Private Company Financial Reporting Strategies for Small and Midsize Companies

INTRODUCTION At a recent national conference, Leslie F. Seidman, current chair of the Financial Accounting Standards Board (FASB) noted that there were "two elephants in the room" (Seidman, 2011). She was referring to International Financial Reporting Standards (IFRS) and private company financial reporting, which she identified as the two most significant issues affecting the accounting profession, companies, and capital markets (Seidman, 2011). These two issues while targeting different types of companies--public and private--are related. Specifically, the likely future implementation of IFRS in the U.S. has lent momentum to a longstanding movement toward the creation of private company financial reporting standards. For decades, private companies have called for the creation of financial accounting and reporting standards tailored specifically to the needs of their financial statement users. Recent developments in financial reporting have significantly increased the chances of this finally becoming reality. The advent of private company accounting standards, likely will provide companies with the opportunity to choose between private company accounting standards and accounting standards required to be used by public companies. Especially small and midsize private companies will benefit from the development of private company standards. However, prior to adopting a new set of accounting standards, private companies should carefully consider a number of factors relating to their short-term and long-term strategic plans and assess the advantages and challenges of each choice. This study provides information about the current status of financial reporting for private companies in the U.S. and explores key factors that private companies should consider. The paper is organized as follows. The first section presents background information regarding accounting standard setting in the U.S., explains the challenges that current accounting standards entail for private entities and their financial statement users, and informs about the current status of the quest for private company financial reporting standards. The second section presents a discussion of factors that private companies may want to consider and the potential effect of their choice on their strategic short term and especially long-term goals. BACKGROUND By law, private companies are not required to issue annual or quarterly financial statements. Thus, private companies can choose to apply U.S. Generally Accepted Accounting Principles (U.S. GAAP), or another set of standards, such as cash basis. In fact, since the American Institute of Certified Public Accountants (AICPA) recognized the International Accounting Standards Board (IASB) as a "designated standard setter" in May of 2008 (AICPA, 2008), private companies can utilize IFRS as an alternative to U.S. GAAP. However, many private entities, including small and midsize private companies, utilize accrual accounting, apply current U.S. GAAP, and issue financial statements to outside users. The reasons for choosing to apply U.S. GAAP vary, but tend to include specific lender requirements and desired comparability with public companies, which are required to issue annual reports consistent with U.S. GAAP. Since its creation in 1973, the Financial Accounting Standards Board (FASB) has become the primary source of U.S. GAAP. In its mission statement, FASB states that its mission is "to establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports" (FASB, n.d., Facts about FASB). Thus, the standards issued by FASB are meant to serve as financial accounting and reporting rules for both public and private companies. FASB derives its standard setting authority from the U.S. Securities and Exchange Commission (SEC), which has the legal authority to set accounting standards for public companies in the U. …