Private-Company GAAP: Another Set of Standards to Ignore?

If a &doublequot;little GAAP&doublequot; were developed for private U.S. companies, key stakeholders would likely ignore it. Here's why.
Bruce PounderDecember 21, 2010

Over the past year, a blue-ribbon panel has been working to solve some of the problems associated with private-company financial reporting in the United States. The panel has focused on the current process by which the Financial Accounting Standards Board sets generally accepted accounting principles. What the panel has tentatively concluded is that a new standard-setting body should define a “little GAAP” for private U.S. companies by specifying extensive exceptions to existing GAAP.

Unfortunately, the panel has not addressed the significant risks associated with this solution. As I have explained in previous columns, attempts to implement the panel’s recommendations are likely to backfire unless more attention is paid to risk management.

In this column, I’ll focus on the second of four key, unaddressed risks: solution-acceptance risk. I’ll also explain how this risk can be mitigated through a more-realistic approach to problem-solving.

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What Is Solution-Acceptance Risk?
Solution-acceptance risk is a type of goal-setting risk. Specifically, it is the risk of defining a target solution that will be ignored or rejected by stakeholders whose acceptance of the solution is necessary for the subject problem to actually be solved.

It’s natural to assume that stakeholders will automatically embrace a given solution — even a solution that isn’t well suited to their problems. Thus, solution-acceptance risk is distinct from solution-suitability risk, which is another type of goal-setting risk, as explained in my previous column.

Stakeholder acceptance of any proposed solution depends on three critical factors. To the extent that these factors aren’t present, there is risk that stakeholders will ignore or reject the solution.

Pounder Dec 21-2010

The first critical acceptance factor is the existence of “someone in charge.” In other words, is there an individual, organization, or coherent group of individuals/organizations that could compel stakeholders to accept a particular solution through some combination of rewards and penalties? If not, stakeholder acceptance isn’t likely.

The second critical acceptance factor is uniformity of stakeholder needs and capabilities. The less uniform stakeholder needs and capabilities are, the less likely that a single solution will be uniformly accepted.

The third critical acceptance factor is the active, intimate engagement of stakeholders in the development of any potential solutions to their problems. To the extent that change agents seek to impose a solution on stakeholders without engaging those stakeholders in the solution-development process, the likelihood of success is low.

Absence of Critical Acceptance Factors
With regard to the solution that the blue-ribbon panel is about to formally propose, none of the critical acceptance factors are present. Consequently, solution-acceptance risk could not be higher. Yet the panel has not formally acknowledged or addressed this risk. As a result, its solution is likely to be completely ignored by the very stakeholders it is intended to help.

Why is the first critical acceptance factor absent? Simply because nobody is “in charge” of private-company financial reporting in the United States. Unlike public U.S. companies, private U.S. companies have no statutory financial-reporting obligations. There is no individual, organization, or governmental agency that can unilaterally require private U.S. companies to use GAAP or any other specific accounting standards.

What about the second critical acceptance factor? Primary users of private-company financial information have extremely diverse needs. Lenders, venture capitalists, and surety companies each demand different information, and the information they demand is often specific to a particular information user, a particular reporting company, and the nature of the relationship between the two.

The absence of the third critical acceptance factor was highlighted within the context of solution-suitability risk in my previous column. To date, primary users of private-company financial information have not been engaged to a significant degree in the formation or deliberations of the panel.

Beyond simply observing the absence of critical acceptance factors in this situation, there is a growing body of real-world evidence that private-company stakeholders in the United States can and do ignore GAAP and alternatives to GAAP as they wish. For example, private-company stakeholders in the United States have largely ignored the International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs), despite the fact that it was created specifically as a simplified, cost-effective set of financial accounting and reporting standards for private entities.

Mitigating Solution-Acceptance Risk
In the United States, private-company financial-information users generally have the power to obtain the diverse information they want from reporting entities. You can tell users of financial information what they should want, but you can’t make them want it. And the ubiquitous NIH — “Not Invented Here” — syndrome guarantees that stakeholders won’t embrace a disruptive change that they’ve had no role in defining.

Mitigating solution-acceptance risk should be a top priority in present efforts to fix the problems of private-company financial reporting. To maximize stakeholder acceptance of any solution, the problem-solving process must:
• acknowledge that in the United States, a solution cannot be imposed on private-company stakeholders from without — it must be embraced from within;
• acknowledge that in the private-company realm, stakeholder needs and capabilities are diverse — a “one size fits all” solution isn’t likely to work; and
• engage all key stakeholders actively and deeply.

In the case of private-company financial reporting, any attempt to impose a single, complex solution on unengaged stakeholders will be met with failure. Here, the risk is that the huge community of users who have not been interested or engaged in the panel’s activities will reject a solution that wasn’t their idea, especially when they have no legal or economic incentive to accept it. It’s time to stop wasting resources on a solution that has little chance of being accepted when it is possible to mitigate the solution-acceptance risks we face.

CFO Contributing Editor Bruce Pounder is president of Leveraged Logic and is the immediate past chair of the Small Business Financial and Regulatory Affairs Committee of the Institute of Management Accountants (IMA). He will be a featured speaker at the 18th annual CFO Rising Conference & Expo in March 2011. He is also the lead developer and presenter for the Webcast series “This Week in Accounting.”