Accounting Standards and Small Firm Debt and Equity: An International Research Agenda

Abstract

Notwithstanding exemptions provided through professional accounting bodies around the world, standards and procedures applicable to publicly traded firms are often used to identify and analyse financial information about privately held firms. Such approaches may not always be applicable. In an environment of emerging international standardisation and differential reporting for small enterprises, the focus of this paper is on one potentially inappropriate procedure that relates to the identification of debt and equity. In many instances the debt reported in the financial reports of privately held firms is provided to the firm only because the owner's personal assets have been provided as debt collateral. Such a circumstance means the amount involved has more of an equity characteristic than a debt characteristic because the owner's personal wealth is put at risk for an uncertain return. For this reason the existence of debt secured by personal collateral is often referred to as quasi-equity. The presence of unrecognised quasi-equity generates two significant types of problem. Firstly, a potential investor analysing the financial reports of a firm in which reported debt is really quasiequity may assess the firm to be a poor investment opportunity because it has an apparently high reliance on debt in its financial structure. The second problem is that there is an increasing reliance on the content of the financial reports of privately held firms by researchers gathering and analysing data to inform and guide policy. By aggregating that data without recognition of the quasi-equity characteristic of such debt, invalid understandings of the nature of the equity and debt funding of privately held firms might be emerging. Unfortunately the accounting profession has not recognised the existence of these problems and, apart from the special reporting requirements in the United Kingdom, there does not appear to be any attempt to ensure reports prepared for privately held firms identify the presence of quasiequity.