Another generally accepted accounting principle (GAAP) alternative created by the Private Company Council (PCC) was released by the Financial Accounting Standards Board (FASB) on December 23, 2014, giving private companies a new option for possible cost savings in their financial reporting. The new Accounting Standards Update (ASU) contains an accounting alternative for private companies that acquire intangible assets in a business combination. Under the accounting alternative, many customer-related intangible assets and all non-compete agreements would not be recognized separately and would be incorporated into goodwill.
The Private Company Council (PCC) added this issue to its agenda in response to feedback from private company stakeholders indicating that the benefits of the current requirements relating to the accounting for identifiable intangible assets acquired in a business combination do not justify the related costs. Customer-related intangible assets and non-compete agreements often do not meet the typical characteristics of intangible assets that users find most relevant (legally protected, separately transferable, and capable of providing discrete cash flows). This accounting alternative should allow private companies to avoid the unnecessary costs and complexity encountered when measuring certain customer-related intangible assets and non-compete agreements.
Currently, a company recognizes most assets acquired and liabilities assumed in a business combination at their acquisition-date fair values, including all intangible assets that are identifiable. A private company that elects this accounting alternative would no longer recognize the following intangible assets separately from goodwill:
- Customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of the business
- Non-compete agreements
Examples of customer-related intangible assets include customer lists, order or production backlog, customer contracts and related customer relationships, and non-contractual customer relationships.
Elliott Davis Decosimo Observation: Since many customer-related intangible assets are not capable of being sold or licensed independently from the other assets of the business, most would not be separately recognized under this accounting alternative.
A private company that elects this accounting alternative must also adopt the private company alternative related to goodwill which, among other things, requires that goodwill be amortized over a period of 10 years or less. However, the linkage between the two alternatives is “one-way”, meaning that the adoption of the goodwill alternative would not require the adoption of this alternative for identifiable intangible assets.
What Types of Entities Can Elect this Option?
The following types of entities will not be able to elect the new alternative (or any other private-company accounting alternatives): (a) public business entities as defined below, (b) not-for-profit entities and (c) employee benefit plans.
The FASB Accounting Standards Codification (ASC) defines a “public business entity” in its master glossary as an entity that meets any of the following criteria:
- It files or furnishes—or is required to file or furnish—financial statements with the Securities and Exchange Commission (SEC). This includes other entities whose financial statements or financial information are required to be or are included in a filing.
- It is required to file or furnish financial statements with a regulatory agency by the Securities Exchange Act of 1934, as amended, or rules or regulations promulgated under the Act.
- It is required to file or furnish financial statements with a regulatory agency in preparation for the sale of securities or for the purposes of issuing securities.
- It has (or is a conduit bond obligor for) unrestricted securities that are traded or can be traded on an exchange or an over-the-counter (OTC) market.
Elliott Davis Decosimo Observation: The FASB has stated that an OTC market includes an interdealer quotation or trading system for securities that are not listed on an exchange (for example, OTC Markets Group Inc., including the OTC Pink Markets, or the OTC Bulletin Board).
- It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
Elliott Davis Decosimo Observation: An entity has to provide a full set of U.S. GAAP financial statements (including footnotes) to meet the last criterion. Call reports that are required to be filed by all federally insured depository institutions (which include financial information prepared in accordance with U.S. GAAP, but not a full set of financial statements) would not meet this criterion. However, a bank with over $500 million in assets required to file annual audited financial statements with the FDIC and whose financial statements are available upon request would meet the last criterion, if it has one or more securities not subject to contractual restrictions on transfer. These restrictions may be contained in buy-sell, shareholder, or other agreements.
When is this Option Available?
Although the alternative is effective for transactions in fiscal years beginning after December 15, 2015, early adoption is permitted. This means that an eligible private company could elect to apply this alternative in its 2014 financial statements, as long as those financial statements have not been made available for issuance prior to the release of the final standard. Otherwise, a private company that elects to adopt the alternative would apply the guidance prospectively to the first transaction that occurs in an annual period beginning after December 15, 2015 and all transactions thereafter.
Elliott Davis Decosimo Observation: Customer-related intangible assets and non-compete agreements that arose from transactions prior to adoption of this alternative would continue to be accounted for under existing guidance. That is, existing customer-related intangible assets and non-compete agreements should not be incorporated into goodwill upon adoption of this alternative.
The alternative would be applied on a prospective basis for all business combinations entered into after the effective date.
What Should Private Companies Be Doing Now?
A private company should carefully consider whether electing this accounting alternative makes sense based on its specific facts and circumstances. The needs and views of current and potential future users of the private company’s financial statements should be considered in this regard. In other words, before deciding to elect an accounting alternative, a private company should determine whether users of its financial statements will accept financial statements in which the accounting alternative has been applied. In addition, if a private company goes public in the future, it will lose the option to elect the accounting alternative(s). There could be challenging accounting consequences when this happens or when a private company discontinues its election to apply one of the accounting alternatives for any other reason. A private company should take those potential challenges into consideration when deciding whether to elect one of the accounting alternatives. In the meantime, if you have questions, please contact your Elliott Davis Decosimo advisor.