On December 23, 2013 the Financial Accounting Standards Board (FASB) issued the Private Company Decision Making Framework for Private Companies (Guide) as well as Accounting Standards Update 2013-12 Definition of a Public Business Entity (ASU 2013-12). The completion of these projects represents an important step in the development and implementation of alternatives within US generally accepted accounting principles (GAAP) for private companies by assisting the FASB and the Private Company Council (PCC) in defining both the framework under which such proposed alternatives should be evaluated as well as defining the scope of those entities that may elect to adopt such alternatives.
Decision Making Framework for Private Companies
Known informally as "the Guide," the framework identifies factors that cause the needs of financial statement users, along with the cost-benefit analysis for financial reporting, to differ for private companies as compared to those of public entities. The five differential factors include the a) number of primary users and their access to management b) investment strategies of primary users, c) ownership and capital structure, d) accounting resources, and e) manner in which preparers learn about new financial reporting guidance.
The differential factors will be used by the PCC as they propose and evaluate alternatives within GAAP for private companies. The Guide further highlights several important guidelines for private companies to consider when deciding whether to elect the alternatives approved by the FASB:
- Evaluate if an accounting alternative may be elected independently of others. A private company will be permitted to select the alternatives that it deems appropriate to apply, and there will generally be no requirement to apply all available recognition and measurement alternatives for private companies. But it is important to evaluate the terms of each alternative as the FASB and the PCC may require that application of certain alternatives within recognition and measurement in one area of accounting be linked together with the application in another area.
- Ensure appropriate disclosures are made of private company accounting alternatives. Private companies that apply alternatives within recognition and measurement guidance should disclose that fact in the notes to the financial statements so that users of the financial statements understand that one or more areas of the company's financial statements are not presented on a comparable basis with those of public companies or of other private companies that elected not to apply the alternatives within GAAP.
- Check with the users of the financial statements. Although the FASB has issued a definition of a public business entity to help determine which entities are within the scope of the Guide, the FASB acknowledges that decisions about whether an entity may apply permitted alternatives within GAAP are ultimately determined by regulators, lenders and other creditors, or other financial statement users that require GAAP financial statements. As a result, private companies may want to check with users of the financial statements before electing any alternative accounting treatments.
Definition of a Public Business Entity
Five Criteria that define a Public Business Entity
Criteria 1: "It [the entity] is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing)."
Criteria 2: "It [the entity] is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulation promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC."
Criteria 3: "It [the entity] is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer."
Criteria 4: "It [the entity] has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market."
Criteria 5: "It [the entity] has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract , or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion."
The definition of a public business entity was designed to identify the types of entities which are considered to be public business entities, and therefore, are not subject to consideration and evaluation for potential accounting alternatives in accordance with the criteria outlined in the Guide. An entity may only apply the accounting alternatives available to private entities if it does not meet any of the criteria that define a public business entity.
The Guide does not address not-for-profit entities and employee benefit plans as they are not included in the definition of a business entity. The FASB and PCC will decide whether an accounting alternative should apply to such entities on a case by case basis.
Types of Entities that are Public Business Entities
Any entity that meets any one of the five criteria of a public business entity is considered a public business and cannot elect accounting alternatives available to private companies which are established after December 2013. These five criteria encompass a wide range of entities, therefore, before electing an accounting alternative available to private companies, an entity will need to carefully evaluate whether it qualifies as a public business entity for the financial statements being issued (as discussed below, an entity may meet the definition of a public business entity in one instance and a private company for another).
Regulated Entities (Criteria 1 or 2): An entity that is required to provide GAAP prepared financial statements to the Securities and Exchange Commission (SEC) or file GAAP prepared financial statements with a regulator under the Act is a public business entity. Such entities include all entities required to file GAAP prepared quarterly and annual reports with the SEC as well as registered brokers and dealers. In addition, an entity that elects to voluntarily file with the SEC is considered a public business entity.
Entities whose financial statements are included in an SEC filing of another public business entity are also considered public business entities. These include entities that are considered significant equity method investments of a registrant, entities significant to and and/or being acquired by an SEC registrant, as well as all other entities whose financial statements are required to be filed with a registrants financial statements under Regulation S-X, Rule 3-09 Separate Financial Statements of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons, Regulation S-X Rule 3-05 Financial Statements of Businesses Acquired or to Be Acquired, and Regulation S-X, Rule 4-08(g) Summarized Financial Information. However, an entity that does not otherwise meet the definition of a public business entity except for the inclusion of its financial statements in another public business entity is only considered a public business entity for purposes of the publicly available financial statements. If the entity also prepares financial statements unrelated to the public business entity, for purposes of those financial statements, the entity would be considered a private business entity, and therefore could elect the applicable accounting alternatives.
Entities with unrestricted securities (criteria 3 or 5): The term securities, is a broad term encompassing both debt and equity instruments, and an entity with outstanding unrestricted securities or preparing to issue unrestricted securities should evaluate whether it is a public business entity. An entity that is preparing to issue unrestricted securities and as a result is required to provide GAAP prepared financial statements to a regulator is considered a public business entity.
The FASB is considering a potential future project toconform existing definitions within GAAP to the reviseddefinition of a public business entity provided by ASU2013-02, as well as the explicit inclusion or exclusionof not-for-profit and employee benefit plans from thescope of alternatives available to private entities.Financial institutions may also be excluded from certainalternatives regardless of whether they do or do not meetthe definition of a public business entity.
Other considerations may include potential deferredeffective dates of future Accounting Standards Updatesfor entities that do not meet the definition of a publicbusiness entity or for entities that are only public businessentities as a result of being a conduit bond obligor.
An entity, other than a not-for-profit or employee benefit plan, with outstanding unrestricted securities may be a public business entity even if its securities are not publicly traded if the entity is required to prepare GAAP financial statements and distribute them publically on a periodic basis. This criterion includes those entities that by law, contract or regulation are required to post GAAP financial statements on a website or to provided GAAP financial statements to the public upon request. Thus an entity required to make financial statements available upon request from the public that has not in the past made them publicly available, because they have not previously been requested, would be considered a public business entity. However, if such an entity is not required to issue a full set of GAAP financial statements, for example a balance sheet only, statements without full disclosures, or a Report of Condition and Income (Call Report), would not be considered GAAP financial statements and thus, would not be a public business entity under criteria 5.
In certain instances, an entity may issue restricted securities, yet not be considered a public business entity. Qualifying restrictions would permit an entity to control a transfer within a secondary market. Entities with restrictions on their securities that permit the entity to control the transfer of the security, such that they can effectively limit the type and number of investors, would not be considered a public business entity under criteria 3 or 5.
Conduit bond obligor (Criteria 4): A conduit bond obligor is an entity that has had securities issued on its behalf by a governmental entity. Conduit bond securities are typically called revenue bonds or certificates of participation, but encompass any similar debt. These securities are in the name of the issuing governmental entity, however the governmental entity has very limited obligations related to repayment of the debt (for example limited to payments received by the governmental entity from the conduit bond obligor). In addition, the conduit bond obligor is the party responsible for financial reporting related to the issued security. If the conduit bond obligation is traded, listed, or quoted in a public market (including exchanges, as well as over the counter markets), the conduit bond obligor meets the definition of public business entity.
Subsidiaries: The consolidation of a public business entity by a privately held company that does not meet the definition of a public entity does not change its status as a private entity. However, the qualifying subsidiary would be considered a public business entity for purposes of stand-alone financial statements.
Similarly, a private business entity that is a subsidiary of an entity considered to be a public business entity is not considered a public business entity for the purpose of preparing separately issued stand-alone financial statements.
For more information
If you would like to discuss this further, please contact James Comito of MHM's Professional Standards Group at email@example.com or 858.795.2029.
Published on January 28, 2014