Differential problems & possibilities accounting: the concept of big and little GAAP has been discussed for more than 20 years. Now, on the brink of international convergence, many argue its time has finally come.

For over 20 years there has been some disgruntled rumbling in the trenches of the accounting profession. As the Financial Accounting Standards Board (FASB) issues ever-more complex and arcane standards, financial executives of nonpublic companies have been groaning under the weight of onerous accounting requirements that often just don't seem to apply for them.

The thing they groan most is, "Why?" Why, they want to know, should Mom-n-Pop's Coffee Shop have to meet the same generally accepted accounting principles (GAAP) as giant General Motors Corp.? All Mom-n-Pop want is a bank loan for a new grill, while GM needs to justify several billion dollars in stock market investments.

From such questions came the concept of Big GAAP-Little GAAP--a system that would require big companies to meet one set of standards while little companies meet another. The idea kicked around in the 1980s and died out; it was revived in the 1990s, only to fizzle again.

Here in 2004, it's back--with its now politically correct term: "differential accounting." The division isn't between big and little companies, but rather between public and nonpublic companies.

Bill Balhoff, CPA, a partner with Postlethwaite & Netterville and an accounting activist who has held positions on the American Institute of CPAs' governing council and FASB's advisory council, and whose voice has been heard at Congressional hearings, believes the time for differential accounting has come.

"Over the years, I've defended the concept of a single set of accounting rules for all companies, public and private," Balhoff says. "But over the past year, decisions at FASB, the creation of the Public Company Accounting Oversight Board (PCAOB) and the drift of the International Accounting Standards Board (IASB) have led me to the conclusion that GAAP for public companies is less than ideal for private companies, sometimes even less than tolerable."

Balhoff points out that half of America's economic output is generated by millions of nonpublic companies, yet FASB writes standards primarily for the complex finances of about 15,000 public companies, establishing the GAAP that the SEC requires for listing on U.S. stock exchanges.

The Sarbanes-Oxley Act may also worsen the situation for privately held companies. The Act mandates that public companies provide funding for FASB. Formerly, funding came from a variety of sources, including accounting firms, investment companies, trade associations and nonpublic companies. While the change in funding may relieve FASB of implicit pressures, Balhoff says, it may also orient the board more toward standards for public companies, to the detriment of the rest.

The problem may be exacerbated by a joint project of FASB and IASB to converge U.S. and international standards. Because international standards inevitably apply mainly to big, international companies, those standards can often be less than appropriate for smaller, nonpublic companies. And since international standards have to apply in scores of national jurisdictions, they tend to apply to the most ponderous common denominator--again, the international public companies that sell equities in other countries.

Keeping the small company in mind when writing standards or converging with international standards is made more difficult by FASB's difficulty in finding accountants from small companies or auditors from small firms to serve on its board or work on staff. For the past several years, there have been none. Everyone at FASB headquarters in Norwalk, Conn., comes from a public company or Big Four audit firm.

AICPA Chairman and President Barry Melancon says the institute has issued a call for a nationwide discussion on the feasibility and advisability of differential accounting. Actually, AICPA is already working on a similar concept that relates to auditing standards. The Auditing Standards Board (ASB), which set audit standards for all companies until the creation of the PCAOB, has decided to shift its mission. Now that PCAOB is setting the standards for audits of public companies, the ASB intends to set standards that apply to private companies.

The 'Cons' Are Plenty

"We need to have this debate, and we need to not be fearful about the out-come," Melancon says. "We have to be open enough to say, 'No, we're not going to do it,' or 'Yes, we are going to do it.' There are pros and cons to the question."

The cons are plenty, and raise plenty of questions: Who would set the new standards, and how long would it take? Would division be drawn along the public-private line or by company size? Can transactions really be accurately recorded by two means of measurement? How would this affect the U.S. acceptance of international standards? What happens to the comparability of private and public companies and between U.S. and offshore companies? What happens to the books when a private company goes public? Will investors and other users of information respect one kind of accounting more than the other? Are there really two correct ways to account for transactions?

Any such change would affect every part of the accounting profession. Many auditors would have to learn two different sets of accounting standards, or possibly two specialties would develop. Changing jobs or moving up the audit firm ladder would get tricky.

If financial statements came in two forms, financial analysts would have to assess private companies one way, public companies another. Corporate accountants and financial executives would often have to juggle two kinds of accounting as their careers moved between private and public companies, or as their private company went public. In fact, all companies to which the new standards applied would have to convert their books, and their auditors would have to verify that it was done right. To many, that doesn't sound like much of a simplification.

The difficulties are not only technical but political. The new entity designated to set private company accounting standards would become both powerful and indispensable, its funding substantial, its obligations heavy, its influence far-reaching. Ideally, it would be an organization that is balanced and independent enough to serve America's Moms and Pops as well as its Morgan Stanleys and corner banks.

Maybe this is a job for the federal government--or maybe not. Not surprisingly, AICPA's Melancon is of the opinion that if the country decides to go the way of differential accounting, the AICPA is the logical body to write the standards, and FASB should be left to focus on standards for public companies.

No Threat to FASB

"If 50 percent of our economy is in the public companies, the writing of their standards has to be done and has to be done well," Melancon says. "But that doesn't mean that those same standards have to apply to corner grocery stores. Differential standards are not a threat to FASB at all," he adds.

Melancon says that if AICPA is called on to create an independent organization to set private company standards, it could do so in the same way it has done with the new ASB. Though overseen and organized by AICPA, the ASB operates outside of any official or direct influence by the institute council or its staff.

The Financial Accounting Foundation (FAF), which oversees FASB and the Governmental Accounting Standards Board (GASB), might also be a logical place to build a new standard-setting body. No such possibility has been discussed there, however. Bill Balhoff counters that slicing private companies from the scope of FASB-based GAAP might make the board's job easier. It wouldn't have to devise standards that serve different purposes, and the convergence with international standards would be greatly simplified.

FASB member Michael Crooch, however, doesn't see separate standards making either process any easier. "We write standards by looking at the economic transaction and coming up with the best answer we can with regard to the appropriate financial statement answer, and then we consider any differential disclosures that might relate to nonpublic companies," Crooch says. "My first reaction is that standards written only for public companies would not make the process that much simpler."

International Project Launched

Regardless of steps taken in the U.S., IASB has already launched a project to write special disclosure standards for small and medium-sized companies. The scope of the project does not reach into recognition, measurement or the definitions of assets and liabilities, but board member James Leisenring foresees pressure for the board to expand the scope in that direction.

The project comes in reaction to a recent IASB survey that found respondents generally agreeing there should be international standards for small and medium-sized entities (SMEs) and that mere addendums to existing standards would not suffice. A strong majority of the respondents also felt that the world could use a little simplification of recognition and measurement principles for these smaller companies.

Paul Pacter, IASB director of standards for small and medium-sized entities, says that the board wants to avoid a proliferation of national standards for small companies. Such an international mish-mash of standards is a possible consequence of international standards that apply mostly to large, public companies. Unlike the U.S., most countries require nonpublic companies to file reports under national GAAP.

"Today, no developed economy requires these little companies--five million in Europe alone--to follow GAAP as rigorous as that of international or U.S. standards, and that is not likely to change," Pacter says. "The board has agreed that it should develop a simplified SME GAAP based on international standards that is suitable for use globally by the millions of SMEs with a statutory reporting obligation."

The international board has already made it clear that size will not be the sole criterion for the special standards. Other criteria will include such factors as public accountability and the needs of the users of a given company's financial information. The board has rejected suggestions that special standards be written for companies in nations with developing economies. Representatives in those nations have said they do not want to be effectively ostracized because they have different accounting systems.

Requirements for special disclosures for SMEs would not affect U.S. accounting until the SEC accepts international standards for companies wishing to list on U.S. stock exchanges. If that day ever arrives, the commission will have to decide whether to accept differential accounting or disclosures for all sizes of public companies.

FASB's Michael Crooch warns the country not to leap into differential accounting until it is clearly being demanded by most companies and users of financial information. "Before I embark on differential accounting, I would make sure there's a demand for it," Crooch says. "This has been addressed many times, and it has never gone anywhere."

Glenn Cheney is a freelance writer based in Hanover, Conn., who frequently writes on accounting and financial subjects. He can be reached at [e-mail].