Key developments in standard-setting for private companies
The FASB issued ASU No. 2014-02, Accounting for Goodwill, on January 16, 2014. This guidance provides private companies with an accounting alternative which is intended to simplify the accounting and reporting for goodwill. Under this alternative, a nonpublic entity is able to amortize goodwill on a straight-line basis over a period of ten years (or over a shorter period if the company demonstrates that another useful life is more appropriate). Goodwill would be subject to impairment testing only upon the occurrence of a triggering event. The impairment test can be performed at an entity-wide or reporting unit level, based upon the company’s accounting policy election. If a quantitative impairment test is required, a one-step impairment test would be performed. The amount of the impairment would be measured by calculating the difference between the carrying amount of the entity (or reporting unit, as applicable) and its fair value. A hypothetical purchase price allocation to isolate the change in goodwill (i.e., step two) would no longer be required.
Concurrently, the FASB issued ASU No. 2014-03, Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps—Simplified Hedge Accounting Approach. This guidance provides private companies that are not financial institutions with an accounting alternative which is intended to make it easier for certain interest rate swaps to qualify for hedge accounting. Under this alternative, receive-variable, pay-fixed interest rate swaps that meet specific criteria would qualify for a simplified hedge accounting model, which would make it easier to qualify for and to apply hedge accounting and also extend the time companies have to complete the necessary documentation. Furthermore, it provides a simplified measurement model based on the settlement value of the swap rather than its fair value.
On March 20, 2014, the FASB issued ASU No. 2014-07, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements. Under this guidance, private companies can elect an exemption from the variable interest entity (VIE) consolidation model applicable to certain common control leasing arrangements when a specific set of criteria are met. A private company electing to adopt the alternative would no longer be required to consolidate certain entities it had previously consolidated under the VIE model. However, the private company would still need to consider whether it should consolidate the legal entity under a voting interest model. There are additional disclosure requirements for companies electing to apply the alternative. A private company electing this alternative is required to adopt it using a retrospective transition approach.
The FASB issued ASU No. 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination on December 23, 2014. This guidance provides private companies an accounting alternative not to recognize and measure: (1) customer-related intangible assets (unless they are capable of being sold or licensed independent from other assets of the business) and (2) certain noncompetition agreements. Instead, the value of these intangibles would be subsumed into goodwill.
The adoption of the intangible asset accounting alternative would also require a company to adopt the goodwill accounting alternative. As a result, intangible assets with a finite life that, under current accounting standards, would have been subject to amortization will continue to be amortized as part of goodwill. However, if a company has adopted the goodwill alternative, it is not required to adopt the alternative for intangibles.
The standard is applicable only to transactions after the adoption date. Therefore, customer-related intangible assets and noncompetition agreement intangible assets that exist as of the beginning of the period of adoption should not be subsumed into goodwill upon adoption.
On March 7, 2016, the FASB issued ASU No. 2016-03, Private Company Council Accounting Alternatives - Effective Date and Transition Guidance, which removes the effective dates for all of the accounting alternatives, making them effective immediately. The update provides an unconditional one-time option to forgo a preferability assessment the first time an accounting alternative is elected. The update also extends the transition guidance for the accounting alternatives for goodwill and the simplified hedge accounting approach for interest rate swaps. The extension of the transition guidance for the goodwill alternative requires prospective application. The extension of the transition guidance for the simplified hedge accounting approach for interest rate swaps allows for either modified or full retrospective application to all existing in-scope swaps the first time the election is made. Subsequent to adoption, the simplified method can be elected on a swap by swap basis for new swaps within scope. Once elected, an accounting alternative must be maintained and any subsequent changes, other than due to meeting the definition of a public business entity, would be considered a change in accounting policy and subject to a preferability assessment.
The accounting alternatives, other than the intangible asset alternative, must be applied as of the beginning of the first annual reporting period in which the accounting alternative is elected. The intangible asset accounting alternative must be applied to the first in-scope transaction in the annual period in which the alternative is elected.
Why it's important
The accounting alternatives provide relief to nonpublic entities by offering simplified accounting models. For example:
– Under the goodwill alternative, the previously required annual impairment assessment is now a trigger-based impairment assessment. In addition, companies have an opportunity to make an accounting policy election to perform the impairment test at an entity-wide level as opposed to the previously required reporting unit level. Finally, any goodwill impairment loss is measured in a one-step test, so the hypothetical purchase price allocation (i.e., step 2) is no longer required.
– The simplified hedge accounting alternative provides relief from existing hedge accounting guidance by making it easier for a company to qualify its receive-variable, pay-fixed interest rate swaps for hedge accounting, as long as certain conditions are met, and also provides a simplified measurement model
– The alternative for common control leasing arrangements simplifies the consolidation model for private companies by providing them with an exemption from applying VIE guidance for certain common control leasing arrangements.
– The accounting alternative for intangible assets simplifies the accounting for customer-related intangible assets that are not capable of being sold or licensed independent from other assets of a business and also for certain non-competition agreements. Estimating the fair value of these intangible assets when separately recognizing them may be costly and time consuming. Under the alternative, private companies would not have to separately recognize and measure these intangible assets. Instead, these intangible assets would be included in goodwill.
Any accounting alternative approved by the PCC and endorsed by the FASB is optional for private companies to adopt. A private company always has the option to continue to follow existing GAAP.
Companies can generally make an election on a standard by standard basis. That is, when a private company elects to adopt a PCC-approved accounting alternative, it is not required to adopt other PCC-approved accounting alternatives. The exception is for the adoption of the intangible asset accounting alternative, which requires that a company also adopt the goodwill accounting alternative.
Before adopting the private company alternatives, an eligible private company should carefully weigh the impact of applying the standard on its key financial metrics and debt covenant compliance.
Additionally, if an eligible private company becomes a public business entity in the future, the company will need to retrospectively adjust its historical financial statements to remove the effect of applying the PCC alternatives for all prior periods presented. This could prove to be a time consuming and costly exercise for a private company that becomes a public business entity.
Finally, an eligible private company should consider the impact that adopting the PCC’s alternatives could have on its equity method investors that may file public financial statements. The public company investor’s equity method income would likely be different had the investee not adopted the accounting alternatives. The SEC staff has preliminarily indicated that it will require the impact of any private company accounting alternatives to be unwound in the public company investor’s determination of equity method income.