Early indications suggest that the combination of accounting elections commonly referred to as “private company GAAP” are growing in popularity and may soon be expanding in focus. 

According to FASB, the intent of the accounting alternative described in ASU 2014-18 was to reduce the cost and complexity associated with the measurement of certain identifiable intangible assets without significantly diminishing decision-useful information to users of private company financial statements.

As described in FASB’s December 2018 meeting memo discussing Accounting Standards Updates (“ASU”) No. 2014-02 (Accounting for Goodwill) and No. 2014-18 (Accounting for Identifiable Intangible Assets in a Business Combination), FASB staff surveyed the AICPA Private Companies Practice Section Technical Issues Committee and other practitioners and found that the “adoption rates of both Updates were generally high, with the adoption rate of Updates 2014-02 being higher than the adoption rate of Update 2014-18.”  

Additionally, during the December 2018 meeting, the Financial Accounting Standards Board (the “Board”) proposed extending the private company GAAP accounting alternatives related to the accounting for goodwill and accounting for identifiable intangible assets in a business combination to not-for-profit entities.¹ As of the drafting of this article, the proposed extension is still in the comment period and an open issue.

For the purposes of this election, a “private company” is an entity other than a publicly traded company or entity, a not-for-profit entity, or an employee benefit plan.³

While cost and complexity may be reduced for companies unaccustomed to acquisitions or the election, the rules and implications of electing the private company alternative can be confusing, and possibly costly.

ASU NO. 2014-02, INTANGIBLES – GOODWILL AND OTHER (TOPIC 350): ACCOUNTING FOR GOODWILL

As it relates to business combinations, ASU 2014-02 offers two key advantages over traditional GAAP, including:     

1. Goodwill Amortization- ability 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).  
   • Based on feedback and its own research, the Private Company Council (“PCC”) found that the goodwill impairment test provided limited “decision-useful” information as most private company stakeholders generally disregarded goodwill and goodwill impairment losses in their analysis of company financial statements.  Consequently, under the new private company treatment, private companies may elect to amortize goodwill rather than carrying it on the books at original value and testing it for impairment annually.

1. Simplified Impairment Testing
   • Trigger-based impairment model that permits an election to perform impairment assessment at either the entity-wide level or the reporting unit level.  Requiring goodwill impairment tests only upon a triggering event results in less frequent testing requirements.
     1. Triggering events include events such as deteriorating economic conditions, changes in the market for a company's products or services, regulatory or political developments, increases in raw material, labor, or other costs, negative or declining cash flows, declining revenue or earnings (actual or planned), changes in relevant parties, or a sustained decrease in share price. 
   • Elimination of step two of the impairment test.  It is worth noting that later (in January 2017), FASB eliminated Step 2 from the impairment test for public companies and other entities that have goodwill reported in their financial statements and have not already elected the private company alternative.

 ASU NO. 2014-18, BUSINESS COMBINATIONS (TOPIC 805): ACCOUNTING OR IDENTIFIABLE ASSETS IN A BUSINESS COMBINATION

Two of the four alternatives within private company GAAP relate specifically to business combinations. With ASU No. 2014-18, private companies also have the option to reduce the scope of work required by eliminating the need to book certain intangible assets on the opening balance sheet.

1. Reduced Scope– Certain intangibles that would typically be recognized under traditional GAAP, such as customer relationships and noncompete agreements,do not generally need to be separated from goodwill.
   • It is worth nothing that the purchase price allocation process still requires the valuation of many other acquired assets including, but not limited to: inventory, real and personal property, favorable and unfavorable leasehold interest, backlog, trade names and trademarks, patent and technology-based intangible assets, franchise agreements, reacquired rights, and assumed liabilities such as deferred revenue and contingent consideration. 

Although valuation of the customer relationships is generally not required under the private company alternative, several customer-related intangible assets may still meet the criterion for recognition such as customer lists, mortgage servicing rights, commodity supply contracts, and core deposits.   Further, in the event that customer relationships are capable of “being sold or licensed independently from the other assets of the business,” they will need to be recognized separately from goodwill.⁴

Contract assets, defined as “an entity’s right to consideration in exchange for goods or services that the entity has transferred to a customer when that right is conditioned on something other than the passage of time (for example, the entity’s future performance),” are not recognized as customer-related intangible assets and must be valued separately.⁵

Pre-existing customer-related intangible assets and noncompetition agreements that exist at the beginning of the period of adoption are not affected by the Intangibles Accounting Alternative. That is, such existing assets may not be subsumed into goodwill.

CONSIDERATIONS

Before choosing to proceed with ASU No. 2014-02 or ASU No. 2014-18, several potential drawbacks should be considered:     

1. Financial statements prepared under private company GAAP will be less comparable to those prepared under regular GAAP for public companies that may be used as benchmarks for performance measures.  For example, adoption of the private company alternative for business combinations generally results in companies reporting lower earnings and less total assets due to the amortization of goodwill.  
2. Some amount of time and expense may be required to adjust accounting systems to record the appropriate entries required under the election (note, in some cases, auditors may still require a valuation specialist to perform an assignment in accordance with traditional GAAP to provide sufficient audit support).
3. Potentially the biggest drawback occurs if a private company ever decides to go public or issues publicly traded debt, as the company is required to discontinue the use of the accounting and reporting under the private company alternative and revise comparative financial statements to comply with traditional GAAP.  FASB validated this concern within the December 2018 memo stating that private companies considering a public exit generally do notadopt the updates due largely to the cost of recasting the financial statements.  More specifically, the company would need to reverse previously amortized goodwill, recognize and separately value customer-related assets and noncompetition agreements previously subsumed into goodwill, and correspondingly restate goodwill.  This process is challenging as the analysis must be performed as of the original acquisition date(s).  Gathering the necessary information and support can be very difficult if significant time has elapsed since the transaction(s).

As suggested by the different adoption rates between ASU No. 2014-02 and ASU No. 2014-18, companies do not have to elect to follow both updates.  While a company that elects to adopt ASU No. 2014-18 (intangible accounting standard) must adopt ASU No. 2014-02 (the goodwill accounting standard), a company that adopts ASU No. 2014-02 is not required to also adopt the ASU No. 2014-18.  

Consequently, if you are having difficulty deciding whether to adopt the standard, another option is to value all intangibles prescribed by regular GAAP, but then amortize goodwill as prescribed under ASU No. 2014-02.  If the company elects to go public in the future, the purchase price allocation will meet requirements under ASC 805, simplifying the adjustments required to amend financials to reflect traditional GAAP.  

WRAPPING UP

As your organization evaluates its options under GAAP, it may be worthwhile to discuss the implication with your auditor or other professional advisors. Professionals experienced in the valuation of assets for purchase price allocation purposes and impairment testing may be able to provide additional insight as to the costs and benefits of the different options available.  BVA has extensive experience in valuing assets and liabilities for clients pursuant to ASC 805 under traditional GAAP as well as for clients electing to adopt the private company alternatives.    Please contact us for more information on how we can best assist with your next business combination.