The Financial Accounting Standards Board (FASB) issued in January 2014, two Accounting Standard Updates (ASU) to US Generally Accepted Accounting Principles (GAAP) that provide private companies with accounting alternatives for the subsequent measurement of goodwill (ASU No. 2014-02) and the accounting for certain interest rate swaps (ASU No. 2014-03). Early application of both updates is permitted and private companies whose financial statements have not yet been made available for issuance may elect to apply the accounting alternatives. Financial statements are not considered available for issuance until they are complete and in a form and format that complies with GAAP and all approvals necessary for the issuance of the financial statements have been obtained. Based on this definition, most private companies with 2013 calendar year-ends would still have the option of electing these accounting alternatives. These accounting alternatives were developed by the Private Company Council (PCC) and endorsed by FASB as part of its broader effort to simplify GAAP for private companies, while still providing decision-useful information to users of private company financial statements.
In a separate ASU (ASU No. 2013-12), the FASB defined public business entities to clarify which entities would not be eligible to elect the private company accounting alternatives that it issues. In addition to entities which meet FASB’s definition of a public business entity, not-for-profits and employee benefit plans are not eligible to elect either accounting alternative while financial institutions are not eligible to elect the interest rate swap accounting alternative.
ASU No. 2014-02 allows entities to elect to amortize goodwill on a straight-line basis over 10 years, or a shorter period if an entity is able to demonstrate that another useful life is more appropriate. The alternative also permits entities to perform a one-step goodwill impairment test at either the entity or reporting unit level only when events or circumstances indicate that the fair value may be less than its carrying amount, rather than the annual two-step goodwill impairment test at the reporting unit level which is currently required. Under the alternative, impairment is calculated as the difference between the entity’s or reporting unit’s carrying amount and its fair value. The hypothetical application of the acquisition method currently required to calculate the amount of the goodwill impairment is not required under the accounting alternative. If an entity adopts ASU No. 2014-02, all of the accounting alternatives included in the ASU must be elected by the entity. For example, an entity could not elect to test goodwill for impairment at the entity level using the one-step goodwill impairment test, but elect not to amortize goodwill.
ASU No. 2014-03 allows entities, on a swap-by-swap basis, to:
- Assume that qualifying receive-variable, pay-fixed interest rate swaps are effective as long as certain conditions are met,
- Complete hedge documentation by the date on which their financial statements are available to be issued, rather than when the swaps are entered into, and
- Elect to measure the swaps at settlement value rather than fair value. The primary difference between settlement value and fair value is that nonperformance risk is not considered in the determination of settlement value.
What to consider before adopting
With an understanding of the main provisions of the updates, there are several factors you should consider before deciding to adopt these accounting alternatives.
- Scope: Is your entity included in the scope of the accounting alternatives? As indicated above, public business entities, not-for-profits, employee benefit plans, and in the case of ASU No. 2014-03, financial institutions are not eligible to elect these accounting alternatives. Also, entities that may meet the definition of a public business entity in the future (e.g., through an initial public offerings or an acquisition by a public business entity) may not want to elect these accounting alternatives. They may have to retrospectively apply the financial reporting and accounting requirements in effect for public business entities during the time period in which they elected to apply the accounting alternatives.
- Financial statement users: Entities should consider whether the users of its financial statements will accept financial statements prepared using these accounting alternatives. In addition, entities that anticipate future changes to the users of its financial statements (e.g., lenders or investors) may want to consider whether those users would accept financial statements prepared using these accounting alternatives.
- Effect on existing agreements: Entities should consider the effect that the election of these accounting alternatives could have on their existing agreements (e.g., unless an entity’s debt agreements are amended, the amortization of goodwill could impact the entity’s debt covenant calculations).
- Future changes to accounting standards: The FASB has stated that they are still researching whether changes to the accounting for goodwill and interest rate swaps should also be made for public business entities. The FASB has indicated that if such changes are made, it could also affect these accounting alternatives, resulting in additional changes to how private companies are required to account for goodwill and interest rate swaps.
The PCC and FASB are continuing to evaluate whether additional accounting alternatives should be made available to private companies ( e.g., related to common control leasing arrangements and intangible assets acquired in business combinations). Private companies should continue to monitor the developments at the PCC and the FASB to determine how these potential future accounting alternatives might impact them.