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By Joel Steinberg, CPA, Goldstein Golub Kessler & Company, P.C.

In December 1996, the FASB issued SFAS No. 126, Exemption from Certain Required Disclosures About Financial Instruments for Certain Nonpublic Entities, which amends SFAS No. 107. The statement is one more instance where GAAP for public companies are more extensive than for nonpublic companies. SFAS No. 126 makes the disclosures about the fair value of financial instruments prescribed by SFAS No. 107 optional for entities that meet all of the following criteria:

* Is a nonpublic entity.

* Total assets are less than $100 million on the date of the financial statements.

* Has not held or issued any derivative

financial instruments as defined in SFAS No. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments, other than loan commitments, during the reporting period.

The following summarizes other areas of GAAP that contain provisions applicable to public companies or exemptions for nonpublic companies.

Definition of a Public Entity

The definition of a public entity is not uniform throughout GAAP. A nonpublic entity is defined in SFAS No. 126 as any entity other than one a) whose debt or equity securities trade in a public market either on a stock exchange (domestic or foreign) or in the over-the-counter market, including securities quoted only locally or regionally, b) that makes a filing with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market, or c) that is controlled by an entity covered by a) or b). SFAS No. 123 defines a public entity similarly except that "debt" is omitted.

The definitions found in APB No. 28 and SFAS Nos. 21, 69, 79, and 109 use criteria essentially the same as a) and b) above, but do not include criteria c). Accordingly, the public entity provisions of these statements are not applicable to nonpublic subsidiaries of entities that meet criteria a) or b).

SFAS No. 128 requires the presentation of EPS by all entities that have issued common stock or potential common stock (options, warrants, convertible securities, or contingent stock agreements) if those securities trade in a public market either on a stock exchange or in the over-the-counter market. The statement also requires the presentation of EPS by an entity that has made a filing or is in the process of filing with a regulatory agency in preparation for the sale of those securities in a public market. Entities whose publicly traded securities include only debt, however, are not included in the scope of SFAS No. 128.

Accounting Changes

A change from one acceptable accounting principle to another acceptable principle is generally accounted for by including the cumulative effect of the change in net income in the period of the change. APB No. 20, Accounting Changes, provides certain exceptions. Paragraph 29 provides that when an entity first issues its financial statements for the purpose of registering securities, for example in an initial public offering (IPO), such a change can be accounted for by retroactively restating all prior periods presented.

Business Combinations

APB No. 16, Business Combinations, paragraph 96, requires that notes to the financial statements for the period in which a business combination occurs and is accounted for by the purchase method include as supplemental information the following results of operations on a pro forma basis: a) results of operations for the current period as though the enterprises had combined at the beginning of the period, unless the acquisition was at or near the beginning of the period, and b) results of operations for the immediately preceding period as though the enterprises had combined at the beginning of that period if comparative financial statements are presented. As amended by SFAS No. 79, these disclosures are not required for nonpublic entities.

Stock-Based Compensation

While GAAP prescribes different disclosure criteria for public and nonpublic entities, it does not prescribe different measurement criteria. Transactions are accounted for the same way under GAAP whether a company is public or private. A theoretical exception can occur with the application of SFAS No. 123, Accounting for Stock-Based Compensation. Paragraph 19 of SFAS No. 123 provides that the value of options granted by a public entity should be estimated using an option-pricing model that takes into account factors including volatility of the underlying stock. Volatility is a measure of the amount by which a price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility). Paragraph 20 states that a nonpublic entity need not consider expected volatility. Paragraph 332 illustrates a computation using the minimum value method, which does not consider volatility. The minimum value of an option is the fair value of the stock less the present value of the exercise price.

Estimating the value of an option without taking volatility into account could yield a different result. Accordingly, if the accounting provisions (as opposed to the disclosure provisions) of SFAS 123 are adopted, the computation of compensation cost could differ for public and nonpublic entities. As a practical matter, most companies did not adopt the accounting provisions of SFAS No. 123.

Earnings Per Share

SFAS No. 128, Earnings Per Share, issued in February 1997, supersedes APB No. 15 and related pronouncements, effective for periods ending after December 15, 1997. The statement requires the presentation of earnings per share (EPS) for all periods for which an income statement or summary of earnings is presented.

EPS presented in registration statements filed in connection with an IPO can differ from the results obtained by computing EPS in accordance with SFAS No. 128. SEC Staff Accounting Bulletins Topic 4D (SAB No. 83) requires potentially dilutive instruments with exercise prices below the IPO price that are issued within a one-year period prior to the initial filing of an IPO be treated as outstanding for all periods presented. This method should be applied for all prior periods, including loss years in which the impact of the incremental shares is antidilutive. Under SFAS No. 128, on the other hand, those potentially dilutive shares would be included only in the computation of diluted EPS and only from the date of issuance. Also, SFAS No. 128 does not permit incremental shares to be included when there is a loss from continuing operations, as the effect is antidilutive. Appendix F to SFAS No. 128 states that with the issuance of the statement, the status of SAB No. 83 is pending.

Additionally, under the provisions of SAB Topic 1B (SAB No. 55), when dividends or distributions are to be paid from the proceeds of the offering, pro forma EPS for the latest year and interim period prior to the IPO should give effect to the number of shares whose proceeds are to be used to pay the dividends or distributions. SFAS No. 128 does not contain any such provisions.

Income Taxes

SFAS No. 109, Accounting for Income Taxes, paragraphs 43 and 47, requires additional disclosures for public entities. A public entity is required to disclose the approximate tax effect of each type of temporary difference and carryforward that gives rise to deferred tax liabilities and assets. A nonpublic entity is only required to disclose the types of significant temporary differences and carryforwards but may omit disclosure of the tax effects of each type. A public entity not subject to income taxes because its income is taxed directly to its owners is required to disclose that fact and the net difference between the tax bases and the reported amounts of its assets and liabilities.

Additionally, a public entity is required to disclose a reconciliation using percentages or dollar amounts of a) the reported amount of income tax expense attributable to continuing operations for the year to b) the amount of income tax expense that would result from applying domestic Federal statutory tax rates to pretax income from continuing operations. The "statutory" tax rates should be the regular tax rates if there are alternative tax systems. The estimated amount and the nature of each significant reconciling item should be disclosed. SEC Staff Accounting Bulletins Topic 6I provides that the reconciliation should be made to the Federal income tax rate. It also provides that if there is a loss, the reconciliation should be to the expected tax benefit at the Federal rate. A nonpublic entity is only required to disclose the nature of significant reconciling items but may omit a numerical reconciliation.

Interim Financial Reporting

APB No. 28, Interim Financial Reporting, sets forth minimum disclosure requirements for interim financial reports of publicly traded companies. The SEC rules covering interim financial reporting are found in Regulation S-X Article 10 or Regulation S-B Item 310(b), Interim Financial Statements, as applicable. As amended by SFAS No. 3, the opinion requires that if interim financial data and disclosures are not separately reported for the fourth quarter [for example, where the requirements of Regulation S-K, Item 302(a), selected quarterly financial data are not applicable to the entity]; accounting changes; disposals of segments; extraordinary, unusual, or infrequent items; and the aggregate effect of year-end adjustments that are material to the results of that quarter should be disclosed in a note to the annual financial statements.

Segments of a Business Enterprise

SFAS No. 14, Financial Reporting for Segments of a Business Enterprise, requires disclosure of disaggregated information about the enterprise's operations in different industries, its foreign operations, export sales, and major customers. SFAS No. 21 suspended these requirements for nonpublic companies.

Nonpublic companies are required to disclose major customers if they meet the criteria of SOP 94-6, Disclosure of Certain Significant Risks and Uncertainties. While SFAS No. 14 uses a 10% threshold, SOP 94-6 requires the disclosure of major customers if the total or partial loss of the customer could have a severe impact on the entity.

In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. The statement, which also applies to public companies only, supersedes SFAS No. 14, effective for fiscal years beginning after December 15, 1997.

Oil and Gas Producing Activities

SFAS No. 69, Disclosures About Oil and Gas Producing Activities requires public entities that have significant oil and gas producing activities provide certain additional disclosures.

What's Ahead

In June 1997, The FASB issued an exposure draft titled Employers' Disclosures About Pensions and Other Postretirement Benefits, an amendment of SFASs No. 87, 88, and 106. The exposure draft includes a provision that would make certain disclosures optional for nonpublic companies, if certain criteria are met.

In 1994, The AICPA Special Committee on Financial Reporting, released a report titled Improved Business Reporting--A Customer Focus. The report included a recommendation that standard setters allow for flexible reporting. Because financial statement users differ in their needs for information, not all companies should report all elements of information. Rather, companies should report only those elements that users and preparers agree are needed in the particular circumstances. The report stated that nonpublic company owners and lenders probably would limit reporting to specific elements required for their purposes. The committee was chaired by Edmund Jenkins, who is now the FASB chairman. It would not, therefore, be unexpected to see an expansion of disclosure provisions that differ for public and nonpublic companies.

Gary Illiano
Grant Thornton LLP

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