On July 31, 2012, FASB issued an Invitation to Comment, which reviewed key areas of the Private Company Decision-Making Framework – A Framework for Evaluating Financial Accounting and Reporting Guidance for Private Companies staff paper. This project was to gather comment from stakeholders about how they evaluate this private company decision-making framework. Therefore, FASB was able to decide carry the new concept into execution. The project provided serious of questions for respondents, in this paper we focus on the differential factors between private companies and public companies, and elaborate the necessity of adjustment.
A private company denotes a company of two or more persons, but not exceeding fifty excluding the employees and shareholder. A private company is nothing but the extension counter a partnership with limited liability. It prohibits any invitation to the public to subscribe for shares and restriction the right to transfer its shares. Private company is desirable in those cases where it is intended to take the advantage of corporate life, limited liability and the control of the business over the hands of few persons.
Public companies are any company whose securities trade in a public market on either of the following: A stock exchange (domestic or foreign) ? In the over-the-counter market (including securities quoted only locally or regionally), or any company that is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets). (ASC. 840-10-20) The main difference between them is trading security, accompany with some other differences leading the differential factors between private companies and public companies.
In the project, the staff identified and focused on six differential factors of accounting guidance between private companies and public companies. First of all, types and number of financial statement users are different in private companies and public companies. Since the size of private companies is differ from public companies, users size may vary in those companies. Financial statements of private companies have smaller number of users than public companies have.
Public company equity and debt investors and analysts typically are the most common types of users of public company financial statements, while lenders and other creditors and equity investors typically are the most common users of private company financial statements. Second is the difference of access to management. Due to private companies often have fewer financial statement users than public companies. The economic influence of those users often varies, and private companies have the direct access to management to obtain additional material financial information and analysis.
In contrast, public companies often have more financial statement users, financial statements are not always enough for their users, and they often have strong desire to obtain extra information beyond financial statements. Thus public companies have indirect access to management to acquire additional material financial information and analysis. Third is the difference of investment strategies. The major investment strategy may vary in holding period of their equity between private companies and public companies. For public companies, they prefer to hold equity ownership interests for a shorter duration than many private companies.
Longer duration bonds will have a more certain return than short-term bonds. The strategy made two types of companies concerning different area in investment. Private companies consider dividends, possible buyouts, business combinations, or, less frequently, initial public offerings as the sources for their return on investment. Public companies also need these sources, but they more changes in share price and the sale of those shares in a quoted market as the primary source of their return on investment. The different needs affect them to fill different financial statement amounts and disclosures.
Moreover, the ownership and capital structures are different in private companies and public companies. Private companies ownership structures include S-corporations, limited companies, general, limited, limited liability, or family limited partnerships and so on. But ownership for public companies is much simple than private companies, which just have the structure of C-corporation. The different ownership may influence on their account for taxes. Currently the income tax regulations seem not suitable for private companies. FASB issued a statement for accounting for income taxes.
Companies to record a tax liability on their balance sheets, showing how much they have in reserve in case the IRS or state tax authorities disagree with their tax positions. The calculation is time-consuming and expensive, and is thought by some to be an appropriate requirement for large public companies that are audited regularly, but less appropriate for private companies. The last two differences the project presented are accounting resources and learning about new financial reporting guidance. Private companies generally have fewer and less specialized accounting personnel than public companies have.
Consequently, many private companies are less likely than public companies to actively participate in the standard- setting process and to closely monitor changes in accounting guidance. Since then, private companies may find it more difficult than public companies to dedicate the time and resources necessary to evaluate and apply certain new standard. Private company issues their financial report twice or once a year, so they always learn about new financial accounting and reporting guidance in the second half of the calendar year.
But public companies issue their financial report quarterly, so they always learn new financial accounting and reporting guidance faster. Above are the main factors that this project presented about the differences between private companies and public companies. The private companies’ amount is large and they are all diversity. The FASB used general rule to evaluate the differences between majority private companies and public companies. It is considered that the staff identified and focused on the appropriate differential factors between private companies and public companies.
However, there are still some minor differences not issued in this project, a differentiating factor that is not discussed in the ITC is the generally higher level of regulatory oversight of public companies. The accounting regulations written by the Securities and Exchange Commission, and its review and comment letter process, promote greater disclosure and more consistent application of U. S. GAAP by public companies. In contrast, private companies do not have a common regulator and, in general, are less regulated than public companies or are unregulated.
As a result, there is greater variability in financial reporting, within the boundaries of U. S. GAAP, by private companies. IASB (International Accounting Standard Board) also concerned about the differences between private companies and public companies, and also set a new council for private companies. The IASB explained: Because full IFRSs were designed to meet the needs of equity investors in companies in public capital markets, they cover a wide range of issues, contain a sizeable amount of implementation guidance, and include disclosures appropriate for public companies.
Users of the financial statements of private entities do not have those needs, but rather are more focused on assessing shorter-term cash flows, liquidity and solvency. Also, many private entities say that full IFRSs impose a burden on them — a burden that has been growing as IFRSs have become more detailed and more countries have begun to use them. Thus, in developing the proposed IFRS for Private Entities, IASB’s twin goals were to meet user needs while balancing costs and benefits from a preparer perspective.
FASB’s parent organization FAF also created a new council for private companies, Private Companies Council. IFRS and FASB are both concern about the differences between private companies and public companies. They created new councils to emphasis current accounting guidance may not suitable for private companies.