Private companies may have something to celebrate in 2014. The Private Company Council (PCC), an advisory body to the Financial Accounting Standards Board, is rejiggering financial reporting for private firms this year. Among the changes is a new standard that proponents say will make it easier for companies to account for goodwill.
Currently, all firms that comply with generally accepted accounting principles (GAAP) and have goodwill on their books must run an impairment test annually. As is the case with many accounting regulations, the resulting process can be costly and onerous, especially for smaller firms with modest finance departments. The new standard, released in January 2014, will allow private companies that adhere to GAAP to instead amortize goodwill on a straight-line basis over 10 years or less.
The goodwill standard comes directly after FASB and the PCC released the Private Company Decision-Making Framework, which explains what constitutes a “public business entity,” in terms of financial reporting, and lays out several differentiating factors between public and private companies. The framework will help FASB make decisions on private company accounting under U.S. GAAP.
The PCC was launched in May 2012 with several goals. Among them, it wanted to reduce the cost and complexity of financial reporting for private companies while still providing useful information for financial statement users, such as investors, says Kirsten Schofield, partner at PwC. “They looked at areas that were overly complex and costly for private companies from an accounting perspective while offering little perceived benefit to the users of their financial statements,” Schofield says. “One of those was accounting for goodwill.”
The Goodwill Standard
All companies adhering to GAAP must perform an impairment test on goodwill every year. The process requires firms to identify their reporting units, which they typically don’t have to specify otherwise. Often, private firms will hire a valuation-services firm to do the impairment test — a significant expense, Schofield says.
Thanks to the new standard, companies that don’t fit the definition of a “public business entity” can choose to adopt the goodwill alternative, which allows them to amortize their goodwill on a straight-line basis over 10 years or less rather than annually run the impairment test. They would only need to do an impairment test if there were a triggering event (something that would significantly alter the value of a firm’s goodwill) such as a substantial decline in operating results, the loss of a key employee or a change in the market for the relevant products or services.
The new standard makes the impairment test simpler. Companies that adopt the alternative can do the test at the entity-wide level, rather than a reporting unit level. The alternative also makes impairment a one-step test, removing a costly second step from the process.
Some question the usefulness of the goodwill standard to very small firms. The alternative allows companies to amortize over 10 years or less, but the Internal Revenue Service requires them to amortize over 15 years. Often, smaller companies keep one set of books: IRS-compliant ones, says John Exline, chair of the small business financial and regulatory affairs committee at the IMA (Institute of Management Accountants). Small firms would likely not want to keep two separate sets of books to account for the difference between goodwill amortization for the IRS and for GAAP, Exline says.
Exline acknowledges that there are a number of differences between IRS regulations and GAAP standards, and small firms can usually hire an external CPA to make adjustments for GAAP. But the more differences there are, the harder that becomes, he says.
At the same time, Exline is talking about very small companies. Most firms with a CFO will easily be able to account for the different amortization schedules. Exline also says he supports the new standard overall, because it will make the lives of small company finance teams easier, he says.
Companies that consider adopting the alternative should spend time mulling their options, says Kirsten Schofield. “If I were a CFO of a company, I would be thinking about what is the cost to my organization of applying the existing standard versus the alternative and I would also be thinking about the users of my financial statements, my constituents,” she says. “How does this impact them, what information is important to them?” For instance, companies should consider whether switching to the new accounting alternative will create any debt- covenant compliance problems, she says.
Private companies should also keep in mind that if they adopt the alternative standard and meet the definition of a public business entity in the future (if they’re acquired or go public, for instance), they would have to “unwind” their earlier accounting. That means a firm would have to go back and “retrospectively apply [the existing standard] for the years that it used the alternative [standard] in the financial statements being presented,” Schofield says.
“If you’re a private company and you think you’re going to go through an IPO in the near-term, you would really want to think about whether or not this was the right solution for you,” she says. “Some companies might say ‘that’s okay, I’ll deal with this when the time comes.’ Others might say it’s easier to stay under the existing rules.”
The FASB will issue another alternative in January related to certain interest rate swaps. Companies can choose to adopt the alternatives on a standard-by-standard basis.