Little GAAP Exemptions for Private Companies
At this YE Closing of Your Books, Don’t Forget the New Little GAAP Exceptions for Private Companies.
The Finance Accounting Standards Board (FASB) approved several exceptions to the Generally Accepted Accounting Principals (GAAP) for private companies. The exceptions are:
- Give private companies the ability to amortize goodwill acquired in a business combination.
- Allow private companies to choose a simplified hedge accounting approach to their financial reporting when they enter into interest rate swaps to economically convert their variable-rate interest payments to fixed-rate interest payments.
- Elect not to separately recognize and measure certain intangible assets acquired in a business combination such as noncompetition agreements and customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of a business.
- Allow a private company to elect – under certain circumstances – not to consolidate variable-interest entities (VIEs) in common-control leasing arrangements.
For many years, privately-held companies have called for a different set of Generally Accepted Accounting Principals (GAAP) for private companies arguing that much of GAAP is written with large public companies in mind and many provision don’t work well for smaller private companies. This discussion is often referred to as Big GAAP – Little GAAP. The Private Company Council was formed by the parent organization of FASB, the Financial Accounting Foundation, in part to create exceptions and modifications to GAAP for private companies.
The goodwill exception directs private companies to amortize goodwill over 10 years, or less than 10 years if the company can demonstrate that another useful life is more appropriate. Under the exception, a private company will be able to make an accounting policy decision to perform its impairment testing at the entity level or the operating level.
A private company would test goodwill for impairment only when a triggering event occurs that may reduce the fair value of an entity or reporting unit (if elected) below its carrying amount. The exception also would eliminate Step 2 of the impairment test.
Many financial statement users disregard goodwill and goodwill impairment in
their analysis of a private company. Dugan & Lopatka and many financial statement preparers are concerned about the cost and complexity of the current goodwill impairment test.
The guidance can be applied going forward for goodwill existing as of the beginning of the period of adoption, and for goodwill generated from business combinations occurring in the first annual period beginning after Dec. 15, 2014, and interim and annual periods thereafter. Goodwill that exists at the beginning of the period of adoption can be amortized going forward over 10 years, or less than 10 years if another useful life is more appropriate. Early adoption would be permitted for any annual period for which the entity’s annual financial statements have not yet been made available for issuance.
Hedge Accounting Approach
The other exception—the simplified hedge accounting approach—is a practical expedient that allows private companies to qualify for hedge accounting under Topic 815, Derivatives and Hedging. For private companies using this approach, the periodic income statement charge for interest would be similar to the amount that would result if the private company had entered into fixed-rate borrowing rather than variable-rate borrowing.
Private companies would be able to apply the approach when the following criteria are met:
- Both the variable rate on the swap and borrowing are based on the same index and interest rate.
- The swap is what is known as a “plain vanilla” swap, and there is no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap.
- The repricing and settlement dates for the swap and the borrowing match or differ by no more than a few days.
- The swap’s fair value at the time the simplified hedge accounting approach is applied is at or near zero.
- The notional amount of the swap is equal to or less than the principal amount of the borrowing.
- The term of the swap is equal to or less than the term of the borrowing.
One-time transition relief would be allowed, so that companies could apply the simplified hedge accounting approach to existing swaps that meet the criteria.
The approach will take effect for the first annual period beginning after Dec. 15, 2014, and interim and annual periods thereafter. Early adoption would be permitted for any annual period for which the entity’s annual financial statements have not yet been made available for issuance.
The Private Company Council (PCC) voted recently to approve a private company GAAP alternative that will allow privately-held companies to elect not to separately recognize and measure certain intangible assets acquired in a business combination.
Private companies that elect the alternative would not recognize:
- Noncompetition agreements.
- Customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of a business
Customer-related assets that may meet one of the criteria for recognition would include mortgage servicing rights, commodity supply contracts, and core deposits.
Private Companies that elect the alternative would be required to separately disclose qualitatively any intangible assets that did not meet separate recognition under this alternative. The alternative would be applied prospectively for all business combinations entered into after the effective date, and there would be no option to apply it retrospectively.
A private company that elects the alternative would continue recognizing and measuring under existing GAAP all intangible assets that exist at the beginning of the period of adoption. That means that noncompetition agreements and customer-related intangibles that were recognized prior to the adoption of the alternative would continue to be amortized over the expected life that was set previously.
Private companies that elect to adopt the alternative also would be required to adopt Accounting Standards Update (ASU) No. 2014-02, Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill. Under ASU No. 2014-02, a private company can elect to subsequently amortize goodwill on a straight-line basis over 10 years, or less if the company demonstrates that another useful life is more appropriate. ASU No. 2014-02 also permits a private company to apply a simplified impairment model to goodwill.
The linkage between the two alternatives is one-way. A private company that adopts ASU No. 2014-02 is not required to adopt the alternative approved by the PCC.
The alternative the PCC approved Tuesday would take effect for business combinations entered into in the first annual period beginning after Dec. 15, 2015, and interim periods within annual periods beginning after Dec. 15, 2016. Early adoption would be permitted for any annual period for which the entity’s annual financial statements have not yet been made available for issuance.
Variable-interest Entities (VIEs)
Under a recent GAAP alternative by the PCC, a private company lessee can elect not to apply variable-interest entity guidance to a lessor when the following conditions exist:
- The private company lessee and lessor are under common control.
- The private company lessee has a leasing arrangement with the lessor.
- Substantially all activity between the entities is related to the leasing activity between them.
- If the private company lessee explicitly guarantees or provides collateral for any obligation of the lessor related to the asset leased by the private company, then the principal amount of the obligation at inception does not exceed the value of the asset leased by the private company from the lessor.
A private company that elects to take advantage of the exemptions would make certain new disclosures about the lessor and the leasing arrangement. If elected, the accounting alternative should be applied to all leasing arrangements that meet the conditions for applying the alternative. The alternative should be applied retrospectively to all periods presented and takes effect for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. Early adoption is allowed for all financial statements that have not yet been made available for issuance.
The PCC also discussed narrowing the intangible assets acquired in a business combination that private companies would be required to identify and recognize separately from goodwill and will continue that discussion at another time after further research by FASB’s staff.
In addition to the two exceptions approved for this year, the PCC has sent to FASB for endorsement an exception to applying variable-interest entity (VIE) guidance to common-control leasing arrangements for private companies.
The formation of the Private Company Council ensure that the voices of users, preparers, and public accountants of private company financial statements are heard. Dugan & Lopatka anticipates additional exceptions and modifications of GAAP for private companies and will keep you informed as changes become finalized.
If you have any questions, please call Dugan & Lopatka at (630) 665-4440.