GAAP for private companies is a hot issue that can be looked at from varying perspectives. With that in mind, we offer this first entry of a two part blog series presenting both sides of the issue; be sure to check back next week for “the argument against!”

The Blue Ribbon Panel of the Financial Accounting Foundation (FAF) met on July 19^th to encapsulate the problems that private companies have with U.S. GAAP, how accounting standards are set, and to shorten the list of viable proposed accounting model choices. Also in July, the International Accounting Standards Board (IASB) released a condensed (230 pages, from 2,500 pages originally) International Financial Reporting Standards (IFRS) for small and medium entities (SMEs). This set of rules could in theory become the standard for private companies in the U.S.

Most would agree that a fundamental goal of GAAP reporting is to provide relevant information useful for the decision-making needs of its users; it is encouraging to see some effort to distinguish the needs of private companies from publics. Financial reporting for private companies should be driven by the need for them to have access to capital and key information for their banks and creditors. On the other hand, that drive for public companies is influenced by needs of investors and stockholders and the general legal and regulatory environment.

Because GAAP is not truly geared to the private company model, under current accounting standards such companies encounter issues surrounding relevance, consistency, and perceived unnecessary complexity in presenting financial statement information.

With this in mind, it is not fair to penalize and burden private companies with excessive and sometimes irrelevant accounting and financial reporting requirements, given that their banks and creditors in reality are concerned with a much narrower scope of matters. Keeping apprised of and in compliance with these additional requirements unnecessarily divert private company resources and capital, robbing them of the ability to deploy them in other areas of opportunity.

On top of these issues, private companies are often forced to circumvent the requirements by issuing GAAP exceptions with audit opinions and blaming noncompliance on “unnecessary” GAAP requirements. These frequent actions can result in confusion, consternation and dissatisfaction on behalf of the private company financial statement users – for whom it was the original intent to provide relevant information for decision-making!

FASB Chairman Robert Herz once commented the following, which remains true today: “Private companies are a vital force in the nation’s economy and it is, therefore, critical that their financial reporting be conceptually sound, cost effective, and provide relevant, reliable and useful information.”

To stay on course with that sentiment – I say let’s take the GAPs out of GAAP for private companies!

Buried within the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 is the requirement for public companies to develop and implement a mandatory policy to recoup excess incentive-based compensation from current and former executive officers after a material financial restatement.

While compensation recovery policies (or “clawback” policies) are not new, these latest requirements are more stringent and are designed to force companies to tighten up the provisions within their clawback policies and get tough on actual enforcement. As evidence of this “get tough” stance, the Dodd-Frank Reform Act goes so far as to require the national exchanges to delist any company that fails to comply with its own clawback policy.

The new clawback policy requirements

As many know, the concept of clawback policies originally came onto the scene back in 2002 as a result of the Sarbanes-Oxley Act (specifically, Section 304). At the time, the clawback provisions only applied to the chief executive officer and chief financial officer. Furthermore, the provisions were only applicable if the noncompliance resulted from misconduct and was only relevant for compensation events during the year following the misstatement.

Fast forward to July 2010 and we find new and more stringent clawback provisions that require any company listed on a national securities exchange to develop and implement a mandatory recoupment policy stating that following an accounting restatement due to material noncompliance with financial reporting requirements under securities laws, the company will recover certain incentive-based compensation (including stock options) from current or former executive officers for amounts received during the three-year period preceding the date on which the company is required to prepare the accounting restatement. The amount of compensation to be recovered is calculated as the excess amount paid on the basis of the restated results.

In contrast to Section 304 of the Sarbanes-Oxley Act of 2002, the new clawback provisions are broader and cover more individuals. They now apply to all current and former “executive officers” which includes not only the CEO and CFO but also a company’s president, any vice president in charge of a principal business unit, division or function and any other officer who performs a policy making function or person who performs similar policy making functions for the company. In addition, the new requirement to recoup compensation is not dependent on the restatement being a result of executive misconduct. Furthermore, the look back period has been extended from one year to three years and companies must now disclose their clawback policy.

While further clarification is needed, companies would be wise to get ahead of the curve

Some aspects of the Dodd-Frank Act clawback provision are ambiguous and it is clear that further guidance will be required. For starters, the Reform Act does not specify an effective date for implementing the clawback provisions nor does it clearly define what constitutes “material noncompliance” or “incentive-based compensation.”

Until the SEC issues more detailed rules (perhaps in time for 2011 proxy statements?), it will be difficult to ensure complete compliance, however, from a corporate governance perspective, it is recommended that companies not wait — review current policies and consult with an attorney to determine whether or not your policy aligns with the new legislation and subsequent guidance.

Accountants, auditors, and corporate entities alike, take notice: the exposure draft recently issued by the Financial Accounting Standards Board (FASB) promises that big changes are in store. Weighing in at 170 pages, the proposed new revenue recognition standard is designed to improve and align the financial reporting of revenue from contracts with customers and related costs.

The draft is a joint effort with the International Accounting Standards Board (IASB), and if adopted would create a single revenue recognition standard for International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP) to be applied across various industries and capital markets.

The two groups have four objectives for the new standard:

-  Remove inconsistencies and weaknesses in existing revenue recognition standards and practices;

-  Provide a more robust framework for addressing revenue recognition issues;

-  Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; and

-  Simplify the preparation of financial statements by reducing the number of requirements to which entities must refer.

In a podcast posted on the FASB website, board member Leslie Seidman said the current system was developed over many years on an ad hoc basis, creating a “very complex, inconsistent, and incomplete set of standards.” The proposal, she said, “will make accountants’ jobs easier when new types of business arrangements emerge because they’ll have one standard to look to on how to recognize revenue for the arrangement.”

If both groups can sort through and incorporate the various feedback received – the comment period ends on October 22^nd – the final standard is expected in the second quarter of 2011. Assuming it is adopted, the FASB has produced a chart outlining the five steps companies will need to follow to apply the revenue recognition proposal.

While it still has a long way to go, the new standard represents a significant improvement over the current system. When combined with other projects in the works to reconcile GAAP and IFRS, they will collectively amount to a single set of high quality, global accounting standards.