FACTORS TO CONSIDER BEFORE ADOPTING THE NEW APPROACH
The Private Company Council (PCC) and Financial Accounting Standards Board (FASB) recently issued new guidance on goodwill impairment and the recognition and measurement of certain intangible assets in a business combination. These rules are based on the final recommendations from the Private Company Council, which was formed in 2012. The guidance is part of a broader effort by PCC/FASB to address the cost and complexity of preparing financial statements for private companies and their stakeholders.
OVERVIEW OF NEW GUIDANCE
In a business combination, private companies can choose to elect the new alternative and limit the customer-related intangibles it separately recognizes to those that are capable of being sold or licensed independently from other assets acquired in the business combination. Examples of customer-related intangibles that will continue to be recognized separately include:
- Mortgage service rights
- Commodity supply contracts
- Core deposits
- Many customer lists/information
As a result, private companies that elect the new alternative will subsume into goodwill many types of customer-related intangible assets that they recognize separately today.
Also under the new guidance, private companies will no longer recognize non-compete agreements acquired as part of a business combination. For example, non-compete agreements with employees would not need to be identified and valued. However, there is a diversity of views as to whether non-compete agreements entered into with a seller concurrent with a business combination will need to be valued.
The guidance also clarifies that contract assets and leases are not considered customer-related intangible assets and thus not eligible to be subsumed in goodwill. It also identifies and differentiates between customer contracts that may include terms that are either favorable (can be subsumed into goodwill) or unfavorable (cannot be subsumed into goodwill).
Companies adopting the alternative must also elect the new goodwill alternative accounting and would be required to amortize goodwill over a period of 10 years or less. Without this requirement, companies would be subsuming finite-lived intangibles into indefinite-lived goodwill.
The PCC related goodwill alternative also has several other modifications to ASC 350, Intangibles—Goodwill and Other. These differences are summarized below.
HOW WE SEE IT
While this alternative can reduce some costs and complexity for private companies, we think companies need to think carefully about adopting the alternative:
- FASB adopted the new guidance with considerable disagreement. While some companies were concerned about the additional costs and effort of recognizing intangibles, a number of other concerns were raised for companies who may be considering future combinations or public offerings. The guidance just barely got the needed 4-3 vote to pass. The final version was significantly different from the original and did not go out for comment.
- Some companies won’t be able to justify foregoing valuation work as it could lead to more complexity and cost.Any company planning to be acquired by a public company, take an investment from a public company, or issue debt or stock in an IPO will need to issue financial statements that are compliant with Generally Accepted Accounting Principles (GAAP) for public business entities. Companies that become public after using the private company alternative would have to retroactively apply the public business entity accounting and reporting requirements to all prior periods presented. This could be challenging and add cost and complexity by affecting other aspects of the financial statements.
- Will there be cost savings? The original purpose of the PCC recommendations was to simplify accounting for private companies with an eye toward cost savings. The final standard allows private companies not to value certain items in a business combination such as covenants not to compete and customer-related intangibles. However, the final report to the PCC staff was unable to assert that these changes would lead to significant cost savings for anyone.
- The guidance was also not clear on valuing non-compete agreements with selling shareholders. If one concludes that a non-compete agreement with a selling shareholder is a transaction executed concurrent with the business combination, but is not part of the business combination, that non-compete agreement would need to be valued and accounted for separate from goodwill. We believe there will be diversity in practice with some entities concluding a seller non-compete agreement is part of the business combination and other entities concluding a seller non-compete agreement is not part of the business combination.
- FASB has suggested they will consider similar guidance for public entities and non-profits. We find this surprising as there has been little indication that public companies are looking for changes or find it too expensive to value intangibles and goodwill. In fact, the FASB’s post-implementation review of ASC 805, Business Combinations, suggested that both users and preparers were comfortable with the standard currently in place.
Before adopting the new guidance, we encourage private companies to perform a thorough analysis of the implications. Consider strategic growth plans and future capital needs. While adopting the rules could simplify valuation of intangibles today, it could make for significant complexity and cost in the future under certain circumstances.