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Private Company Financial Reporting Task Force Report

This report is not to be read apart from the entire AICPA report, nor is it a report prepared by the AICPA. This report was prepared for FEI by Arthur Neis, who takes sole responsibility for its content.

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Private Company Financial Reporting Mission Members Methodology

• Survey

• Participation

• Constituent Roles

Findings Conclusions and Recommendations

• GAAP for Private Companies - Fundamental Change

• Recommended Action

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Mission

What was being heard. Some GAAP reporting not understood or

needed by private company users. Complexity of GAAP. Public company accounting issues and

answers are driving GAAP. Caution – this is only one side of the story – was this simply a vocal minority?

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Mission

Conduct research to explore whether:

• general purpose financial statements of private, for profit companies prepared in accordance with GAAP meet the financial reporting needs of the constituents of that reporting, and,

• if the cost of providing GAAP financials is justified compared to the benefits.

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Members of Task Force

Users

• Owners/Managers

• Venture Capitalists

• Bank Lender

Former standards setter Practitioners

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Methodology

Engage market research firm Random – scientific – survey Broad outreach on web

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Participation

Random survey – 1,200. Broad outreach – 2,500.

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Random and Broad Outreach Survey

3,709 in total. 653 users. 1212 owners and financial managers. 1,702 practitioners. 142 other.

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Participation

Results stratified by constituencies – no averaging.

Results essentially the same. Random survey basis for report. Broad outreach commented only if different.

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Findings

GAAP is rated moderately high to high because such standards, for example, provide for comparability and consistency, by all constituents.

An independent accountant’s report is also rated moderately high to high, by all constituents, and the external stakeholders rate the value of an independent accounting report higher than all other constituencies.

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Findings (Continued)

A significant majority of external stakeholders have accepted financials on a basis other than GAAP, or with exceptions to GAAP.

• External stakeholders who have ever accepted financial statements from privately held, for-profit companies on a basis different from GAAP (cash, tax, OCBOA) range from approximately 60-90+ percent.

• Those that have accepted GAAP financial statements with exceptions ranged from 61-71 percent.

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Findings (Continued)

All key constituent groups rated many GAAP requirements as lacking in relevance and decision usefulness.

And finally, of those who had an opinion, the majority of all constituents believe it would be useful if the underlying accounting in GAAP reporting was different in certain instances for private, for-profit companies.

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Detailed Findings Comparisons

Would it be useful if the underlying accounting in GAAP reporting were different, in certain instances, for public vs. non-public companies?Business & Industry

38.0%50.0% 49.0%

61.3% 66.0% 67.8%

20.8%22.9% 23.1%38.0%

31.0%22.0% 17.9%

11.1% 9.1%

29.0%19.0%

24.0%

Revenue <$5Million

Revenue $5-$25 Million

Revenue >$25 Million

Revenue <$5Million

Revenue $5-$25 Million

Revenue >$25 Million

No answer

No

Yes

Random Broad Outreach

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Detailed Findings Comparisons

Would it be useful if the underlying accounting in GAAP reporting were different, in certain instances, for public vs. non-public companies?Practitioners

81.3% 83.0%90.0%

78.0%86.7% 85.3% 90.8%

66.5%

21.0%9.3% 9.1%

27.9%

4.7% 6.0% 3.8% 5.2% 5.6%6.7%

14.0% 11.0%9.0%

1.0% 1.0% 2.5%

5 or less Partn

ers

6-10 Partners

11-20 Partners

21 or more Partn

ers

5 or less Partn

ers

6-10 Partners

11-20 Partners

21 or more Partn

ers

No answer

No

Yes

Random Broad Outreach

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Detailed Findings Comparisons

Would it be useful if the underlying accounting in GAAP reporting were different, in certain instances, for public vs. non-public companies?External Stakeholders

51.0% 50.5%39.0% 37.6%

53.7%

28.6%

35.2%

24.4%

39.6%

16.0%8.9%

25.0% 26.8% 22.0%30.8%

33.0% 40.6%

36.0%

Creditor/ L

ender

Investor/ Venture Capita

l

Surety/ Bonding

Creditor/ L

ender

Investor/ Venture Capita

l

Surety/ Bonding

No answer

No

Yes

Random Broad Outreach

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1983 FASB Survey – 2004 AICPA Survey

1983* 2004**

Practitioners 57% 86%

Managers 35% 66%

Users 9% 56%

* Should GAAP permit certain areas to be measured differently by private companies than by public companies?

** Of those that had an opinion.

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Private Companies Distinctly Different Needs/Characteristics

Capital succession considerations and planned transfers of ownership.

Different capital structures.

Income and estate tax planning considerations.

Multiple entities with common private ownership.

Private companies cannot create cash (funny money) through their stock values for use in acquisitions, or for compensation.

Outstanding stock is typically controlled by a Buy/Sell Agreement which restricts liquidity, transferability, use as collateral.

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Private Companies Distinctly Different Needs/Characteristics (cont.)

Common use by lenders of loans with personal guarantees and cross-collateralization.

GAAP financial statements primarily for external lenders, who have direct access to company information.

Ownership typically closely held. Owners active rather than passive investors.

Private companies have stewardship needs versus valuation considerations of a public entity.

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Conclusions GAAP for private companies should be developed based

on concepts in accounting that are appropriate for the distinctly different needs of constituents of that reporting.

Although GAAP with exceptions and other bases are being used, and sometimes appropriate, these exceptions and other bases of accounting are not the best response to the private company needs.

Fundamental change should be made in the current GAAP standards setting process to ensure that financial reporting and needs of private companies are met.

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Conclusions (cont.) Develop a cooperative effort that includes

representatives of the key constituents of private companies to determine:

• Who should establish private company GAAP.

• How to best effect fundamental change of standards setting and develop and oversee the implementation process.