IFRS and Privately-Held Companies

8/3/2019 IFRS and Privately-Held Companies

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IFRS and Privately-Held Companies

Gregory J. Millman

the source for financial solutions

200 Campus DriveP.O. Box 674Florham Park, New Jersey 07932-0674www.ferf.org

an affiliate of financial executives international


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Many have heard about something new, something different happening in therealm of accounting, but few have a clear picture of what that is, or how it willaffect them.

In this well researched, concise report on international financial reportingstandards (IFRS), Greg Millman has provided the critical information that keyplayers will need to know as they begin the process of determining how andwhen to respond to these important developments. This balanced presentationprovides perspectives from key constituents with important knowledge of theareas you will need to consider in the near term, and beyond.

Gary IllianoNational Partner-in-ChargeInternational and Domestic AccountingGrant Thornton LLP

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TABLE OF CONTENTS

Purpose and Executive Summary 1

Research Methodology 2

What is IFRS? 3Definition 3Growing Acceptance of IFRS in the United States 3Relevance to Private Companies in the United States 3

IFRS vs. IFRS for Private Entities 5Why IFRS for Private Entities? 5How Does IFRS for Private Entities Differ from Full IFRS 5

IFRS vs. GAAP: Implications for Private Companies 7Principles vs. Rules 7The LIFO Tax under IFRS 7Other IFRS-GAAP Issues Important for Private Companies 9

The Bankers Perspective 11

Mary Ann Lawrence, Key Bank 11Dev Strischek, SunTrust 12Mike Cain, Frost Bank 13

The Private Company Executive Perspective 14George Beckwith, National Gypsum 14William D. Koch, Development Dimensions International Inc. 15Arthur Neis, Alliance Minerals North America LLC 16Andy Thrower, Naviscent 17

Summary and Conclusion 19

About the Author and Financial Executives Research Foundation, Inc. 20


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PurposeThe purpose of this report is to give executives of private companies abasic introduction to the implications of International Financial Reporting

Standards (IFRS). In November 2008, the SEC proposed a roadmap forthe use of IFRS by publicly held companies. Privately held companies arenot subject to SEC reporting requirements, but should be aware that IFRSrepresent an alternative to GAAP that they may want to consider.

Unlike public companies, private companies face a choice not onlybetween GAAP and IFRS, but between full IFRS and IFRS for PrivateEntities. Therefore, this report addresses both sets of standards insofar asthey may affect private companies. The report does not limit itself todiscussions of accounting differences, but discusses the impact of thosedifferences on financial reporting, tax reporting, the raising of capital, and

other activities.

Executive SummaryHere are the key findings of this report, based on interviews of bankers, financialexecutives, and other experts:

Principles-based IFRS may supplant rules-based GAAP for public companiesin the United States by 2014, according to a roadmap proposed by theSecurities and Exchange Commission (SEC).

Although there will be no regulatory requirement that private companies adoptIFRS, there are sound reasons for private companies to consider it.

There will soon be two options for private companies interested in adopting

IFRS: full IFRS and IFRS for Private Entities. Even if privately held,companies that are accountable to the public because they issue publiclytraded debt securities, or have fiduciary responsibilities (such as banks andmutual funds) must use full IFRS and follow the same rules as publicly heldcompanies. Private companies that are not accountable to the public may optfor IFRS for Private Entities.

IFRS for Private Entities is expected to be approved in the first quarter of2009. The AICPA already recognizes IFRS as a legitimate alternative toGAAP. So private companies should be able to adopt either full IFRS or IFRSfor Private Entitiesas early as next year, if they choose.

For some companies, full IFRS or IFRS for Private Entities may offer clear

advantages, but for others, these methods may entail potentially steep taxand audit costs.

IFRS for Private Entities represents the International Accounting StandardsBoards attempt to, in its words, provide a simplified, self-contained set ofaccounting principles that are appropriate for smaller, non-listed companies.It could mean that private companies will have lower costs for financial-statement preparation and auditing.


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However, neither full IFRS nor IFRS for Private Entities permits LIFO. This

means that under current U.S. tax law, companies on LIFO could face steeptax penalties for adopting IFRS.

Many U.S. banks say they currently are not equipped to deal with IFRS. Theircredit analysts do not understand it, and their analytical software, credit ratios,

etc. do not address IFRS statements. Most accountants in the United States have little or no training in IFRS.

Accounting schools have not prepared the profession for IFRS. Although the IASB claims that IFRS for Private Entities represents a

simplification of full IFRS, critics say that the simplicity is only apparent, andthat private companies adopting the standard will still have to do much of themeasurement and reporting that is of little relevance or utility to the users oftheir financial statements.

Research Methodology

This report is based on interviews with accounting professionals, policymakers, bankers,private-company executives, and other experts. The interviews were conducted duringthe second and third quarters of 2008. The intention was to identify the issues mostimportant for private companies, but not to compile an exhaustive catalog of accountingtreatments under U.S. GAAP, full IFRS, and IFRS for Private Entities. This report distillswhat some of the leading authorities in private-company accounting have to say aboutIFRS as it relates to private companies. It aims to reach a general-managementaudience, and is not primarily addressed to accounting specialists.

As this report was going to press, the International Accounting Standards Board was inthe process of finalizing IFRS for Private Entities(formerly IFRS for Small and Medium

Enterprises). Although some outstanding issues would affect the details of reportingunder the new standard, their disposition would neither substantially alter the mainfindings of this report, nor affect the interviewees concerns about the impact of IFRSconvergence on private companies.

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What is IFRS?

DefinitionInternational Financial Reporting Standards are issued by the International AccountingStandards Board (IASB), a 14-member organization appointed by the trustees of the

International Accounting Standards Committee Foundation. The IASB defines itsmission as to develop, in the public interest, a single set of high-quality, understandableand international financial reporting standards (IFRS) for general-purpose financialstatements.

Growing Acceptance of IFRS in the United StatesIn October 2002, the Financial Accounting Standards Board (FASB) of the UnitedStates and the IASB announced a memorandum of understanding known as theNorwalk Agreement. The memorandum was a step toward convergence of U.S.generally accepted accounting principles (GAAP) with international standards.

Subsequently, the U.S. Securities and Exchange Commission (SEC) made severaldecisions that led many to wonder whether IFRS might replace GAAP altogether. Themost notable of these decisions were:

November 15, 2007 The SEC voted unanimously to eliminate therequirement that foreign issuers of securities in the United States reconciletheir IFRS financial statements with GAAP, provided that they use IFRS asadopted by the IASB, and not a local adaptation of IFRS.

August 27, 2008 The SEC announced a plan to propose a roadmap foradoption of IFRS by U.S. public companies. The roadmap would identifyconditions under which the SEC might permit or require public companies toreport using IFRS.

Relevance to Private Companies in the United StatesUnlike most other jurisdictions, the United States does not require private companies toprovide general-purpose financial statements (or have those statements audited) as amatter of course. Unless companies access the public capital markets, or operate incertain regulated industries, they need not provide financial statements (other than taxreturns) to any government entity.

Thus, U.S. private companies do not and very likely will not face any regulatoryrequirement that they prepare their financial statements in accordance with either GAAPor IFRS.

That said, many private companies will sooner or later find themselves facing thedecision of whether to adopt IFRS. At present, although regulators do not require themto prepare audited financial statements, other constituencies may. Thus, privatecompanies often prepare audited financial statements according to GAAP for bankers,customers, suppliers, management and other constituencies. The process ofconvergence launched by the FASB and the IASB, and the roadmap defined by theSEC, suggest that IFRS will not only influence but may even supplant GAAP for public

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companies within the next decade. As IFRS becomes more widely accepted, andpossibly even required, as an accounting standard for publicly held companies, it shouldbehoove private companies to be aware of how they may or may not benefit fromadopting it.

IFRS offers clear advantages to many private companies in the United States. Forexample, some U.S. private companies may have subsidiaries outside of the UnitedStates that are already using IFRS to comply with the law in those jurisdictions. Suchcompanies could well find it simpler to adopt IFRS at the parent level than to reconcileto U.S. GAAP. For these and other private companies, the transition to either full IFRSor IFRS for Private Entities may and we emphasize may -- mean simpler financialstatements and lower audit costs.

Yet IFRS may also impose new and onerous costs on some private companies. Forexample, companies that use the last-in-first-out (LIFO) method may find that adoptingIFRS carries a steep tax penalty. Many of these companies have substantial LIFO

reserves. IFRS does not permit the use of LIFO (in contrast with GAAP). The U.S.Internal Revenue Service requires companies to be consistent in their use of LIFO orFIFO: that is, they must use the same method for tax reporting as they do for financialreporting. Converting from LIFO to FIFO would mean a tax hit because the LIFOreserves would become taxable. Some interviewees expect to see congressional orregulatory relief to encourage companies to make the transition to IFRS. However, notall interviewees expect relief. In fact, some suggest just the opposite that the IFRStransition could represent a stealth tax increase on businesses. There is some evidencefor the latter, pessimistic view: some Congressional members have proposed increasingtax revenues by repealing LIFO.

The transition to IFRS will have unique consequences for government contractorsbecause of the regulatory environment in which they operate, notes William Keevan,senior managing director of Kroll, Inc. He explains that virtually all governmentcontractors are subject to the "cost principles in Part 31 of the Federal AcquisitionRegulation ("FAR") and most contractors are subject to the Cost Accounting Standards("CAS") promulgated by the Cost Accounting Standards Board, which is part of theOffice of Federal Procurement Policy. The CAS set forth the rules contractors mustfollow for measuring costs, assigning costs to accounting periods and allocating costs togovernment contracts. The FAR cost principles determine whether a cost is or is notreimbursable. Both the CAS and FAR cost principles incorporate GAAP to a certaindegree, while differing from GAAP in other respects. Adoption of IFRS may require thatcosts and prices of contracts be adjusted. "Depending on how the regulators view theseaccounting changes, contract costs and prices could be adjusted both upward anddownward, or only downward. Other complications are also likely to result," saysKeevan.

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FullIFRS vs. IFRS for Private Entities

Why IFRS for Private Entities?There will soon be two separate sets of IFRSs. Full IFRS applies to public companiesand to private companies that are publicly accountable because they access the public

debt markets or hold assets as fiduciaries (such as banks, insurance companies,securities broker/dealers, pension funds, mutual funds, investment banks, etc.).However, in February 2007, the IASB published an exposure draft of a proposed IFRSfor Small and Medium-sized Entities. In May 2008, the board changed the title to IFRSfor Private Entities. Full IFRS fills approximately 2,700 pages. By contrast, the exposuredraft of IFRS for Private Entitieswas approximately 250 pages long.

The IASB explained:

Because full IFRSs were designed to meet the needs of equity investors in companies in publiccapital markets, they cover a wide range of issues, contain a sizeable amount of implementation

guidance, and include disclosures appropriate for public companies. Users of the financialstatements of private entities do not have those needs, but rather are more focused on assessingshorter-term cash flows, liquidity and solvency. Also, many private entities say that full IFRSsimpose a burden on them a burden that has been growing as IFRSs have become moredetailed and more countries have begun to use them. Thus, in developing the proposed IFRS forPrivate Entities, IASBs twin goals were to meet user needs while balancing costs and benefitsfrom a preparer perspective.(source: http://www.iasb.org/Current+Projects/IASB+Projects/Small+and+Medium-sized+Entities/Small+and+Medium-sized+Entities.htm)

The objective of the project is to develop a set of standards that meets the needs ofentities that are not publicly accountable but that do publish financial statements forexternal users, including providers of capital, credit rating agencies, owners who are notactive in management, etc.

How Does IFRS for Private Entities Differ from Full IFRS?Full IFRS applies to publicly accountable companies. The IASB claims to have madefive kinds of changes to full IFRS in order to develop a standard for private entities:

1. Topics deemed not relevant to private entities are eliminated.2. Where full IFRS allow accounting policy options, IFRS for Private Entities

includes only the simpler option.

3. Many simplifications of the recognition and measurement principles that are infull IFRS.4. Many reductions in disclosures.5. Simplified drafting.

The abbreviated, private-entity standard eliminates topics not relevant to most privateentities. Whereas full offers a choice of accounting treatment, IFRS for Private Entitiesprovides only the simple option. Recording and measurement is also simpler. For

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example, there are only two categories of financial assets, instead of four, and privateentities are permitted to expense all research and development costs, instead ofcapitalizing development after viability of the innovation. However, private entities maychoose to use the more complex accounting treatment by cross-referencing to full IFRS.

Yet critics say that the simplification apparent in IFRS for Private Entities is misleading.Andy Thrower, former national chairman of the Standards Subcommittee of FEIsCommittee on Private Companies, says, Simplification is not there, and I dont believethat private companies will experience any meaningful difference between whats inIFRS for Private Entities and what theyre doing now. Thrower says that IFRS forPrivate Entities looks simple because it is a short, clearly written document but stillrequires private companies to do the same kind of extensive and expensivemeasurement and disclosure required by U.S. GAAP.

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IFRS vs. GAAP: Implications for Private Companies

Principles vs. RulesThe acronym GAAP stands for "generally accepted accounting principles. The wordprinciples is a bit misleading, because in practice, U.S. GAAP is a rulebook with more

than 20,000 pages of detailed prescriptions, industry-specific applications, variations,exceptions, and provisions.

By contrast, even full IFRS is only about 2,700 pages long and, as mentioned above;the simpler IFRS for Private Entities is only about one-tenth the length of full IFRS.There is a cost to this simplicity: a greater range of variations in accounting practice.Paul Pacter, director of standards for private entities, IASB, says, "Obviously, at 10percent of the size of full IFRS, there are fewer issues covered in the private entitiesstandard, which will mean more diversity in practice than with full IFRS or U.S. GAAP."

A panel addressing a gathering of bankers at the Risk Management Association's

annual conference in October 2008 advised that two CPAs working with the same datacould produce quite different reports, both in accordance with IFRS. Consequently,footnotes to financial statements will be indispensable to explain the preparer's logicand provide context for users.

U.S. GAAP offers quite detailed and industry-specific rules for revenue recognition.IFRS does not. The principle under IFRS is to recognize revenue when it is probablethat future economic benefits will flow to the entity and these benefits can be measuredreliably. Press reports suggest that, internationally, companies switching from their localGAAP to IFRS have generally been able to report higher revenues. See, for example:http://www.cfo.com/article.cfm/10919122/c_3395216

Even if IFRS is simple and clear now, some question how long it may remain so after itsadoption in the United States. More than one interviewee described IFRS as "GAAP 25years ago, and suggested litigiousness in the United States will lead inexorably todetailed application guidance and blur the distinction between "principles" and "rules.

Arthur Neis, president of Alliance Minerals North America LLC and a member of theStandards Subcommittee of FEI's Committee on Private Companies, says, "We aregoing back to the old days, when the auditors had to stand tall and individually takeresponsibility and say, 'This fairly represents the entity'. They can no longer hide behindpage 892, paragraph 3."

The LIFO Tax under IFRSLIFO (last-in-first-out) is a method of calculating the cost of goods sold that assumes thelast items to enter inventory are the first to be sold. The opposite of LIFO is FIFO (first-in-first-out), which assumes that the first items to enter inventory are the first sold. Ininflationary periods, LIFO accounting reports a higher cost of goods sold, and thereforea lower net income. The opportunity to reduce tax liabilities by using LIFO was attractive

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to many companies. The inflationary gains in the value of their inventory went not to thebottom line, but to a special LIFO reserve account.

Over the years, those LIFO reserves have become quite substantial. In fact, in 2006,the Senate Republican leadership proposed getting rid of LIFO in order to raise

revenues to pay for a $100 gas tax rebate for every American family. AssociatedEquipment Distributors, a trade group, reported that, Assuming a 35 percent tax rate,LIFO repeal could mean an $870 million tax increase for AED members alone! [Source:http://www.aednet.org/government/aed-washington-insights.cfm?id=07/01/2006#ref2]

George Plesko, a professor at the University of Connecticut School of Business,testified that according to the most recent data available at that time, the LIFO reservesof U.S. publicly traded companies totaled $60 billion. He estimated that, assuming a 30-percent tax rate, repealing LIFO could bring in $18 billion in tax revenues, before credits.[Source:http://www.senate.gov/~finance/hearings/testimony/2005test/061306testgp.pdf].Of course, financial statements of privately held companies are not publicly available,and some critics disputed Pleskos calculations for publicly held companies. A broadcoalition of trade associations and industry groups opposed the proposal to repeal LIFO,and it did not move forward.

However, in 2007, U.S. House Ways and Means Committee Chairman Charles Rangelof New York proposed a tax reform bill that included repeal of LIFO to raise anestimated $107 billion over 10 years. A report by Credit Suisse indicated that basicmaterials and energy companies would be particularly exposed. [Source:http://emagazine.credit-suisse.com/index.cfm?fuseaction=OpenArticle&aoid=206991&lang=EN&coid=177883]

Under current U.S. tax law, private companies that use LIFO and have accumulatedsubstantial LIFO reserves would face a substantial tax penalty if they were to adoptIFRS, which does not permit LIFO. George Beckwith, controller of National Gypsum,says, Many private companies are S-corporations and are very attuned to the taxconsequences of transactions. Giving up LIFO would be a big deal if it lands on theowners personal tax return. They wont be able to change their financial reportingmodel if its going to cost them cash.

There have been reports of meetings and discussions with IRS officials about this issue.However, the requirement that companies be consistent in their use of LIFO or FIFO forboth financial and tax reporting is not a matter of regulatory interpretation, but of tax law.Congressional action may be necessary to address it. Given the history of proposals torepeal LIFO advanced by both Republican and Democratic legislators specifically inorder to raise tax revenues, it is far from certain that Congress would act to protectcompanies from the tax impact of the IFRS transition.

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Other IFRS-GAAP Issues Important for Private CompaniesAsked to note some of the differences between GAAP and IFRS, Paul Pacter, directorof standards for private entities at the International Accounting Standards Board,indicated the following:

Investments in real estate: full IFRS allows fair-value reporting, i.e., revaluingthe investment at each reporting date. The change in value goes to the P&L. Provisions, such as liabilities of uncertain amounts: in U.S. GAAP, when a

liability, such as a lawsuit, might have a range of possible outcomes,accountants accrue the minimum and disclose the potential excess. UnderIFRS, accountants accrue the expected amount, which is a probability-weighted estimate.

Borrowing costs: GAAP requires capitalization of borrowing costs relating toconstruction of a long-lived asset, but under IFRS for Private Entities,borrowers may either capitalize or expense these costs.

Research and development (R&D): GAAP expenses all R&D. Full IFRS

expenses research costs but capitalizes development costs, defined as thosecosts incurred after the product is commercially viable. IFRS for PrivateEntities follows the GAAP approach of simply expensing all R&D costs, butallows the option of capitalizing development costs (with a cross-reference tofull IFRS).

Impairment: full IFRS requires calculating impairment based on thediscounted cash flows. U.S. GAAP, by contrast, does not require animpairment calculation as long as the present value of future paymentsequals or exceeds the carrying amount of the asset. Pacter offers theexample of a strip mall that is half empty. If gross expected rental paymentsequal or exceed the carrying amount, there is no need to calculate

impairment under U.S. GAAP, but there is under IFRS. Income taxes: IFRS requires accrual of deferred taxes on non-deductible

goodwill; U.S. GAAP may or may not. IFRS also requires accrual of deferredtax on undistributed earnings of consolidated subsidiaries.

Companies may find their income statements more volatile under IFRS, says KarineBenzacar, president of KnowledgePlus, a consulting firm based in Toronto. Sheexplains, Reported income tends to be higher under IFRS but also tends to be a lotmore volatile. Under current Canadian or U.S. GAAP, when there is asset impairment,the asset gets written down but not back up. Under IFRS, if circumstances change, theasset will have to be written up. She notes that IFRS also requires disclosure of

constructive obligations. If a company has an expectation that it will make a payment, ithas to disclose that in its financials. For example, suppose a company promises publiclyto clean up an oil spill, even if it doesnt have to by law. Since it has made a publicannouncement, its expected to incur those expenses. Under IFRS, its required to showthat liability in the financials.

Banks are the primary source of capital for privately held companies, and IFRS isstricter than GAAP with respect to waivers of covenant issues. Mary Ann Lawrence,

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senior vice president, credit risk review, at Key Bank, says that under U.S. GAAP, acompany technically in default on a covenant at the end of a reporting period can goback to the bank and ask for a waiver. If the waiver is granted, the company need notreport the default as a current liability. However, under IFRS, if the company has notalready obtained a waiver before the end of the period, it must report the liability as

current. The large companies have financial staffs that can project and track theseissues. But a lot of small, private companies will run into a real problem with thisbecause they dont realize theyre in default until the accountants do the books. Nowtheyll be in default, not just technically, but really in default, and thats a big distinctionin the banking world, she says.

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The Bankers Perspective

This section of the report presents reflections on IFRS by bankers who provide capitalto privately held companies.

Mary Ann LawrenceSenior Vice President, Credit Risk ReviewKey Bank

Were a large enough bank that we do public companies, but we also do a lot of privatecompanies, and we get the entire gamut of small-enterprise statements. I think mostpeople dont know and dont realize the effect of accounting convergence. It means,number one, everybody will have to be retrained and, number two, covenants are goingto have to be rewritten and models to rate credit redone. Anything that relies onaccounting data is going to have to be redone.

It is going to be a massive change and will cost lots of money. Banks will need trainingfor credit analysts and new software to get financial statements and ratios. They willhave to rethink what ratios are and what they really mean, so they can figure out how toset covenant levels. It will be a brave new world for a whole bunch of people, not justthe banks but also the bank regulators. It will be a big cost to the economy, and giventhe current conditions, Im not sure we have the extra economic power to provide thetraining necessary. Its a hidden cost that people dont think about.

Theres no place to get really good training. The schools are not teaching IFRS.Academics will not start making changes in academic programs until there is clearguidance from the SEC for large companies and some guidance on what will happen

with private companies.

Lenders are not actually so concerned about what the rules are, but we want consistentapplication of those rules, so that when were looking at statements for two companieswe can make an informed decision. Frequent changes in GAAP have hurt theconsistency of accounting for private companies. Im not saying accountants are notdoing the right thing, but there are many changes, and not a lot of lead time, soaccountants arent always up-to-date. If youre a sole practitioner accountant doingprimarily small private companies, you depend on continuing education to keep youabreast of the latest changes.

The foundation of a principles-based system is that the accountant is a professional andunderstands the principles. I can see, in our litigious society, the legal system having afield day. So I think it will morph into more rules. The reason many people think IFRS ismore principles- than rules-based is that IFRS hasnt been around long enough. WhenIFRS has been around as long as GAAP, youll see the same volumes of interpretationsand rules. Its a cultural thing.

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I think there is going to have to be some kind of governing body in this country tooversee accounting for private companies. Who it should be is an interesting question.One could make an argument that it should be some new group that is anamalgamation of the FASB and the AICPA, a group that could speak both for theprofession and for users.

Dev StrischekSenior Vice President and Senior Credit Policy OfficerSunTrust

We bankers are always a little bit reserved when it comes to changes in accounting,and particularly a change as large as this one is going to be.

IFRS has been totally focused on global publicly traded companies. The puzzle is howin the world you can focus only on a few thousand globally traded companies and put

off until tomorrow the vast majority of corporations. My first thought is theres an equityanalyst focus on IFRS, which seems to ignore the vast majority of corporations in theUnited States. The second interesting item is that most companies would report anincrease in income under IFRS. Given that most privately held companies generally tryto avoid paying additional taxes, they are not going to be very excited about that.

Third, consider IFRS a Trojan horse for fair-value accounting: now your incomestatement is reflecting not just the cost and revenues associated with products orservices you have sold, but also changes in value from time period to time period. Isthat what we really want? Fourth, IFRS does not permit LIFO accounting, but many autodealers and manufacturers use LIFO, so suddenly they have to push out their LIFOreserves into their income statements. Its an incredibly embarrassing time to showhigher income when you probably dont have the cash flow to pay the taxes. A fifth itemis that under IFRS, all leases would be treated as capital leases; there will be no off-balance-sheet operating leases. But for tax purposes theyre likely to continue to permitoperating leases, so you have another deferred item popping up on balance sheets.

In banking well accommodate just about anything. Many of our borrowers provide uswith cash-based accounting that is not GAAP, or with tax statements.

The amount of effort necessary to get onto a fair-value basis is big. For example, if youhave an airplane, you cant just have a value for the plane, but you have to break itdown into component parts. And how do you value nonfinancial assets anyway?

The SEC itself seems to have slowed down its embrace of IFRS because of thefinancial crisis. If you were to look at the tenor of SEC pronouncements and guidancethree or four months ago, IFRS was the way we were going to go. Now, in the financialcrisis, fair value begins to look a little more challenging to implement. We in banking aregrateful for the rethinking.

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Mike CainSenior Executive Vice PresidentFrost Bank

It will really come down to cost-benefit. From my perspective, I get no real benefit. Most

of our customers are middle-market companies with total sales from $1 million to $100million. We have a few that do business internationally, but very few have reportingentities that are on IFRS. So in terms of making their accounting life easier, IFRS isntreally a factor. Most of these business users do not provide financial information tointernational grantors of credit but instead use letters of credit. So the biggest downsideI see is that private companies are going to have to change their accounting with nobenefit. The private sector is left with the cost of changing systems, familiarizing theinternal staff with the new approach, working with preparers, and so on. Maybe theresan undefined long-term benefit, but most of our clients are looking at todays cost andrevenue and arent too worried about two years from now.

The LIFO issue will have a huge impact on private companies. Large numbers of ourcustomers have a LIFO position, and I can think of several whose LIFO reserve is asbig as their net worth. It was done that way for tax reasons. Although their profits havelooked smaller, their cash flows have been better because of the tax subsidy theyvegotten for LIFO accounting. From a practical standpoint, thats probably the biggestdirect cost.

We have a financial analytic software package that serves us well, but it would notnecessarily deal with a new basis of accounting. The system is not really going to map.An updated version of that will cost half a million bucks, plus who knows how manymore dollars in training costs and reeducation. Those are the negatives.

Most of the private companies I deal with perceive that accounting, whether its U.S.GAAP or IFRS, is really built for public companies and not for private companies. Imseeing a lot of statements these days that have opinions with qualifications orexceptions from GAAP. Ten years ago that would have been the kiss of death, but nowits fairly commonplace.

IFRS for Private Entitiesmay be a middle ground, possibly a bit too light for a lot of ourcustomers, but there are probably a lot for whom it would fit well.

For us, cash flow is obviously paramount. Verification of numbers is important. But formost of the people we deal with, the more esoteric things like derivatives and fair-valueaccounting are not issues.

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The Private Company Executive Perspective

This section of the report presents reflections on IFRS by executives of privately heldcompanies and preparers of financial statements. Each of these executives is amember of the Standards Subcommittee of FEIs Committee on Private Companies.

George BeckwithControllerNational Gypsum

Private companies need to know that IFRS is not completely different. Its not as if youchange how you record receivables and payables and basic expenses. The maindifferences are things that private companies would find to be favorable. Its much moreprinciples-based and focused on general-purpose financial statements, unlike GAAP,which has evolved to be a special-purpose financial statement. For example, theremight be special-purpose financial statements made up just for a regulator. Utility

regulators require a utility to list and account for assets differently; bank regulatorsrequire different disclosures from energy regulators. GAAP has moved [accounting] tobe almost exclusively for publicly traded companies. IFRS takes it back to being whatthe general person wants to see. Many of the frustrations private companies have comefrom the fact that everybody has to play by the public-company rules; other than filing a10-k and following proxy rules, private companies have the same disclosurerequirements.

IFRS is much more principles-based. Thats certainly a benefit. GAAP requires a $20-or $50-million dollar construction company to go through with its auditors all thedisclosures that would be required for some obscure thing that doesnt really apply to it.

Getting away from that is going to be a big benefit to private companies.

I think it would make our financial information more understandable to our owners andour creditors. We would have fewer carve-outs for debt covenants and so forth. Todaywe back out a lot of FASB accounting that banks and owners say is not relevant to themas users. We would have fewer of those. Wed have a better look into the financials ofthe organization. From an internal perspective, the preparer would find it simpler. I thinkour audit fees would go down.

We hope to adopt it, but we have roadblocks in our way. Like many others, we wouldlike to see LIFO addressed. LIFO doesnt have any good accounting theory behind it;

its much more of a tax theory. Its not as if its good financial reporting to use LIFO.IFRS does not allow it. But many public and private companies are more attuned to thetax consequences of transactions. They wont want to change their financial reportingmodel if its going to cost them cash.

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William D. (Bill) KochVice President and CFODevelopment Dimensions International Inc.The train is moving to convergence: either jump on or get run over. I dont know whats

going to happen with U.S. standards, but theyre going to converge at some point intime.

Were a human resources consulting firm focusing on three things: 1) employeeselection, 2) leadership development, and 3) execution of corporate strategy. Wereabout 50/50 U.S. and non-U.S., with a lot of pass-through subsidiaries. Many, if notmost, jurisdictions use IFRS or a variant. We consolidate using U.S. GAAP atheadquarters, and it turns out that for us, its close to being the same. There are somespecial cases where the rules are different. But when we did an analysis of IFRS forPrivate Entitiesa year ago, we walked away saying wed move to that someday. Wedhave to do some work, but the fact that the rules wouldnt be changing every three

weeks was very appealing. CFOs dont generate business value by spending time onaccounting pronouncements; not one of my customers has asked me about what ourposition is on fair value, FIN 48 or FIN anything else.

Owners of private companies are generally significant percentage owners, not minorityshareholders. Theyre involved, know whats going on in the business, and are muchmore interested in cash flow than valuation. Analysts of public companies are lookingfor a piece of differential value that, when the world catches on, will drive up the price.Its a totally different motivation. We run a pretty simple business you have to get yourcost to be nine when you sell for 10. If I were czar of all Russia, Id issue cash-flowstatements. But we have to capitalize R&D software development and amortize it,because from a valuation standpoint its supposed to be better. We dont manage ourbusiness that way. Its one of the things we put up with because thats what GAAP saysyou must do, but we dont need that kind of profitless bookkeeping.

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Arthur NeisPresident, Alliance Minerals North America LLCMember of the IASB Working Group for Small and Medium-sized EnterpriseFinancial Reporting and of the FEI Standards Subcommittee

The logic is pretty clear and compelling. We have in IFRS a set of standards, not rules,which can be applied rationally. The AICPA has said that IFRS is a recognized set ofstandards on which auditors can opine. Bank agreements that specifically referenceGAAP are beginning to reference IFRS. IFRS seems to be very well field-tested andeasily implemented, and the lenders have gone along, recognizing that privatecompanies are different from public companies.

In preparing IFRS for Private Entities, we started with all of the accounting and reportingprinciples for any given area and asked ourselves which of those accounting andreporting principles applied only to public entities. We eliminated a large percentage ofthe principles, and delineated the key accounting and reporting principles that apply to

private entities.

It seems to me that almost everyone in the world of business has a concept of thefundamentals of accounting and financial reporting. The problem is that we havedeviated down the path of innumerable rules and nuances that were specific tosituations and werent relevant to operating management. But every business personhas been through at least a few courses at a business school and has had a basicintroduction to financial reporting. IFRS for Private Entities is contained in 250 pages,and anybody can read that, understand it, take it away and hang on to it.

Were going back to the old days, when the auditor had to stand tall and individuallytake responsibility and say, This fairly represents the entity. They can no longer hidebehind page 892, paragraph 3. Thats where we were 50 years ago when I got intobusiness. I got lectures on how my personal financial strength was dependent on myintegrity and my auditing. The same applies to all preparers/CFOs.

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Andy ThrowerPartner, Naviscent

If Im a small company on the European continent, Im required by law to have financialstatements audited and filed. Here in the United States, Im not required to have that,

but in the event I go out to seek capital, debt or equity financing, the party that may bewilling to invest or lend may require me to have a set of audited financial statements. Soits a market-based determination here in the United States.

A database of the Risk Management Association lists 150,000 private companies.About 30,000 to 40,000 issue audited statements. Another 30,000 to 40,000 issuestatements according to GAAP, and the rest either say they are tax-based, other-comprehensive based, or else dont disclose. So there are many more privatecompanies issuing GAAP statements than public ones.

If the AICPA says it will now accept IFRS for Private Entities, but the banks dont want it,

then there isnt a demand. The preponderance of support for GAAP is market-driven,and by market I basically mean custom and tradition. We could end up adopting IFRSfor Private Entities, or we could end up doing nothing.

It appears to be a simpler version and perhaps a less costly option for U.S. companies,as it excludes some of those things that private-company users say are irrelevant. Butmy opinion is that IFRS for Private Entitiesis basically designed for companies with 50employees, and I think it is still too complicated for the small company that needs GAAPstatements only because it needs a bank loan.

IFRS for Private Entitiesgives the impression of being simpler because there are fewerpages and it reads nicely. But some things are summarized by cross reference to fullIFRS. That makes IFRS for Private Entitiesa lot smaller, but it does not take away therequirement. At some point, it may state a principle identical to full IFRS or GAAP, butleave out the implementation guidance. That doesnt mean you dont have to implementit or report it; the fact that IFRS for Private Entitiesdoesnt tell you how doesnt meanyou dont have to do it.

The debate over GAAP for private companies has been around for a while, but now thatwe have convergence, it raises again whether its a convenient opportunity for privatecompanies to do something different. We have had a lot of standards in recent yearsbased less on accounting transactions and more on economic events. That adds adegree of difficulty for private companies. With no transaction, they have to hire anappraiser. Then the banker says I dont need that information; if I need to know thevalue of your fixed assets, Ill hire an appraiser.

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In 2005, the AICPA published the Private Company Financial Reporting Task ForceReport. The report identified 12 GAAP requirements that were low either in relevanceor usefulness for private companies. However, when the IASB issued its final exposuredraft of IFRS for Private Entities, it included all 12. **

Well continue to hear the same complaint: that the information satisfies the needs ofinvestors and potential investors, but not of users of financial statements of privatecompanies, who are primarily bank lenders. I dont see any improvements. Moreover, inthis country there is an insatiable demand for implementation guidance, interpretation ofstandards, etc. You wont change the U.S. cultural and legal environment. When weadopt IFRS, a void will be created, and somebody will step in and write rules andimplementation guidance because our culture will require that. Then private companies,as long as theyre in the system, will be pulled along, and it will be business as usual.Just because somebody puts out a principles-based standard on leases doesnt meanmy auditors are going to be comfortable. Legal exposures remain the same, second-guessing remains the same, so the idea that well magically drop all of these detail

demandsyou tell me how in the world could that possibly happen?

**Note: in an article now under consideration for publication by The CPA Journal, AndyThrower details the problematic standards and their treatment under IFRS for PrivateEntities.

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Summary and Conclusion

IFRS for Private Entities will offer privately held companies an alternative to GAAP.Principles-based rather than rules-based, this alternative promises to be simpler andmore straightforward than GAAP. The IASB has also committed to put changes on a

timetable, so the first release of IFRS for Private Entitieswill be unchanged for at leasttwo years. Companies frustrated with the complexity of GAAP and the frequent changesfrom the FASB may find IFRS for Private Entitiespreferable. However, tax issues will bea deterrent for companies that use LIFO to calculate the cost of goods sold.

Executives of private companies seem more receptive than bankers to the prospect ofIFRS for Private Entities. Bank credit analysts do not, for the most part, have training orexpertise in IFRS. Banks will need to upgrade software and human resources in orderto cope with the change. Although bankers are decidedly unenthusiastic about makingthese investments, bankers who spoke on the subject for this report indicated that theywould accommodate borrowers who opt to make the switch.

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About the Author

Gregory J. Millman is a contributing editor to Financial Executivemagazine and editor of IFRS Reporter(http://www.ifrsreporter.com ). He has also written for Forbes, Barrons, the Wall Street Journal, TheWashington Post, and numerous other periodicals. He is the author of books of financial journalism

including The Floating Battlefield: Corporate Strategies in the Currency Wars; The Vandals Crown: HowRebel Currency Traders Overthrew the Worlds Central Banks, and The Day Traders: the Untold Story ofthe Extreme Investors and How They Changed Wall Street Forever. His most recent book isHomeschooling: A Familys Journey.

Prior to making a career shift to journalism, he worked in banking, consulting, and project finance in China.He earned an MBA at the Olin School and a Master of Arts (Asian Studies) from Washington University inSt. Louis. He may be reached at [email protected] or by phone at (732) 926-1225.

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IFRS and Privately-Held Companies

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