In recent years there has been extensive activity in the world of financial reporting, from the ongoing efforts to converge International Financial Reporting Standards (IFRS) with U.S. generally accepted accounting principles (GAAP) to the launch of the Private Company Council (PCC) to the release of the American Institute of Certified Public Accountants (AICPA) Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs).
Standard Setting for U.S. GAAP
U.S. GAAP is the most acknowledged set of accounting standards in this nation. The term “generally accepted accounting principles” was first formally used in the 1930s by the Committee on Accounting Procedure of the American Institute of Accountants (AIA), which was later reorganized as the AICPA.
For decades, three organizations effectively set the standards under U.S. GAAP: the Financial Accounting Standards Board (FASB), the FASB’s Emerging Issues Task Force (EITF) and the AICPA. In 2002, however, the AICPA bowed out of the standard-setting process, leaving the task for nongovernmental entities in the United States solely to the FASB and EITF.
Until a few years ago, U.S. GAAP was scattered across a hodgepodge of difference sources published by the FASB, EITF or AICPA, including:
• Statements of Financial Accounting Standards (FAS);
• FASB Interpretations (FINs);
• FASB Staff Positions (FSPs);
• FASB Technical Bulletins (FTBs);
• EITF Abstracts;
• Derivatives (Statement 133) Implementation Group
(DIG) Issues;
• Accounting Research Bulletins (ARBs);
• Accounting Principles Board (APB) Opinions;
• AICPA Practice Bulletins (PBs);
• AICPA Accounting Interpretations (AINs);
• AICPA Accounting Statements of Position (SOPs).
In 2009, following a four-year process, the FASB formally approved the Accounting Standards Codification (ASC) as the single source of authoritative U.S. accounting and reporting standards, other than guidance issued by the U.S. Securities and Exchange Commission (SEC). The ASC thus superseded all of the existing non-SEC standards. The codification reorganized the thousands of U.S. GAAP pronouncements into roughly 90 accounting topics. The ASC also includes relevant SEC guidance. Updates are made via the issuance of FASB Accounting Standards Updates (ASUs).
Public vs. Private Companies Under U.S. GAAP
Until recently, the differences between the U.S. GAAP standards for public and private companies were primarily in the effective dates, which typically are earlier for public than nonpublic entities. Public companies might have greater disclosure obligations as well. Otherwise, private companies are generally subject to the same standards as public companies.
In 2012, though, the Financial Accounting Foundation (FAF), which oversees the FASB, established the Private Company Council (PCC) with the goal of improving the process of setting accounting standards for private companies. PCC is charged with determining whether exceptions or modifications to existing U.S. GAAP are needed to address the needs of users of private-company financial statements. PCC also serves as the primary advisory body to FASB on the appropriate private-company treatment for items under active consideration on the FASB’s technical agenda.
Although PCC can propose changes, any changes are subject to endorsement by FASB and will be issued as ASUs and included in the ASC. PCC, therefore, cannot unilaterally modify U.S. GAAP.
Since the PCC launch, differences in the substance of recognition and measurement standards for public and private companies, as opposed to differences just in effective dates, have begun to emerge. And, PCC has identified several additional areas of concern voiced by its private-company constituents.
Among the most commonly mentioned items are uncertain tax positions; fair value measurement and disclosures; disclosures related to defined benefit pension and other post-employment benefits plans; impairment testing of goodwill and intangibles; and derivatives and hedge accounting.
Less commonly cited items include stock compensation and other equity issues, as well as other comprehensive income (OCI).
PCC has already addressed a few of these areas by issuing four proposals, all of which have been endorsed by the FASB and released for public comment:
• PCC Issue No. 13-01A, Accounting for Identifiable Intangible Assets in a Business Combination, would not require private companies to separately recognize certain intangible assets acquired in a business combination. Such companies could recognize only those intangible assets arising from noncancellable contractual terms or those arising from other legal rights. Otherwise, an intangible asset would not be recognized separately from goodwill even if it were separable.
• PCC Issue No. 13-01B, Accounting for Goodwill Subsequent to a Business Combination, would permit amortization of goodwill (the residual asset recognized in a business combination after recognizing all other identifiable assets acquired and liabilities assumed) and a simplified goodwill impairment model for private companies. Private companies could amortize goodwill over the useful life of the primary asset acquired in a business combination, not to exceed 10 years. Goodwill would be tested for impairment only when a triggering event occurs that would more likely than not reduce the fair value of a company below its carrying amount.
Further, goodwill would be tested for impairment at the companywide level; currently, it must be tested at the reporting unit level.
• PCC Issue No. 13-02, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements, would exempt many private companies from applying variable interest entity guidance to lessor companies under common control.
• PCC Issue No. 13-03, Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps, would give private companies, other than financial institutions, the option to use two simpler approaches to accounting for certain types of interest rate swaps that are entered into by a private company for the purpose of economically converting its variable-rate borrowing to a fixed-rate borrowing.
Under both approaches, the periodic income statement charge for interest would be similar to the amount that would result if the private company were to have entered into fixed-rate borrowing instead of variable-rate borrowing.
If these less complex standards are adopted, private companies could apply them instead of the existing standards on these topics. If adopted as final standards, private companies could enjoy simpler accounting.
SEC registrants must also take heed of the commission’s Staff Accounting Bulletins (SABs). SABs reflect the commission staff’s views regarding accounting-related disclosure practices. SABs represent interpretations and policies followed by the Division of Corporation Finance and the Office of the Chief Accountant (OCA) in administering the accounting and disclosure requirements of the federal securities laws.
Is That Entity Public?
Determining which companies are public, and which are not, is not as straightforward as it would appear. FASB stakeholders have noted the inconsistency and complexity of having multiple definitions of a nonpublic entity and a public entity within the current U.S. GAAP. In response, FASB undertook a project to clarify which nonpublic entities would potentially qualify for alternative accounting and reporting guidance.
On Aug. 7, 2013, FASB issued a potentially significant proposal, Definition of a Public Business Entity: An Amendment to the Master Glossary. Notably, the proposed definition is broader than simply those entities that file with the SEC, encompassing, among others, certain entities that have regulatory and legal requirements to make financial statements publicly available.
According to the proposal, a “public business entity” is one that meets any one of the following criteria:
• It is required by the SEC to file or furnish financial statements or does file or furnish financial statements with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
• It 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.
• It is required to file or furnish financial statements with a regulatory agency in preparation for the sale of securities or for purposes of issuing securities.
• It has (or is a conduit bond obligor for) unrestricted securities that are traded or can be traded on an exchange or an over-the-counter market.
• Its securities are unrestricted, and it is required to provide U.S. GAAP financial statements to be made publicly available on a periodic basis pursuant to a legal or regulatory requirement.
The proposed definition appears to exclude certain not-for-profit entities and employee benefit plans. Entities deemed to be public business entities would be excluded from using guidance issued by the PCC. The proposed definition would also clarify which entities potentially will qualify for alternative accounting and reporting guidance and fall within the scope of the FASB’s framework for determining whether and when to modify U.S. GAAP for private companies, Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies, once it is finalized.
The proposed amendment to the Master Glossary would not affect existing requirements in U.S. GAAP. FASB did pose a question for commenters about whether to undertake a second phase to examine whether to amend current U.S. GAAP with a new definition resulting from this proposal.
The Role of the SEC
The authority for standard setting for U.S. registrants in the United States actually resides with the SEC. The SEC long ago delegated that authority to the FASB, which it continues to oversee, as well as having a hand in shaping the FASB agenda. The SEC’s OCA assists the commission with executing its responsibility under the securities laws to establish accounting principles and oversee the private-sector standard-setting process.
International Standards and Convergence
International accounting standards, referred to as International Financial Reporting Standards (IFRS), are set by the International Accounting Standards Board (IASB), a London-based independent body of the IFRS Foundation. Launched in 2001, IASB is the successor international standard setter to the International Accounting Standards Committee (IASC). IASB’s mission is to develop a single set of global accounting standards that require transparent and comparable information in general purpose financial statements.
Notably, IFRS, though issued by IASB, are adopted in various fashions in different countries. Some adopt IFRS directly, while others apply their own regime for adoption, such as adhering to a legislative or regulatory due process, which might result in the adoption of a standard as issued by the IASB or modified to accommodate a country’s particular needs.
The AICPA formally recognized IASB as an accounting body for purposes of establishing international financial accounting and reporting principles in 2008, removing a potential barrier and giving U.S. private companies and not-for-profit organizations the option to use IFRS as an alternative to U.S. GAAP. The SEC decided in 2007 to allow foreign companies that file with the agency, referred as foreign private issuers (FPIs), to report using IFRS without reconciling to
U.S. GAAP
In 2002, IASB and FASB signed a memorandum of understanding (MOU), known as the Norwalk Agreement, under which they agreed to work together to achieve convergence of IFRS and U.S. GAAP and establish a common set of global standards that companies worldwide would use for both domestic and cross-border financial reporting. The 2002 agreement was followed in 2006 by a second MOU, which was updated in 2008 and 2010. In early 2013, the IFRS Foundation created a new Accounting Standards Advisory Forum (ASAF) to broaden the scope of the IASB’s collaborative efforts. FASB participates as one of ASAF’s 13 members.
So how far have the boards come on convergence? IASB and the FASB have completed several converged accounting standards, including those on business combinations, noncontrolling interests and fair value measurement. They have ongoing major projects addressing revenue recognition, leases, insurance contracts and accounting for financial instruments. Differences remain in the application of other important standards, such as balance sheet offsetting and other comprehensive income.
Some have concluded that complete convergence is unlikely ever to be achieved and that the objective now is to get IFRS and U.S. GAAP as close as possible, knowing they will never be identical. The main obstacle appears to be the divergent needs of various stakeholders.
The topic of convergence has been on the SEC’s agenda for many years. In 2008, the SEC released a proposal for public comment, Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers. The commission subsequently issued a statement in support of convergence and a staff work plan on incorporating IFRS into the financial reporting of U.S. issuers.
In July 2012, the SEC staff issued its final report on the work plan. The report made no recommendation on the potential incorporation of IFRS into U.S. financial reporting; instead, it called for additional analysis and consideration. The report cited several unresolved issues, including the diversity in how accounting standards (including IFRS) are interpreted, applied and enforced in various jurisdictions around the world; the potential costs to U.S. issuers of adopting or incorporating IFRS; the education of investors; and corporate governance.
Nonetheless, in remarks made at the 32nd Annual SEC and Financial Reporting Institute Conference on May 30, 2013, Paul Beswick, SEC chief accountant, focused on the reasons IFRS matter in today’s U.S. capital markets. More than 450 FPIs use IFRS to prepare and file their financial statements with the SEC. Beswick did not try to predict the SEC’s next steps when it comes to IFRS for domestic issuers — understandably, in light of the recent changes at the commissioner level.
AICPA Financial Reporting Framework
In June 2013, the AICPA unveiled its new FRF for SMEs for private companies not required to produce U.S. GAAP-compliant financial statements. Its goal was to provide small and medium-sized for-profit private entities a framework for preparing streamlined, relevant financial statements. It emphasized, though, that it fully supports the efforts of FAF, FASB and PCC to address the private-company environment through changes in U.S. GAAP.
FRF for SMEs is not a U.S. GAAP framework or IFRS but instead an “otherwise comprehensive basis of accounting” (OCBOA), which is similar to a cash basis or an income tax basis, and it has significant differences with U.S. GAAP. Companies considering using the framework will want to analyze the relevant compliance issues, including those related to partnership, financing or lease agreements.
In addition, a company must adopt the framework in its entirety; FRF for SMEs was developed to be a self-sufficient, principles-based reporting framework. As such, the company shouldn’t look to the rules-based U.S. GAAP or any other generally accepted accounting principles for guidance.
This article first appeared in the November 2013 issue of Financial Executive magazine.