The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. Private companies that choose to adopt this alternative will no longer recognize (or otherwise consider the fair value of) certain customer-related intangible assets or those attributable to noncompetition agreements acquired in business combinations and certain other qualifying transactions. Instead, these amounts will be included as a part of goodwill.
An entity must qualify as a private company in accordance with ASU 2013-12 to be eligible to apply the accounting alternative. (See our January 2014 Alert for a more thorough discussion of the distinction between a public and nonpublic business entity.) Entities electing the accounting alternative that allows for not recognizing certain intangible assets must also adopt the accounting alternative for amortizing goodwill (ASU 2014-02). Note also that not-for-profits and employee benefit plans are specifically excluded.
This accounting alternative grew out of a Private Company Council (PCC) proposal that was endorsed by the FASB in November 2014 after comments from private company stakeholders were taken into consideration. The PCC was formed in May 2012 to improve the standard-setting process for private companies that prepare financial statements in accordance with US generally accepted accounting principles (GAAP).
Many preparers and users of private company financial statements have indicated that the benefits of separately accounting for identifiable intangible assets acquired in a business combination do not justify the related costs. Although the feedback received from private company stakeholders was mixed, the PCC determined that intangible assets that are legally protected, separately transferable, and capable of providing discrete cash flows are those that users typically find most relevant. As a result, the PCC and FASB concluded that it would be beneficial to provide private companies with an alternative to the requirement to measure and recognize certain other customer-related intangible assets and noncompetition agreements at their fair value.
The alternative is intended to allow private companies to reduce the cost and complexity of preparing their financial statements without significantly diminishing the usefulness of information for users of private company financial statements. It’s generally believed that private companies that adopt the alternative will separately recognize fewer intangible assets in a business combination and larger amounts of goodwill compared to entities that do not elect the alternative.
Existing GAAP for Intangible Assets Acquired in a Business Combination
Under existing GAAP the acquirer in a business combination must recognize most of the assets acquired and liabilities assumed at their acquisition-date fair values, including all identifiable intangible assets. This includes customer-related intangible assets that are not capable of being sold or licensed independently from other assets and noncompetition agreements, since an intangible asset is considered identifiable if it meets either of the following criteria:
- It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
- It is separable, that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged—either individually or together with a related contract, identifiable asset, or liability—regardless of whether the entity intends to do so.
The Private Company Alternative
The new alternative applies when a private company is required to recognize or otherwise consider the fair value of intangible assets as a result of transactions requiring any of the following:
- Application of the acquisition method of accounting for a business combination (Topic 805: Business Combinations)
- Assessment of the nature of the difference between the carrying amount of an investment and the amount of underlying equity in net assets of an investee when applying the equity method of accounting (Topic 323: Investments – Equity Method and Joint Ventures)
- Adoption of fresh-start reporting in accordance with (Topic 852: Reorganizations)
If the alternative is elected, a private company acquirer will no longer recognize either of the following intangible assets separately from goodwill:
- Customer-related intangible assets, unless they are capable of being sold or licensed independently from the other assets of the business
- Noncompetition agreements
It’s important to note that many customer-related intangibles are in fact capable of being sold or licensed independently from the other assets of a business and therefore would still be recognized separately from goodwill. Examples of customer-related intangibles that may still meet the criteria for separate recognition include:
- Mortgage servicing rights
- Commodity supply contracts
- Core deposits
- Customer information (for example, names and contract information)
The alternative is only applicable to transactions that occur after the election of the alternative. This means existing customer-related intangible assets and those intangibles attributable to noncompetition agreements in existence as of the beginning of the period of adoption cannot be subsumed into goodwill. Instead, those previously existing intangibles will continue to be accounted for in accordance with Topic 350: Intangibles – Goodwill and Other.
Benefits of the Intangible Alternative
Private companies that adopt the new alternative may benefit from cost savings, since it eliminates the need to separately recognize certain customer-related intangible assets and noncompetition agreements and eliminates the need for impairment testing of such assets in future periods. If adopted, the alternative would constitute an accounting policy change that requires prospective application to all future transactions after the adoption date.
Evaluating Whether to Apply the Alternative
When deciding whether to adopt the ASU, you may want to consider that, concurrent with its issuance, the FASB also announced the addition of a separate project to evaluate the applicability of this alternative to public business entities and not-for-profit entities. ASU 2014-18 was approved by a vote of four to three by FASB board members, the narrowest margin yet of any of the PCC alternatives. The dissenting members took exception to finalizing an alternative for private companies while continuing to evaluate the same issues for public business entities, indicating a lack of consensus concerning whether an alternative made available to only private companies is appropriate.
Similar to other private company alternatives, private companies should carefully consider the needs of their current and future financial statement users and whether the benefits of this alternative outweigh the current or potential future costs of continuing to apply existing US GAAP.
Even if a private company is otherwise eligible for the alternative, financial statement users (including regulators, lenders, and other creditors) may require the company to continue applying traditional US GAAP as though it were a public business entity. And, as noted earlier, the adoption of this accounting alternative also requires the adoption of the accounting alternative for amortizing goodwill introduced in ASU 2014-02, Intangibles – Goodwill and Other, which does require prospective amortization of all previously recorded goodwill as well as goodwill acquired in the future.
Keep in mind that a company that elects a private company accounting alternative could subsequently become subject to public company reporting—either through a future IPO or acquisition by a public company. In such situations the company would be required to restate its prior periods as if it hadn’t elected the private company alternatives. Depending on the circumstances, this could be a difficult and costly task, so weigh the likelihood of these circumstances when deciding whether to adopt any private company alternatives.
The effective date of the new alternative depends on the timing of the first transaction within the scope of the ASU. If the transaction occurs in the first annual period beginning after December 15, 2015, the election will be effective for that annual period’s financial reporting and all interim and annual periods thereafter. If the transaction occurs in an annual period beginning after December 15, 2016, the election will be effective for that interim period and all subsequent interim and annual periods thereafter. Early adoption is permitted: An eligible private company could elect to apply the alternative in its 2014 or prior financial statements as long as those financial statements haven’t previously been made available for issuance.
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For questions about how these updates will affect the preparation of your financial statements or help determining whether you should adopt the new alternative, contact your Moss Adams professional.