In late 2013, the Financial Accounting Standards Board (FASB) approved ASU 2014-02, an alternative accounting for the treatment of goodwill reserved for private companies, affirmatively electing private company status. In late 2014, FASB also approved an alternative accounting policy for treatment of certain intangible assets acquired in a business combination. These alternatives were developed by the Private Company Council (PCC) to help reduce the cost and complexity of developing financial statements for private companies.
If the goodwill accounting alternative ASU 2014-02 is elected, the private company may amortize its goodwill over a 10-year period, or less, if a shorter remaining useful life is determined. Without the private company election under ASU 2014-02, goodwill remains on the balance sheet indefinitely. In lieu of testing for impairment annually, the private company would only test goodwill for impairment if a triggering event occurs that may reduce the fair value of the entity below its carrying value. This accounting alternative also allows a private company to test for impairment through a one-step process (simplifying the two-step process) in which an impairment loss is measured by the amount the carrying value exceeds the fair value of the measured reporting unit.
The more recent FASB decision on the treatment of certain intangible assets acquired in business combinations focuses on (i) non-competition agreements; and (ii) customer-related intangible assets not capable of being sold or licensed independently from the other assets of a business. If the private company makes this election, these intangible assets would not be separately recognized apart from other assets and would be subsumed into goodwill. It’s important to note that a company may elect the accounting alternative for goodwill in ASU 2014-02, without making the election for the alternative treatment of intangible assets. However, if the intangible asset accounting alternative is elected, the private company would also make the election for the alternative treatment of goodwill under ASU 2014-02.
While these accounting alternatives simplify accounting for intangibles and goodwill for private companies, it is important for each company to process through some considerations in determining whether or not the election is appropriate. For private companies planning to stay private indefinitely, the election may make a great deal of sense. But for private companies planning to sell their company or possibly file for an IPO at some point, they may run into some issues. Currently, these private company accounting alternatives are not available for publicly traded companies and it’s currently unknown whether the FASB will consider them for publicly traded companies in the future. This means that private companies electing these accounting alternatives who subsequently sell their company to a publicly traded firm or pursue an IPO would likely have to re-state their financial statements, thereby reversing the effects of any private company elections.
Traditionally, restating financial statements leads to high costs and valuable time lost when pursuing merger and acquisition activity or an IPO. Unforeseen costs relate to developing new purchase price allocations for each acquisition completed after the company’s private company election. In connection with developing new purchase price allocations those companies would restate prior year goodwill amounts (without amortizing), and annually test goodwill for impairment for each year since the election, under the two-step process.
In conclusion, given some potentially onerous consequences, it is important for private company owners to consider the private company’s reasonable exit alternatives, before electing sweeping accounting changes. For private firms content to stay private indefinitely, the private company election may represent an ideal solution. However, private companies looking for liquidity through a company sale or IPO may decide it’s not worth the risk of making the alternative accounting election now, only to deal with the additional cost and time of unwinding it all in the future. If it is determined that the accounting alternative election is suitable for the company, evaluate any perceived upfront savings in light of potentially significant expense down the road.