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Relief May Be Near for Private Companies’ Biggest Accounting Complaint

The FASB plans to release in the third quarter of this year a proposal that lets private companies opt out of applying the variable interest entity guidance in U.S. GAAP’s complex standard for consolidated reporting. Private companies have long complained that this is their biggest source of frustration with financial reporting.

When the FASB in May 2007 set up its first panel to address the needs of private financial executives, its members immediately cited the accounting standard issued to curb the off-balance-sheet vehicles made infamous by Enron as their biggest source of frustration.

Private companies frequently set up separate limited liability companies, partnerships, or sole proprietorships for estate and tax planning purposes, not to hide liabilities or juice stock prices, members of the panel told the board. Still, they were forced to wade through the same complex accounting guidance as large, publicly traded companies to determine whether they needed to consolidate the entities on their balance sheets.

“It was just an accountant’s nightmare for something that was not an issue in the private company world,” said Judith O’Dell, former chairman of the FASB’s now-defunct Private Company Financial Reporting Council. The panel was replaced in December 2012 by the Private Company Council (PCC).

“A lot of things set up for estate purposes, for tax purposes, they were never set up to hide anything,” O’Dell said, adding that the disclosures private companies offered made it clear about who owned the other entities. “It was not a private company issue, and the private companies just got caught up in things.”

Almost a decade later, the FASB is poised to offer relief.

The board in March agreed to draw up a plan that lets private companies skip what is known as the variable interest entity (VIE) guidance for businesses under common control in U.S. GAAP’s notoriously complicated Topic 810, Consolidation. The board expects to release a proposal for public comment in the third quarter of the year, a FASB spokesperson said.

Some private companies say the proposal cannot come soon enough.

“VIE guidance centers around power — not voting power, but other power — and it’s very difficult to discern who holds the power in a family,” said George Beckwith, a former PCC member and CFO of National Gypsum Co. in Charlotte, North Carolina. “Private companies are often like families. And a lot of them are literally families.”

Real estate development companies, for example, often set up separate entities to run their business, Beckwith said. One company could sell lots that are developed by an affiliated company, and yet another affiliate could grade the lots and build houses. In some cases, all three entities could be owned by one person. In another they could be owned by siblings, or two could be owned by a wife and one by a husband.

Under existing guidance, an accountant has to examine the intercompany transactions, services, leases, and all guarantees of debt or implied guarantees of debt to assess who holds power. With companies where ownership is shared among close relatives, this is not always clear.

“If a husband and wife own, do you consolidate? What if they have a child? What happens if they get divorced?” Beckwith asked. “So the power in private company situations is often harder to determine than in public companies, where it’s very clear what the power is.”

In certain private company transactions, such as those between friends or relatives, there are no formalized arrangements, the parent can change, and there is little to no paperwork to back up decisions, FASB research staff members also told the accounting board.

Many private companies decide that it is easier to err on the side of consolidation, but private company lenders do not always find three or four companies’ financial information to be relevant when they just want to see the assets and liabilities of one entity, O’Dell said.

“So let’s say we consolidate, it goes to the bank, and the bank says, ‘Wait a minute, this building that houses a plant, that’s not my collateral. I want to see the plain financial statement from just the manufacturing company that I lent to,'” she said.

The FASB’s examination of the VIE guidance is part of the board’s broader effort to simplify Topic 810. Designed to prevent abuses, the guidance is considered complicated even for experienced financial professionals. The FASB plans to proceed with the potential changes in two separate proposals — one to address private company concerns and the other to make broader structural changes to the standard. (See “Consolidation Guidance May Be Carved in Two,” in the March 10, 2017, edition of Accounting & Compliance Alert.)

The FASB in March 2014 attempted to ease consolidated reporting for private companies in Accounting Standards Update (ASU) No. 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements, which let private companies ignore the VIE guidance for certain leasing transactions, such as a private company with a separate entity to house its real estate assets.

Private companies applauded this update to GAAP, but problems still persisted with the consolidation guidance for transactions that did not involve leases. In December 2015, the PCC asked the FASB’s research staff to draw up private company-oriented examples for applying the VIE guidance, but staff members could not agree how to apply the accounting principle. The PCC then pushed the FASB to consider an exemption for private companies. If the FASB is to proceed with the plan, the board will rescind the May 2014 update on leasing arrangements.

The support for a private company exemption from the VIE requirements is not unanimous. FASB member Lawrence Smith generally criticizes exempting private companies from U.S. GAAP provisions that apply to public companies. In March, he disputed the logic that private companies tend to be organized with informal arrangements and structures that make it all but impossible to assess which party controls the business.

“Whatever we do doesn’t just apply to mom-and-pop private companies,” Smith told the other board members. “It pertains to billion-dollar multinational entities, and we can’t lose sight of that.”

The CFA Institute, an investor advocacy organization, also has been critical of GAAP carve-outs for private companies, saying the exemptions make it difficult for investors to compare the financial health of public and private companies.

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