On Big GAAP Versus Little GAAP

By Neville Grusd

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I have been a CPA in public accounting, a CFO in industry, and a lender to nonpublic companies for the past 24 years. From the outset, I felt strongly that this whole exercise of rewriting GAAP for nonpublic companies is futile and should be discontinued. In principle, everybody wants a financial statement that is, to quote FASB chairman Robert Herz, “exceptionally sound, cost effective and provides relevant, reliable and useful information.” I agree with this, and stress that either a financial statement is right or it is not. The only way this can be achieved is by having one set of GAAP requirements; anything else is going to be extremely dangerous.

The authors of the abovementioned article give an excellent review of the history of the concept of having different reporting for public and nonpublic companies, going back to 1972 and ending with the AICPA task force survey conducted in 2004 and reported on in early 2005. The survey was addressed to owners/managers, practitioners, and external stakeholders such as lenders, creditors, surety/bonding companies, and investors/venture capitalists. The AICPA task force concluded that most of the constituents within the study are “of the opinion that it would be useful if the underlying accounting for public versus non-public ‘private’ companies were different in certain situations.” As certain GAAP requirements were ranked low in importance for certain constituents, the task force also concluded “that allowing GAAP exceptions and other bases of accounting is not an appropriate response to the unique needs of private company financial reporting.” And finally, “the task force recommends that a recognized set of standards be established as GAAP for private companies.”

While the points of view of all the interested parties are relevant, the main point is why the financial statements are being prepared. If they are purely for the owners and management, who in private companies are usually the same people, then they and their accountants can decide on any format of financial statements they choose. In most cases, however, these financial statements are prepared for the external stakeholders, mainly lenders and creditors. If the financial statements are going to be used to obtain credit, then they must be acceptable to those decision makers.

Many of the items that give rise to the question of “big GAAP versus little GAAP”—such as share-based payments, stock options, deferred income taxes, and retirement-plan accounting—do not apply to the vast majority of private companies anyway. As a lender, I have had only a few requests from a client’s accountants to submit financial statements that are not fully in compliance with GAAP, because the cost of such compliance would be out of proportion to the benefit. In these cases, we have discussed the matter and agreed that the statement can be qualified accordingly and without being considered an event of default in our loan documents.

A specific example from my own experience involved a small company with a defined-benefit plan. The cost and time in obtaining all the necessary actuarial information to make the relevant provisions was deemed not worth the effort because it was highly unlikely that any members of the pension fund would be retiring within the next 10 years. It would be interesting to see if statements submitted to credit grantors with this type of GAAP qualification would result in a reduction in credit available to the company. If any readers of these financial statements were sufficiently interested and concerned about such qualifications, then no doubt they would discuss it with the company and their accountant and then make their decision based on the facts. If preparers and accountants strongly believe that their statements should be issued with GAAP qualifications, they should do so, and the market will dictate whether they are acceptable for their purpose or not.

So let’s not tinker with GAAP. Once concessions are made, where will it end?