FASB Issues Three Proposed Accounting Alternatives for Private Companies
The Private Company Council (PCC) has proposed, and the Financial Accounting Standards Board (FASB) has endorsed, three Accounting Standards Updates (ASUs) for public comment that would allow exceptions to accounting principles generally accepted in the United States (GAAP) for privately held companies. The proposals are designed to reduce some of the complexity of GAAP requirements that many private company stakeholders believe are not relevant for private companies. The three proposals address using alternative approaches for the accounting of 1) intangible assets acquired in a business combination, 2) goodwill and 3) certain interest rate swaps.
The following is a summary of each of the proposed ASUs:
- Proposed ASU – Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (a proposal of the PCC)
- Proposed ASU – Intangibles-Goodwill and Other (Topic 350): Accounting for Goodwill (a proposal of the PCC)
- Proposed ASU – Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps (a proposal of the PCC)
Under this proposal, a private company would have an alternative approach for the recognition, measurement and disclosure of intangible assets acquired in a business combination. Currently, GAAP requires that all intangibles that are separately identifiable to be recognized and measured at fair value at the date of the acquisition. The proposal would allow private companies to only recognize those intangibles that arise from noncancelable contractual terms or those arising from other legal rights. Otherwise, other intangible assets (i.e., customer lists, non-contractual relationships and recipes) would not be separated from goodwill in the business combination. This will potentially lead to fewer intangible assets being recognized and more goodwill being recognized. Private companies electing this alternative accounting would still be required to apply current disclosure requirements, in addition to disclosing additional qualitative information on the intangible assets acquired but not recognized separately from goodwill.
The proposed ASU indicates that private companies that elect to adopt this alternative accounting would be required to prospectively apply the proposed ASU to all intangible assets arising from new business combinations. Early adoption would be permitted.
This proposal would allow private companies to elect simplified accounting for goodwill, including amortization of goodwill and frequency and methodology of impairment testing. Under this proposal, a private company would be allowed to amortize goodwill that has been recognized in a business combination. The amortization of the goodwill will be permitted using the straight-line method over the useful life of the primary asset acquired in the business combination, not to exceed 10 years. The primary asset is the “principal identifiable long-lived tangible or intangible asset that is the most significant asset from which the acquired business derives its cash-flow-generating capacity.” Private companies would also be allowed to test goodwill for impairment only when a triggering event occurs, instead of the current requirement to test at a minimum annually. Additionally, the impairment of goodwill will be tested at a company-wide level and not at the reporting-unit level as is currently required by GAAP. The proposal would eliminate the current step two of the goodwill impairment test. Instead, entities would measure goodwill impairment as the excess of the entity’s carrying amount over its fair value (current step one).
Private companies that elect to use the alternative accounting for goodwill would be required to prospectively apply the proposed ASU to all existing goodwill and any new goodwill resulting from future business combinations. Early adoption would be permitted.
Under this proposal, a private company would have two simpler approaches to account for certain types of interest rate swaps that are entered into to convert variable-rate debt borrowings to fixed-rate debt. Current rules require entities to recognize an asset or liability for interest rate swaps measured at fair value, with a corresponding impact to either the income statement or other comprehensive income depending on the swaps effectiveness. Under both proposed approaches, the periodic income statement charge for interest would be similar to the amount that would result if the private company were to have entered into fixed-rate borrowings instead of variable-rate borrowings. Under the first approach called the “combined instrument approach,” private companies would not recognize the interest rate swap on the balance sheet, except for any accrual or receivable for the next settlement. The second approach called the “simplified hedge accounting approach” would allow private companies to assume no hedge ineffectiveness, and record the interest rate swap on the balance sheet at the settlement price, instead of fair value. There are various criteria that would have to be met in order to use either of these simplified approaches.
Private companies electing either of these alternative approaches would still be required to apply current disclosure requirements, in addition to disclosing additional qualitative information on the swaps and the adoption of an approach.
Companies that elect to apply the combined instruments approach would have to apply the approach to all qualifying swaps that exist as of the date of adoption and to all future qualifying swaps. Companies that elect to apply the simplified hedge accounting approach can apply it on a swap-by-swap basis to any qualifying swap existing as of that date and to any future qualifying swap. Early adoption would be permitted.
These proposed accounting alternatives should reduce the cost and complexities associated with current accounting for these three areas. The alternative accounting approaches are optional, and will generally be available to any private company, which the FASB has yet to define. The comment deadline for all three proposals is Aug. 23, 2013.
In addition to the above proposals, the PCC has voted to expose a proposed alternative for private companies that apply the variable interest entity consolidation guidance to common control leasing arrangements. The proposed alternative, PCC Issue No. 13-02, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements (formerly FIN 46(R) and FAS 167), would exempt private companies from applying the consolidation guidance for variable interest entities under common control leasing arrangements. The disclosures required under the alternative would better provide information that lenders and other users of private company financial statements typically use in assessing the cash flows of an entity. The FASB staff will draft a detailed proposal, which the FASB will discuss and vote on. If endorsed by the FASB, a proposed ASU will be issued for public comment regarding this alternative.