From the May 2010 issue of Treasury & Risk magazine

Rightsizing Accounting

The convergence movement fuels the quest for standards tailored to the reporting needs of smaller companies that are global.

After decades of discussion and debate, private companies in the U.S. may finally get their own set of accounting standards. While a move to a simpler set of standards for smaller companies has been debated for decades, globalization and the prospect of convergence with global accounting standards are making such a switch more likely than ever. Despite the progress, it's expected to take years for the change to occur as experts decide which system would work best for U.S. private companies.

"There are two general debates," says D.J. Gannon, leader of Deloitte's IFRS Center for Excellence. "First, do we move to a global set of standards? Second, what do you do for public vs. private companies?"

Last July, the International Accounting Standards Board published International Financial Reporting Standards for Small and Medium-sized Entities (IFRS for SMEs), targeting the private companies that make up approximately 95% of all companies worldwide. That prompted wide discussion in the United States about whether U.S. generally accepted accounting principles (GAAP), which are currently used by most private companies, satisfy their needs.

In December, the Financial Accounting Foundation, the American Institute of Certified Public Accountants and the National Association of State Boards of Accountancy formed a blue-ribbon panel to look at accounting standards for U.S. private companies, including the question of a separate set of standards. The panel's recommendations are due by year-end.

Private companies in the U.S. that don't have publicly listed stock or debt aren't bound by statutory requirements to follow any specific accounting standards. Most employ GAAP because the users of their financial statements, including banks, suppliers, owners and regulators, require it.

"Like all private companies, we borrow money, and our loan agreements require us to report periodically to our banks under GAAP," says William Knese, a member of the blue-ribbon
panel and vice president of finance and administration at machinery maker Angus Industries, a private company in Watertown, S.D.

GAAP is employed because it's convenient and banks' publicly traded clients already use it. But users of financial statements from private companies are typically more focused on assessing short-term cash flows, liquidity and solvency, while earnings per share matter more to users of publicly held companies' financial statements.

For private companies, there are several alternatives that could replace GAAP, including the possible development of a version of GAAP for private companies, popularly termed Little GAAP. IFRS for SMEs resembles IFRS in that both are principle-based standards. GAAP is based on rules, leaving less room for interpretation, and presumably Little GAAP would also be rule-based.

IFRS for SMEs is a simplified version of IFRS, though, that involves fewer disclosure requirements and accounting options. For example, if a company acquires a fixed asset like a building, under IFRS, it can record the acquisition using either historical cost with accumulated depreciation or fair value on an annual basis. Under IFRS for SMEs, the fair-value option is not available.

"It's more economical," says Bob Dohrer, a partner and national director at accounting firm RSM McGladrey. "Smaller companies don't have to spend the resources to study and evaluate options."

In general, private companies welcome the prospect of accounting standards tailored to their specific reporting needs, as well as the possibility such standards could be global.

Hubert Glover, co-founder and president of REDE, a Washington-based company that provides support services to the federal government and has annual revenue between $10 million and $15 million, currently uses GAAP but says ultimately, a move to IFRS for SMEs adapted for the U.S. market makes sense.

"U.S. GAAP for SMEs would be fine, but I don't think it would be visionary, because many small companies are becoming global," says Glover, who's also a member of the blue-ribbon panel. He notes, however, that a switch would take time, since many private companies are not yet aware of IFRS for SMEs. "IFRS is not on my radar screen, in particular because it hasn't been interpreted effectively," Glover says. "I'm speaking for many of my peers."

So far, very few companies in the U.S. use IFRS for SMEs. "By and large, companies that have adopted it tend to be U.S. subsidiaries of foreign companies," says Dohrer.

Knese says that while he applauds the move from rule-based to principle-based accounting, such as IFRS for SMEs, bankers and auditors will be hesitant to replace GAAP with new standards too quickly. "Bankers and lenders understand GAAP," he says. "When they're comfortable with IFRS is when they'll require it."

A move to IFRS for SMEs would likely occur in tandem with a decision by the Securities and Exchange Commission to require publicly traded U.S. companies to adopt IFRS. While moving to IFRS would require bankers to learn a new set of accounting standards, having the same kind of standards for public and private companies would be a convenience for banks.

After setting a road map for convergence with international accounting standards in 2008, the SEC in February said it would undertake further study of IFRS. It also delayed the potential adoption date for accelerated filers from 2014 to 2015 at the earliest. Although the SEC doesn't oversee private companies, it is considering the impact of IFRS for SMEs on private companies as part of the debate on international standards.

In addition to uncertainty about whether the U.S. will adopt IFRS, there's the question of cost, which would likely be high as companies made the transition to using IFRS for SMEs. Cost is a particular concern for smaller private companies, which might not have the capacity, human or financial, for such a large project. "We don't have the resources to incur a cost we may not recover," says Glover, arguing that the switch "should be done in a manner that's pragmatic. If it's done right, [the cost] should be nominal."

In the longer term, though, most agree it would be less expensive for private companies to use streamlined standards with fewer requirements, such as IFRS for SMEs or Little GAAP.

"There's a lot of fluidity right now, and that's complicated because companies have to deal with that," says Deloitte's Gannon. "But we're talking about less cost for companies ultimately, especially a few years down the line."