Private Company Alternatives: A Beacon of Simplicity – but Proceed with Caution
Author: Peter Kern
After years of increased financial reporting complexity, the Financial Accounting Standards Board (FASB) has listened to financial statement preparers’ and users’ appeals for relief—and progress is well underway. It began in 2013 when FASB created the Private Company Council (PCC) to reduce the complexity of certain U.S. generally accepted accounting principles (GAAP) standards for private companies.
In December 2013, FASB and the PCC agreed on a decision-making framework for future private company accounting alternatives intended to achieve better balance between relevance and cost in U.S. GAAP financial reporting standards. First and foremost, the Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies takes into account financial statement user needs. Since the guide’s development, FASB has issued four Accounting Standards Updates (ASU) intended to simplify accounting standards for companies other than public business entities (PBE), with certain exceptions. Adoption of the new standards is optional; a private company can decide whether to adopt any or all of the accounting alternatives available.
Eligibility – Definition of a Public Business Entity
In December 2013, FASB issued ASU 2013-12, Definition of a Public Business Entity, to clarify which nonpublic entities potentially qualify for alternative financial accounting and reporting guidance. Companies not meeting the definition of a PBE are often coined “private companies.” In general, PBEs are those accessing capital markets by issuing publicly traded securities. A company meeting any of the following criteria triggers classification of the company as a PBE:
- Securities and Exchange Commission requirement
- Securities Exchange Act of 1934 requirement
- Foreign or Domestic Regulatory Agency requirement
- Over-the-counter market requirement
- Legal, contractual or regulatory requirement
Companies not meeting any of these criteria should proceed with caution and consider unique facts and circumstances influencing whether it’s prudent to adopt the accounting alternatives. Before adopting a standard, a company is encouraged to consult with current and future financial statement users, including but not limited to lenders, owners and regulators. Companies considering a public offering or acquisition by a public company should proceed with extra caution. The time necessary to restate financial statements that adhere to PBE standards may not be worth the benefit of adopting an accounting alternative.
As noted, an eligible private company should evaluate each standard to determine whether the standard is applicable and whether it’s advantageous to adopt. In 2014, FASB issued four ASUs providing private company accounting alternatives. Depending on the industry, certain standards may not be relevant. Here’s a brief summary of the four standards:
- ASU No. 2014-02 – allows a company to amortize goodwill on a straight-line basis over a period of 10 years or less; goodwill only would be tested for impairment when a triggering event occurs
- ASU No. 2014-03 – allows a simplified hedge accounting approach to account for interest rate swaps entered into for the purpose of converting variable-rate interest payments to fixed-rate payments
- ASU No. 2014-07 – allows a company to elect, in certain conditions, not to apply variable-interest entity guidance to a leasing arrangement with a lessor under common control
- ASU No. 2014-18 – allows a company to simplify its accounting by recognizing fewer intangible assets in a business combination; an entity adopting this standard also must adopt ASU 2014-02
While the overall impact of adopting an alternative may reduce the cost and complexity of financial reporting, companies should carefully consider the implications in the near and long term.
The PCC continues its work on simplifying financial accounting and reporting, including advising FASB on projects that may apply to all entities. These include:
- Uncertain tax positions (unrecognized tax benefits)
- Share-based compensation
- Partnership accounting
- Debt issuance costs
- Accounting for financial instruments
- Adoption requirements for GAAP alternatives
As financial statement preparers and users enter the era of alternative financial accounting standards acceptable under U.S. GAAP, only time will tell if this approach is beneficial to stakeholders. Companies should engage in discussions with their advisors and stakeholders and evaluate their unique circumstances before adopting a U.S. GAAP alternative.
Refer to our Private Company Reporting page for additional information on these topics. For more, contact your BKD advisor.