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The FASB has a total of five factors proposed as areas where financial reporting and accounting for private companies may differ from organizations. Among the five factors, two that are interesting include ownership and capital structure, and number of primary users and their access to management. The two factors are areas where there is clear difference in their application for private and public companies. It is vital to note that the FASB proposed the five differential factors with the aim of highlighting the areas where accountants for public and private companies may differently approach the accounting and financial reporting work.
Public companies have numerous primary users of financial statements when compared to the privately owned firms. Some of the primary users of financial statements in the case of public companies include main stakeholders like current and potential future investors, employees, shareholders, suppliers, creditors such as bond-holders, the executive management, and the government regulators. Public companies raise their debt capital from the public through sale of stocks on exchange markets. Some issue bonds and debentures in the stock markets. The buyers of the stocks, both ordinary and preferential ones, are members of the public who must understand the financial status of the company by analyzing its statement of income and financial position. It is only with such information that potential investors and creditors like banks can make informed decisions regarding putting their money in the organizations. Moreover, the government agencies related with business regulations are highly involved in the monitoring and controlling the operations of the public organizations to ensure the funds of investors and creditors are well-guarded and not swindled by ill-motivated entities. Most of these users of the financial statements in public companies have highly limited access to the management of the entities.
On the other hand, there are few users of the financial reports in the case of the private companies. Private companies are organizations which are privately owned and do not raise any monies from the public. The capital used in private companies is raised through equity from the owners, and or loans from creditors like financial institutions. Therefore, users of financial statements in private organizations include the owners, management, and creditors like banks. Banks need the financial statements to make decisions on the credit-worthiness of the entity. Interestingly, most of the primary users of financial statements in the case of the private companies have full access to the management unlike in the case of the public companies. Essentially, financial statements of public companies are public documents that have to published for free access by anyone in the market, whereas the same information is private and confidential in the case of the private entities.
On the factor of ownership and capital structure, private entities can have a single owner. In other cases, owners of private entities can also be many partners. However, for the case of the public companies, ownership cannot be by a single person. Ownership is by many people, with the majority shareholder having the strongest influence over others. When it comes to the capital structure, both private and public entities have equity capital. Uniquely, a private firm can have only equity capital in its accounts books and totally avoid being levered. For the case of the pubic companies, there must debt capital with ordinary and preferential shares. Commonly, both types of companies can have loans from creditors in their financial statements.
On the factor of the number of primary users of financial information, accounting risks are high for the public companies since they release much information to the public gallery, which then means competitors can easily monitor its business strategies and counter them. For the private companies, there are minimal and controlled primary users of the financial information hence there are minimal risks of business strategies leaking to competitors and unwanted audiences. In fact, information released by private companies is always purpose-driven. To minimize the risk associated with this factor, public companies need to control access to its financial statements by demanding registration on company websites by potential investors and public members before access.
On the factor of ownership and capital structure, the risk is for the private organizations since they have no access to unlimited sources of debt capital. It implies in cases of insolvency the company goes down and closes shop because it cannot raise any other funds apart from loans from banks and financial institutions. Public entities have no risk on this factor. To minimize this risk, private organizations must always ensure a safe balance between debt and equity capital to avoid being over-burdened by debt-financing costs.
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