnish financial statements (including voluntary filers) with the SEC (including other entities with financial statements or financial information required to be or included in a filing).

(b)

Securities Exchange Act of 1934 Requirement

The entity is required by the Securities Exchange Act of 1934, as amended, or rules or regulations promulgated under the act, to file or furnish financial statements with a regulatory agency other than the SEC.

(c)

Foreign or Domestic Regulatory Agency Requirement

The entity is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restriction on transfer.

(d)

Over-the-Counter (OTC) Market Requirement

The entity has issued or is a conduit bond obligor for securities traded, listed or quoted on an exchange or an OTC market.

(e)

Legal, Contractual or Regulatory Requirement

The entity has one or more securities that are not subject to contractual restrictions on transfer, i.e., the securities are not subject to management preapproval on resale, and is required by law, contract or regulation to prepare U.S. GAAP financial statements, including footnotes, and make them publicly available on a periodic basis, e.g., interim or annual periods. An entity must meet both of these conditions to meet this criterion.

In general, public business entities are those entities that access the public capital markets by issuing securities that are publicly traded. This premise follows FASB’s historical fundamental concept that in order to be defined as a nonpublic entity in U.S. GAAP, the entity must not have securities that trade in a public market either on a stock exchange or in an OTC market. Criterion (e) is intended to capture securities not on an exchange or an OTC market.

Implications

General

The financial accounting and reporting alternatives include simplification in the fundamental areas of recognition, measurement, disclosure, display (or presentation), effective date and transition method. Traditionally, nonpublic companies have been afforded a longer transition date, and this tradition presumably would carry over to private companies. The benefits of simplified recognition, measurement and disclosure requirements will vary by company and industry. These benefits, however, will be questionable if two sets of books must be maintained.   

Consider criterion (a) above, for example. If an entity is classified as a public business entity solely because its financial statements or financial information is included in another entity’s filing with the SEC, the entity is classified as a public business entity only for that purpose. The private company is permitted to apply accounting alternatives in its standalone financial statements that are not included in the SEC filing. The question for management to consider is whether it's worth the time and expense to maintain two sets of books; in most cases, the answer would be “no.”

Additional Considerations for Financial Institutions

FDICIA

Banks with total assets in excess of $500 million are subject to the regulatory reporting requirements of the Federal Deposit Insurance Corporation Improvement Act (FDICIA). This entails filing annual audited U.S. GAAP financial statements with the Federal Deposit Insurance Corporation (FDIC) and making them publicly available upon request.

We believe this requirement results in banks that are subject to FDICIA requirements meeting the second part of criterion (e):  The bank is required—by law, contract or regulation—to prepare and make U.S. GAAP financial statements publicly available on a periodic basis. When a bank also has one or more securities not subject to contractual restrictions on transfer, we believe it meets the definition of a public business entity and, accordingly, would not have the option to adopt financial accounting and reporting standards for private companies.

Call Reports & Thrift Financial Reports

While they are publicly available, we do not believe the requirements to file quarterly and annual Reports of Condition and Income (Call Reports) and Thrift Financial Reports (TFR) meet criterion (e), since they do not require compliance with all of the disclosure requirements under U.S. GAAP. However, there is speculation that federal banking regulators will not allow adoption of FASB’s private company accounting alternatives in these reports. If so, financial institutions must evaluate whether it's worth the time and expense to maintain two sets of books if they wish to adopt those alternatives in their GAAP financial statements. Time will tell.

Conclusion

Even if certain financial institutions qualify to elect U.S. GAAP alternatives, they should proceed with caution until federal banking regulators determine whether they will allow FASB’s private company alternatives to be adopted in regulatory reports; institutions subject to FDICIA have additional considerations to evaluate.  

For more information, contact your BKD advisor.

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