Simplified Accounting for Goodwill for Private Companies
For years, stakeholders in private companies argued that many of the standards that make up U.S. GAAP are overly complex and irrelevant for smaller, non-public companies. Auditors and preparers of financials for private companies complained that the costs of complying with the standards exceeded their usefulness to financial statement users. In response, FASB created the Private Company Council (PCC) in 2012 to serve as an advisory board and to suggest alternatives to GAAP for private companies.
In 2014, following suggestions from the PCC, FASB released four updates that simplify accounting for private companies in goodwill, hedge accounting, leasing arrangements with variable interest entities and intangibles resulting from business combinations. 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, fortunately, FASB eliminated those effective dates in 2016, which means that private companies can adopt these at any time.
Let’s talk about the first one to be issued that year, Accounting Standard Update (ASU) 2014-02, Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill. Like the other simplifications, private companies can’t pick and choose pieces of the new standard to adopt; either the whole standard or none of it must be adopted.
Goodwill Amortized Over 10 Years
Goodwill is the excess of purchase price over the total value of the assets and liabilities when a business is purchased. Until this simplification was issued, goodwill was subject to annual impairment testing to determine if its carrying value exceeded its fair value. However, impairment testing was complicated, and many users of the financials of private companies told the PCC that they simply disregarded goodwill and its impairment.
Now, private companies will amortize goodwill over a maximum of 10 years. A shorter life can be used if that’s more appropriate under the circumstances. Companies that adopt this new standard will apply it to any goodwill currently on their books and to any new goodwill recognized later.
Impairment Testing After Triggering Event
Companies that adopt this standard have to elect whether to test impairment at the entity level or at the reporting unit level. Impairment testing no longer happens every year, but only on the occurrence of a triggering event that reduces the fair value of the entity or the reporting unit below the carrying amount. Triggering events include:
- A downturn in overall economic conditions.
- Increased competition for the company’s products.
- Increased labor or materials costs.
- Negative or declining cash flows.
- Changes in key personnel.
When a triggering event occurs, a qualitative assessment may be performed to determine whether it is more likely than not that the fair value of the entity or reporting unit has dropped below its carrying amount, which will include amortization.
The qualitative assessment is not required. A company may skip straight ahead to a quantitative assessment of the amount of the impairment, which simply requires comparing the fair value of the entity or reporting unit to its carrying value. Any impairment calculated is then allocated across the entity’s units of goodwill or to the specific unit that is most relevant. Total impairment cannot exceed the carrying value of goodwill. The impairment calculation results in a new basis for amortizing goodwill over its remaining life.
A triggering event may also impair the values of an entity’s other assets, such as accounts receivable, inventory or fixed assets. In this situation, impairment of the values of those assets is to be measured first, followed by goodwill.
Going Public? This Simplification May Create Extra Work
Private companies considering going public or companies that may be acquired by a public company should think twice about adopting this new standard. In either of those situations, the company’s financials will have to be restated to be in agreement with the accounting standards used by public companies.
Companies that aren’t considering going public will save time and effort without reducing relevance to financial statement users by adopting this standard. Because goodwill is now being amortized, its carrying value will decrease over time, which will make impairment less likely. Impairment testing will also happen less frequently, further saving complexity.
If your private company clients haven’t adopted this standard yet, be sure to let them know that there’s a simpler option for the goodwill on their books!