Our three-part series on business combinations began with an overview for private companies of the acquisition method, then continued with an in-depth discussion on identifying an acquisition as a business combination or an asset acquisition. In this third and final installment, we discuss private company alternatives for goodwill and business combinations.
In recent years, the Financial Accounting Standards Board (FASB) has issued updates to U.S. generally accepted accounting principles (GAAP) that provide alternatives for private companies. The updates are consensuses of the Private Company Council (PCC) that were endorsed by the FASB.
The purpose of these alternatives is to simplify the application of complex accounting areas like goodwill and provide some relief to private entities on such topics, in response to the voluminous number of changes to GAAP over the years and the relevancy of those changes to users of private companies’ financial statements compared to users of public companies’ statements.
Private companies will need to be aware of alternatives adopted because in an event like the entity being acquired by a public company (i.e., significant acquisition under SEC Regulation S-X, Rule 3-05) or planning an initial public offering, revisions to the privately held financial statements may need to be made to comply with public entity guidance if the private company alternatives were adopted previously.
The private company alternatives for subsequent measure of goodwill and business combinations, which have been codified in Topics 350 and 805, are the following:
- Accounting Standards Update No. 2014-02 (ASU 2014-02), Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill
- ASU 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination
Read on for a summary of each ASU.
Topic 350, as updated by ASU 2014-02: Accounting for goodwill
With ASU 2014-02, a private company can elect to “amortize goodwill on a straight-line basis over 10 years, or less than 10 years if the entity demonstrates that another useful life is more appropriate.” This alternative also permits a private company to apply a simplified impairment model to goodwill. For impairment purposes, goodwill should be tested for impairment when a triggering event occurs that indicates that the fair value of the company (either on an entity-wide basis or reporting unit basis) may be below carrying value. A company electing this alternative is also required to make an accounting policy election to test goodwill for impairment at either the company or reporting unit level.
ASU 2014-02 provides relief for private companies because amortizing goodwill could reduce the likelihood of impairment and could allow private reporting entities to test goodwill for impairment less frequently.
Topic 805, as updated by ASU 2014-18: Accounting for identifiable intangible assets
ASU 2014-18 allows private companies to elect the accounting alternative to no longer recognize separately from goodwill in a business combination the following: “… (1) customer-related intangible assets unless they are capable of being sold or licensed independently from other assets of the business and (2) noncompetition agreements.” It is intended to reduce “the cost and complexity” associated with measuring these identifiable intangible assets.
It is important to note that a private reporting entity that elects the accounting alternative that ASU 2014-18 added to Topic 805 must also adopt the alternative to amortize goodwill as described in ASU 2014-02; but, an entity that elects to adopt ASU 2014-02 does not have to adopt ASU 2014-18.
As a result, the adoption of ASU 2014-18 will generally result in private reporting entities recognizing fewer intangible assets in a business combination compared to if they did not adopt the alternative, the ASU says.
The PCC accounting alternatives for goodwill are intended to provide relief to private reporting entities in the application of GAAP while considering the needs of the users of the financial statements. But, a private reporting entity will need to consider the future of the entity when adopting the alternative guidance. A private reporting entity considering an IPO or being acquired by a public entity should know that there may be additional costs and time incurred associated to the entity in reversing the adoption of the alternative accounting guidance for compliance with public company standards.
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CPA, Partner - National Accounting
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