The FASB released an Invitation to Comment on July 31, 2012. This document reviewed the staff paper titled “Private Company Decision-Making Framework – A Framework for Evaluating Financial Accounting and Reporting Guidance for Private Companies”. Stakeholders were requested to give their input on this framework so that the FASB could determine whether or not to adopt it. The project included a set of questions for respondents. This article will explore the disparities between private and public companies and the necessity for modifications.
A private company is a type of business entity that consists of two or more individuals, with a maximum limit of fifty individuals (excluding employees and shareholders). It operates as an extension of a limited liability partnership, limiting public invitations for share subscriptions and placing restrictions on the transferability of shares. Private companies are preferred when there is a desire to utilize corporate benefits such as limited liability and maintaining control within a specific group.
Public companies, as defined by ASC. 840-10-20, are companies whose securities are traded in a public market, such as stock exchanges or over-the-counter markets. This encompasses both domestic and foreign exchanges, as well as local or regional markets.
Additionally, public companies can act as conduit bond obligors for publicly traded conduit debt securities. While the trading of securities is the main differentiating factor between public and private companies, there are other distinguishing characteristics that set these two types of companies apart.
In the project, the staff recognized and prioritized six distinguishing factors of accounting guidance for private and public companies. Firstly, the types and quantity of financial statement users vary between private and public companies. Due to the differing sizes of these companies, the number of users may also differ. Private companies typically have fewer users for their financial statements compared to public companies.
Public company financial statements are primarily used by equity and debt investors, as well as analysts. On the other hand, private company financial statements are mostly utilized by lenders, other creditors, and equity investors. A key distinction lies in the number of users; private companies usually have fewer financial statement users compared to public companies. Furthermore, private companies have the advantage of direct access to management, allowing them to acquire supplementary material financial information and analysis.
Public companies have a greater number of financial statement users, but financial statements alone may not suffice for their needs. These companies often have a strong desire to obtain additional information beyond what is provided in their financial statements. Therefore, they have the ability to indirectly access management for extra material financial information and analysis. Another distinction is their investment strategies, particularly regarding the holding period of equity. Public companies tend to have a shorter duration for holding equity ownership interests compared to many private companies.
Longer duration bonds offer a more predictable return in comparison to short-term bonds. The investment strategy categorizes companies into two groups based on their focus. Private companies depend on dividends, potential buyouts, business combinations, and sometimes initial public offerings to generate investment returns. Conversely, public companies prioritize changes in share price and selling those shares in a quoted market to achieve their return on investment. As a result of these differing needs, each type of company presents different financial statement amounts and disclosures.
Private and public companies have different ownership and capital structures. Private companies can be structured as S-corporations, limited companies, general partnerships, limited partnerships, limited liability partnerships, or family limited partnerships. On the other hand, public companies typically have a simpler ownership structure as C-corporations. These varying ownership structures can affect tax accounting. Currently, the income tax regulations do not seem suitable for private companies. To tackle this problem, FASB has issued an accounting statement that specifically concentrates on income tax accounting.
Companies must record a tax liability on their balance sheets to demonstrate the amount they have reserved in case the IRS or state tax authorities challenge their tax positions. This calculation is both time-consuming and costly, and is deemed suitable for large public companies that undergo regular audits but less suitable for private companies. Another distinction highlighted in the project is the availability of accounting resources and knowledge of new financial reporting guidance. Generally, private companies possess fewer and less specialized accounting personnel compared to their public counterparts.
Private companies are less likely to actively participate in the standard-setting process and closely track accounting guidance changes compared to public companies. Consequently, it can be more difficult for private companies to allocate sufficient time and resources to assess and adopt new standards. Typically, private companies release their financial reports annually or semi-annually, meaning they often discover new financial accounting and reporting guidance later in the year.
Public companies issue their financial report quarterly, allowing them to quickly adapt to new financial accounting and reporting guidance. The project highlights the main differences between private and public companies. Private companies vary in size and diversity, while the FASB evaluates the differences between the majority of private companies and public companies using general rules. The staff identifies and focuses on the appropriate differential factors between private and public companies.
Although the ITC does not address all the minor differences, one distinguishing factor that is not mentioned is the greater regulatory oversight of public companies. The Securities and Exchange Commission enforces accounting regulations and conducts a review and comment letter process, which fosters greater disclosure and consistent application of U.S. GAAP among public companies. In contrast, private companies lack a common regulator and generally face less regulation or no regulation at all.
Greater variability in financial reporting occurs among private companies within U.S. GAAP boundaries. The International Accounting Standard Board (IASB) shares concerns regarding the disparities between private and public companies and has established a new council for private companies. The IASB has elucidated that full IFRSs were primarily created to address the requirements of equity investors in companies operating in public capital markets. Consequently, these standards encompass a vast array of topics, include extensive implementation guidance, and necessitate disclosures suitable for public companies.
Users of financial statements for private entities have different needs compared to users of financial statements for public entities. Private entity users are primarily interested in evaluating shorter-term cash flows, liquidity, and solvency. Many private entities argue that adhering to the full International Financial Reporting Standards (IFRSs) is burdensome, especially as these standards have become more complex and widespread. Consequently, the International Accounting Standards Board (IASB) aimed to develop the proposed IFRS for Private Entities with a twofold objective: meeting user requirements and striking a balance between costs and benefits from the perspective of the preparer.
FAF, the parent organization of FASB, established the Private Companies Council (PCC). Both IFRS and FASB recognize the disparities between private and public companies and have therefore formed these new councils to address the issue. The objective is to highlight that existing accounting guidance may not be appropriate for private companies.