Investors Unhappy with FASB Simplification of Accounting Standards for Private Companies

A new study questions the wisdom of the Financial Accounting Standards Board’s initiative to simplify accounting standards for private companies.

The CFA Institute’s report, "Addressing Financial Reporting Complexity: Investor Perspectives," examines the effort to reduce complexity in financial reporting, particularly for non-public companies. The study found that initiatives to reduce complexity by FASB and its counterpart abroad, the International Accounting Standards Board, have managed to cut compliance costs for companies, but at the expense of investors. The CFA Institute surveyed its members to gauge the investor perspective on having different accounting standards for public and private companies.

The top three concerns cited by investors about differential standards were decreased comparability (82 percent), greater complexity (73 percent), and the loss of decision-useful information (65 percent). The study argued for conducting a more comprehensive cost–benefit analysis to weigh the advantages of reduced compliance and administrative costs for preparers against the additional complexity and costs for investors of having different standards.

“This whole discussion of simplifying accounting standards has been taking place for a while,” said Mohini Singh, director of financial reporting policy at CFA Institute. “The genesis of this report is that it’s really been the corporate managers who have been saying that adhering to very complex financial reporting requirements is very time-consuming and expensive. The private companies especially have been saying they don’t have adequate resources to deal with these complex requirements and so you need to simplify accounting standards. We felt that in all of these discussions, nobody has really been talking to the investors. So we decided that we would conduct a survey of our membership and find out what they felt about it.”

As investors, the survey respondents pointed out that they don’t invest only in private companies or only public companies. They invest across a spectrum of companies, both public and private, and across various industries.

“They need comparable information,” said Singh. “They agree that the cost for companies to produce the financial statements will fall, so they’ll have lower compliance costs, but unfortunately you’re moving the burden from the companies onto the investor community, because they no longer have comparable information. Eighty-two percent of the survey respondents expressed concerns over that.”

Investors are also worried about losing useful information. FASB and its sister organization, the Private Company Council, have proposed to simplify the accounting standards for goodwill amortization, but investors polled by CFA Institute aren’t so sure that’s a good idea.

“They said accounting for goodwill the way it is today provides us with a lot of useful information about business acquisitions, and amortizing it is simply not going to let us know management made a good deal in terms of an acquisition or not,” said Singh. “There were 65 percent of investors who were concerned about that.”

In some cases investors are concerned that the changes may even increase complexity. “For example, what happens when a private company goes public?” Singh asked. “Do they have to go back and revise their financial statements and, if so, for how many years? Would that just be an extra burden on them and should they have adhered to full GAAP right from the beginning? Or what happens when a private company acquires a public company? They are changing the requirements, but there are all of these unanswered questions that nobody seems to know the answer to, or doesn’t have enough clarity on.”

CFA Institute unveiled the study during its second annual Putting Investors First Month, a global initiative that encourages financial professionals to place the interests of investors above their own and build awareness of the fiduciary duty to protect investor interests. To help drive the campaign, hundreds of CFA Institute members and many of the organization’s 144 member societies worldwide are hosting a series of events and activities in May.

PCC Meeting
The Private Company Council met on Tuesday and directed FASB’s staff to conduct further research and develop recommendations for private companies to have an unconditional option to make an initial election of a PCC alternative, according to a summary of the meeting provided by FASB. This would remove the requirement for private companies to assess preferability if they initially elect PCC accounting alternatives after the effective date.

FASB’s staff also presented research and discussed stakeholder input on possible private company alternatives for the accounting for share-based compensation. The PCC plans to continue its discussion in a future meeting, and will take into consideration feedback it received in connection with FASB’s upcoming exposure draft on employee-based payment accounting improvements.

Also at Tuesday’s meeting, the PCC discussed FASB’s projects on Disclosures by Business Entities about Government Assistance and Disclosure Framework. The PCC continued to express its concerns about FASB’s project on Simplifying the Balance Sheet Classification of Debt.

The PCC also asked FASB and its staff to consider conducting research on clarifying the application of certain aspects of variable interest entity guidance (that are not already addressed by ASU NO. 2014-07—Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements) to private companies under common control.

The next PCC meeting will be held on Tuesday, July 21, 2015. The PCC also plans to hold a Private Company Town Hall Meeting on Tuesday, July 14, 2015 in conjunction with the AICPA National Advanced Accounting and Auditing Technical Symposium in Baltimore.

Accounting Complexity for Investors
Investors may want to get involved in providing more input to FASB and the PCC. Singh feels that investors aren’t making their voices heard when the standard-setters ask for feedback, and they aren’t worried about accounting standards being too complex.

“They don’t have a problem with complexity in terms of just making it easier to account for,” she said. “They do believe that there is complexity, but their view of complexity is very different from how corporate managers view it. Investors’ view of complexity is when there isn’t enough transparency in the financial statements. For example, they believe that if there is a transaction, the accounting needs to reflect the economic substance of the transaction.”

Investor groups typically don’t have as much input into accounting standards, despite FASB’s efforts to reach out to investors and other stakeholders through roundtables, advisory councils, Blue Ribbon panels and streamlined online feedback mechanisms.

Singh doesn’t believe that FASB is ignoring investors, but that accountants and corporate America tend to hold more sway with standard-setters. “It’s not necessarily that they’re just ignoring them,” she said. “I think that companies have a louder voice. First of all, they are a much more cohesive unit. The companies come together and they are heard. The investors are disparate people, and that’s why they really need organizations like ours to represent them because they don’t commonly write comment letters and things like that. It’s not just a problem that we’ve faced with the simplification of standards for private companies. This is a problem we see across the board, that the companies have a much stronger and louder voice. If you look at the number of comment letters, there will be numerous comment letters from the preparers, auditors and accountants, and there is a handful from the investors.”

CFA Institute’s survey indicates that the investors it polled don’t mind so much if companies have to pay more to prepare more complex financial statements as long as all the information is there for investors to evaluate, even though the costs will ultimately be passed on to shareholders.

“If they bear that cost, that cost is transferred onto the investors, but this survey of ours clearly demonstrates that they would rather bear that cost than to lose the information,” said Singh. “If you simplify the standards and you’re not reflecting the true economic substance of the transaction, you’re reducing transparency. If you reduce transparency, it’s much more difficult for the investor to evaluate the company, in which case he’s going to incur a risk premium, which means that the cost of capital for the company will rise. So rather than have that, they would rather that it remains transparent, that the companies bear the cost of producing these financial statements, which will ultimately be borne by the investor, and the investor community is happy to bear that cost.”