When companies come together in a merger or acquisition, it’s not just the business assets, employees and culture that must be combined, but also their financials. FASB’s rules on business combination, Topic 805, Business Combinations, are complex, and, according to comments received by FASB’s Private Company Council (PCC), do not fully serve the needs of stakeholders, especially in the area of intangibles. Financial statement users have long complained that many other parts of U.S. GAAP are irrelevant for private companies.
Fortunately, back in 2014, FASB released an update to simplify accounting for intangibles in business combinations for private companies. This update followed three other updates released in 2014 that simplify private company accounting for goodwill, hedge accounting and variable interest entities. These simplifications can be adopted by any companies except for public business entities, not-for-profit organizations and employee benefit plans. The original pronouncements included effective dates for implementing these alternatives, but, in 2016, FASB eliminated those effective dates, which means that private companies can adopt these at any time.
So let’s take a look at Accounting Standards Update (ASU) 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. This update simplifies the accounting for customer-related intangibles (CRI) and noncompete agreements (NCA). FASB is currently evaluating the possibility of adopting a similar standard for public companies and not-for-profits.
Prior to this update, the practice for intangibles arising from business combinations, the equity method of accounting for investments and fresh-start accounting in reorganizations was to record all identifiable intangibles at fair value as of the relevant date. Stakeholders said that obtaining fair values for all intangibles isn’t worth the cost, especially for intangibles that can’t be separated from the rest of the business.
With this update, certain qualifying CRIs and all NCAs will be included in goodwill, and will not need a separate valuation. Qualifying CRIs and NCAs will be amortized as described in ASU 2014-02, which simplifies accounting for goodwill.
This means that companies that adopt the simplifications for CRIs and NCAs must also adopt ASU 2014-02. However, companies that adopt the goodwill simplification are not required to also adopt this update. If this update is adopted, it must be applied to all subsequent business combinations. It cannot be elected on a case-by-case basis. Any pre-existing CRIs or NCAs will continue to be accounted for as before.
Which CRIs qualify?
The relevant CRIs must be acquired in a business combination, arise under the equity method of accounting for investments, or be part of fresh-start accounting. These include customer lists, order or production backlogs, customer contracts and related customer relationships and non-contractual customer relationships.
To qualify, the CRI must not be capable of being sold or licensed separately from any other assets of the business. This means that companies must carefully examine relevant contracts and circumstances to determine if a particular CRI qualifies. This update cannot be generalized across all CRIs.
For example, let’s say that Andy’s Repair Service acquires Cool Air AC Service. Cool Air AC Service has a large backlog of contracts to be completed. If these jobs require proprietary equipment that only Cool Air AC Service has, then those contracts cannot be sold, and thus qualify for the simplification. However, if those contracts can be sold to other companies for fulfillment by those companies, then they must still be accounted for under the regular rules.
Cool Air AC Service also has a database of names of customers who have not given consent for their information to be sold or shared with others. This CRI cannot be separately sold, so it qualifies for the simplification.
This simplification does not apply to CRIs related to leases or contract assets as described in ASC 606 for contracts with customers. The contract assets covered by ASC 606 arise when a business has transferred goods or services to a customer, and these assets will eventually become accounts receivable when the company has earned the right to consideration. In a customer backlog situation, the transfer hasn’t yet happened.
What else is needed?
FASB standards almost always require additional disclosures, but in this case, the only required disclosures are only those that qualitatively describe what makes up goodwill under ASU 2014-02.
This update will make at least one aspect of a merger or acquisition easier on your clients, so be sure to explain how this will simplify their new accounting!