Goodwill accounting alternative

Transcription

1 No March 10, 2014 What s inside: Overview... 1 Appendix... 2 Goodwill accounting alternative FASB and PCC issue final standard for private companies Overview On January 16, 2014, the FASB issued Accounting Standards Update (ASU) No , Accounting for Goodwill. The standard provides private companies with an accounting alternative that is intended to simplify the goodwill accounting model. For private companies, the new standard represents a fundamental overhaul of the existing accounting model for goodwill. A private company that elects to adopt the alternative will be able to both amortize goodwill and apply a simplified goodwill impairment test. Adoption of the standard is optional, so a private company can continue to apply the existing goodwill accounting model. A company considering adopting the alternative should carefully review the definition of a public business entity, as defined in ASU , Definition of a Public Business Entity, to ensure eligibility. Before adopting, an eligible private company should carefully weigh both the impact of applying the standard on its key financial metrics, and the potential cost of unwinding the accounting and reapplying the existing goodwill accounting standard if its reporting requirements change because it no longer meets the definition of a private company. The standard is effective for annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, Early adoption is permitted for any annual or interim period for which a company s financial statements have not yet been made available for issuance. Therefore, a private company would likely be able to apply the standard to its 2013 financial statements, if it so desires. The appendix to this Dataline discusses the private company goodwill accounting alternative. It serves as an insert to Chapter 11, Accounting for Goodwill Postacquisition U.S. GAAP, in our 2013 Global Guide to Accounting for Business Combinations and Noncontrolling Interests. National Professional Services Group CFOdirect Network Dataline 1

2 Appendix 11.9 Private company accounting alternative On January 16, 2014, the FASB and the Private Company Council (PCC) issued ASU , Accounting for Goodwill (the goodwill alternative ). For private companies, the goodwill alternative represents a fundamental overhaul of the existing accounting model for goodwill. Application of the goodwill alternative is optional, and a private company can continue to follow the existing goodwill accounting guidance. An eligible company that elects the goodwill alternative will be able to apply a simplified impairment test but also will be required to amortize goodwill. Only private companies are eligible to elect the goodwill alternative. Companies considering adoption should carefully review the definition of a public business entity, as defined in ASU , Definition of a Public Business Entity. A company that meets the definition of a public business entity is not eligible to apply any of the PCC s accounting alternatives in its financial statements. Additionally, not-for-profit entities and employee benefit plans are not eligible to adopt PCC accounting alternatives. ASU defines a public business entity as a business entity meeting any one of the following criteria: a. It is required by the SEC to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in the filing). b. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC. c. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer. d. It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market. e. It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion. An eligible private company is required to make an accounting policy election if it intends to adopt the goodwill alternative. The alternative is effective for annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, Early adoption is permitted for any annual or National Professional Services Group CFOdirect Network Dataline 2

3 interim period for which a company s financial statements have not yet been made available for issuance 1. The PCC is addressing accounting alternatives in other areas as well. A private company will generally be able to choose which of the accounting alternatives it will adopt, and will not be required to adopt all of the accounting alternatives being offered just because it adopts one or more of them. However, if the goodwill alternative is adopted, a private company must apply all provisions of ASU prospectively to all of its existing and future goodwill. Therefore, if a company elects to adopt the goodwill alternative for impairment testing, it must apply the standard s amortization guidance 2. Question What factors should a private company consider before deciding whether it will adopt the goodwill alternative? PwC response A company should carefully consider whether it currently meets the definition of a public business entity and whether it expects to meet that definition in the future. If a company that is private today later meets the definition of a public business entity (for example, due to a public offering of the company s securities), it will no longer be eligible to apply the goodwill alternative and will be required to retrospectively adjust its historical financial statements to apply the requirements of the existing goodwill accounting guidance. In addition to determining whether it is eligible to adopt the goodwill alternative, a company should also assess the impact a transition to the goodwill alternative will have on its key financial metrics, particularly those affecting its debt covenant compliance. While a company s EBITDA will not likely be impacted by adoption of the goodwill alternative, other key measures of performance such as net income, operating income, net assets and retained earnings will be affected. Key differences between the goodwill alternative and the existing goodwill impairment guidance are summarized in Figure Under the guidance in ASC 855, Subsequent Events, financial statements are available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained. 2 A private company that elects to adopt the goodwill alternative will be required to amortize the portion of the difference between the cost of an investment accounted for on the equity method and the amount of underlying equity in net assets of the equity method investee that is recognized as goodwill. Additionally, a private company should consider what impact, if any, the amortization of goodwill will have on its accounting for deferred tax assets and liabilities. National Professional Services Group CFOdirect Network Dataline 3

4 Figure Key differences between the goodwill alternative and the existing goodwill guidance Amortization Level of testing for impairment assessment Frequency of impairment assessment Measurement of impairment Allocation of impairment Disposal of business that constitutes a portion of an entity (or reporting unit) Goodwill alternative Requires goodwill to be amortized on a straight-line basis over a period of ten years, or less in certain circumstances Either entity-wide or reporting unit (policy election upon adoption of the accounting alternative) Upon occurrence of a triggering event Single step test, which compares the fair value of the entity (or reporting unit) to its carrying amount Impairment charge allocated to separate amortizable units of goodwill using either a pro rata allocation based on relative carrying amounts of goodwill or another reasonable and rational basis Goodwill allocated to disposed business using a reasonable and rational approach Existing goodwill guidance Does not allow goodwill to be amortized Reporting unit At least annually, and between annual tests whenever a triggering event occurs Two-step test. In the first step, the fair value of each reporting unit is compared to its carrying amount. If the fair value of the reporting unit is less than its carrying amount, a second step is used to measure any impairment. This second step requires the preparation of a hypothetical purchase price allocation to determine the implied fair value of goodwill. The impairment, if any, is the amount by which the carrying amount of the reporting unit s goodwill exceeds its implied fair value Impairment charge allocated at the reporting unit level Goodwill allocated based on the relative fair value of the business disposed of to the portion of the reporting unit being retained The remainder of this section addresses the provisions of the goodwill alternative. National Professional Services Group CFOdirect Network Dataline 4

5 Amortization of goodwill A company should amortize goodwill on a straight-line basis over ten years, or less than ten years if the company demonstrates that another useful life is more appropriate [ASC ]. The amortization guidance applies to existing goodwill, whether it resulted from a business combination or application of fresh-start reporting, at the adoption date as well as any new goodwill arising subsequent to adoption. Upon adoption, a company should assign a useful life to its existing amortizable units of goodwill as of the beginning of the period of adoption and begin amortizing the goodwill on a straight-line basis from the beginning of the period. Assigning a remaining useful life of ten years to all existing goodwill on the adoption date, unless a shorter useful life is more appropriate, is intended to simplify the accounting. In no circumstances is a company permitted to assign a useful life in excess of ten years to its goodwill. Example illustrates how a company should transition to the goodwill alternative. Example Transition to goodwill alternative Company A, which is eligible to apply the PCC s accounting alternatives, elects to early adopt the goodwill alternative in its year ended December 31, 2013 financial statements. On January 1, 2013, the beginning of the year of adoption, Company A has goodwill of CU100. Company A concludes that it will assign a useful life of ten years to this goodwill balance, without further analysis of the life, as a practical expedient. Analysis Assuming there are no impairments or disposals during 2013, Company A should record CU10 of goodwill amortization expense in operating expenses for the yearended December 31, Amortization after initial adoption A company should assign a useful life to new goodwill arising after initial adoption on an acquisition-by-acquisition basis, thus creating separate amortizable units of goodwill. A useful life of ten years can be assigned to a new amortizable unit of goodwill as a practical expedient. As with existing goodwill on the adoption date, a company has the option to assign a shorter useful life to a new amortizable unit of goodwill if it demonstrates that the goodwill has a shorter useful life. The determination of the useful life of goodwill should be made separately for each amortizable unit of goodwill. A company may revise the remaining useful life of each of its amortizable units of goodwill upon the occurrence of an event or change in circumstance that could indicate a different remaining useful life is more appropriate. The cumulative amortization period of any single amortizable unit of goodwill cannot exceed ten years. Therefore, if an individual amortizable unit of goodwill is initially assigned a National Professional Services Group CFOdirect Network Dataline 5

6 useful life of ten years, it may be appropriate in certain circumstances to subsequently shorten the life, but in no circumstances should the useful life be extended beyond a total life of ten years. If the estimated remaining useful life of an amortizable unit of goodwill is adjusted, the change would be treated as a change in accounting estimate, and thus applied on a prospective basis from the date the useful life is adjusted [ASC ] Impairment model The goodwill alternative simplifies many aspects of the goodwill impairment model for private companies by changing the level at which the impairment assessment is performed, when the test is performed, and how an impairment charge is calculated. The goodwill alternative does not change the order in which goodwill is assessed for impairment. The order of impairment testing is described in BCG and BCG Level to test goodwill for impairment Goodwill may be assessed for impairment at the entity-wide level or at the reporting unit level. The level at which to test goodwill for impairment is a policy election that is required to be made on the date the goodwill alternative is adopted. If a company elects to assess goodwill for impairment at the reporting unit level, it will continue to follow the existing goodwill model to determine its reporting units, assign assets and liabilities to its reporting units, and allocate goodwill to its reporting units. See BCG 11.2, 11.3 and 11.4 for more information about these topics. If a company elects to assess goodwill for impairment at the entity-wide level, a determination of the company s reporting units is not necessary Frequency of impairment testing The impairment assessment is a trigger-based assessment, whereby a company is only required to test goodwill for impairment if an event occurs or circumstances change that indicate that the fair value of the entity may be below its carrying amount or the fair value of a reporting unit may be below its carrying amount depending on the level at which the test is performed based on the accounting policy adopted [ASC ]. A company is no longer required to assess goodwill for impairment on an annual basis. The goodwill alternative does not change the examples of events and circumstances, identified in BCG , that indicate that the fair value of the entity (or reporting unit) may be below its carrying amount. However, those examples are not meant to be all-inclusive. As part of its analysis of potential triggering events, a company should consider other factors that could impact the fair value of the entity (or reporting unit), the extent to which each of the identified adverse events or circumstances impact the entity s (or reporting unit s) fair value, the presence of any positive or mitigating factors that impact fair value, and, if applicable, the results of any recent fair value calculations [ASC ]. National Professional Services Group CFOdirect Network Dataline 6

7 The goodwill impairment test Upon the occurrence of a triggering event, a company is permitted to first assess qualitative factors to determine whether it is more likely than not that the fair value of the entity (or the reporting unit) is less than its carrying amount, including goodwill. The qualitative assessment, commonly referred to as step zero, applied in the goodwill alternative is the same as the qualitative assessment under the existing goodwill impairment guidance. See BCG for a discussion of how to apply the qualitative impairment test. An entity is also permitted to bypass the qualitative assessment and proceed directly to the quantitative test. If a company elects to bypass the qualitative assessment, or, after performing the qualitative assessment concludes that it is more likely than not that the fair value of the entity (or reporting unit) is less than its carrying amount, it should proceed to a quantitative impairment test. Similar to step one under the existing goodwill impairment guidance, a company should compare the fair value of the entity (or reporting unit) to its carrying amount, which includes goodwill. If the fair value exceeds the carrying value, no impairment loss exists. If the fair value is less than the carrying amount, a goodwill impairment loss is measured and recorded. Consistent with the existing goodwill impairment guidance, when determining the fair value of the entity (or reporting unit), a company will need to determine whether the entity (or reporting unit) would be bought or sold in a taxable or nontaxable transaction. However, when performing the single step impairment test, a company should include its deferred income taxes in the carrying amount of the entity (or reporting unit), regardless of how the fair value of the entity (or reporting unit) is determined (i.e., whether the entity (reporting unit) would be bought or sold in a taxable or nontaxable transaction) [ASC ] Measurement of an impairment loss A goodwill impairment loss is measured as the amount by which the carrying amount of the entity (or reporting unit) exceeds its fair value. However, the impairment loss cannot exceed the entity s (or reporting unit s) carrying amount of goodwill [ASC ]. A hypothetical application of the acquisition method to calculate implied goodwill (step two) is not required. Question A company elects to continue to assess goodwill for impairment at the reporting unit level and measures an impairment loss in one reporting unit that exceeds the carrying amount of that reporting unit s goodwill. Should the company allocate the excess amount to the goodwill in its other reporting units? PwC response No. For a company that assesses for impairment at the reporting unit level, the measurement of any impairment loss is limited to the carrying amount of goodwill in that reporting unit. Therefore, if the calculated impairment loss for any single reporting unit is greater than the carrying amount of the reporting unit s goodwill, the National Professional Services Group CFOdirect Network Dataline 7

8 company should not allocate the remaining difference to its other reporting units. Separately, the company should assess its long-lived assets for impairment before assessing goodwill for impairment. Example demonstrates measurement of an impairment loss under the goodwill alternative. Example Measurement of an impairment loss Company A has elected to assess its goodwill for impairment at the entity-wide level. During 20x4, Company A experiences a decline in its consolidated earnings and operating cash flows, and on June 30, 20x4, concludes that it is more likely than not that the fair value of the entity has fallen below its carrying amount. Before assessing its goodwill for impairment, Company A assessed its long-lived assets and determined there were no impairments. On June 30, the carrying amount of Company A s consolidated net assets is CU950, which includes goodwill of CU200. Analysis Company A is required to assess its goodwill for impairment on June 30, 20x4, the date it has determined that the fair value of the entity may be below its carrying amount. On that date, Company A should determine the fair value of the consolidated entity using the same measurement principles described in ASC through (i.e., the existing guidance for determining the fair value of a reporting unit). Company A concludes that its fair value is CU800. Therefore, Company A s carrying amount exceeds its fair value by CU150. Company A should recognize a goodwill impairment loss of CU150, thus reducing the carrying amount of its goodwill to CU50. Alternatively, if the carrying amount of Company A s goodwill was CU100 on June 30, 20x4, the impairment loss would be limited to CU100, because the total impairment loss cannot exceed the carrying amount of goodwill. Question How should a company with a negative carrying amount at the entity (or reporting unit) level measure a goodwill impairment loss? PwC response The goodwill alternative does not specifically address how a company should test goodwill for impairment when the goodwill resides within a reporting unit with a negative carrying amount, or the goodwill is being tested for impairment at the entitywide level and the entity has a negative carrying amount. For areas not addressed in the goodwill alternative, an entity should continue to follow the applicable requirements of the existing goodwill accounting and reporting model [ASC ]. Therefore, it would appear that in these circumstances, the guidance in ASC National Professional Services Group CFOdirect Network Dataline 8

9 A should be followed. See BCG for more discussion of the impairment test for entities (or reporting units) with zero or negative carrying amounts Allocation of an impairment loss A company should allocate the goodwill impairment loss to individual amortizable units of goodwill of the entity if it tests for goodwill impairment at the entity-wide level, or to amortizable units of goodwill within the impaired reporting unit if it tests for goodwill impairment at the reporting unit level. Therefore, the level at which a company assesses its goodwill for impairment will determine how a goodwill impairment charge is allocated to the separate amortizable units of goodwill. A company is permitted to allocate the impairment loss on a pro rata basis using the relative carrying amounts of its separate amortizable units of goodwill. While a company may allocate the impairment loss using another reasonable and rational basis, entities generally should use the pro rata allocation method unless there is clear evidence supporting a specific identification of the impairment loss to one or more amortizable units of goodwill. After the goodwill impairment charge is allocated to individual amortizable units of goodwill, the adjusted carrying amounts of the individual units should be amortized over their respective remaining useful lives [ASC ]. Example demonstrates allocation of a goodwill impairment loss to amortizable units of goodwill. Example Allocating an impairment loss to amortizable units of goodwill on a pro rata basis Company A assesses goodwill for impairment at the entity-wide level. Upon a triggering event in 20x5, Company A performs the goodwill impairment test and determines that it has a goodwill impairment loss of CU100 that it needs to allocate to its three amortizable units of goodwill. Goodwill origin Goodwill carrying amount before impairment loss Remaining useful life at impairment test date Unit 1 Existing goodwill on adoption date CU300 5 years Unit 2 20x3 acquisition CU150 8 years Unit 3 20x4 acquisition CU50 9 years Company A determines that the impairment loss will be allocated to its three amortizable units of goodwill on a pro rata basis using their relative carrying amounts. National Professional Services Group CFOdirect Network Dataline 9

10 Analysis Since it is using a pro rata allocation, Company A should allocate 60% of the impairment loss, or CU60, to Unit 1, 30% of the impairment loss, or CU30, to Unit 2, and 10% of the impairment loss, or CU10 to Unit 3 3. The allocation of the impairment loss impacts the amount of amortization expense that will be recognized in each future period Disposal considerations When a company disposes of a business that is part of an entity (or reporting unit), the goodwill associated with that business should be included in the carrying amount of the business in determining the gain or loss on disposal [ASC ]. The amount of goodwill to allocate to a disposed business should be determined using a reasonable and rational approach. A relative fair value approach would generally be considered a reasonable and rational approach. Other approaches may be considered reasonable and rational, depending on a company s specific facts and circumstances. Under the existing guidance, the amount of goodwill to allocate to the business to be disposed of is determined based on the relative fair values of (i) the business being sold and (ii) the portion of the reporting unit that will be retained unless the business to be disposed of was never integrated into the reporting unit (see BCG 11.6). In most cases it is difficult to establish that the benefits of the acquired goodwill were never realized by the rest of the reporting unit. Therefore, the relative fair value approach generally will be the most appropriate method of allocating goodwill to a disposed business for companies adopting the goodwill alternative Presentation and disclosure ASC and ASC describe the presentation and disclosure requirements under the goodwill alternative, which are generally consistent with the disclosures required under the existing goodwill model. Key differences include the removal of the requirement for a company to disclose a tabular reconciliation of the beginning balance, ending balance, and activity in the goodwill balance from period to period, and the addition of a requirement to disclose the weighted-average amortization period of goodwill. Excerpts from ASC through : 3 The total carrying amount of goodwill is CU500. Unit 1 s goodwill represents 60% [CU300 / CU500] of the total, Unit 2 s goodwill represents 30% [CU150 / CU500] of the total, and Unit 3 s goodwill represents 10% [CU50 / CU500] of the total. 4 The excerpts in this section have been reproduced from paragraphs ASC through 45-7 and ASC through 50-7 of the FASB s Accounting Standards Update , Accounting for Goodwill (Topic 350). The FASB material included in this work is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and is reproduced with permission. National Professional Services Group CFOdirect Network Dataline 10

11 Excerpt from ASC The aggregate amount of goodwill net of accumulated amortization and impairment shall be presented as a separate line item in the statement of financial position. Excerpt from ASC The amortization and aggregate amount of impairment of goodwill shall be presented in income statement line items within continuing operations (or similar caption) unless the amortization or a goodwill impairment loss is associated with a discontinued operation. Excerpt from ASC The amortization and impairment of goodwill associated with a discontinued operation shall be included (on a net-of-tax basis) within the results of discontinued operations. Excerpts from ASC through 50-7: Excerpt from ASC The following information shall be disclosed in the notes to financial statements for any additions to goodwill in each period for which a statement of financial position is presented: a. The amount assigned to goodwill in total and by major business combination or by reorganization event resulting in fresh-start reporting b. The weighted-average amortization period in total and the amortization period by major business combination or by reorganization event resulting in fresh-start reporting. Excerpt from ASC The following information shall be disclosed in the financial statements or the notes to the financial statements for each period for which a statement of financial position is presented: a. The gross carrying amounts of goodwill, accumulated amortization, and accumulated impairment loss National Professional Services Group CFOdirect Network Dataline 11

12 b. The aggregate amortization expense for the period c. Goodwill included in a disposal group classified as held for sale in accordance with paragraph and goodwill derecognized during the period without having previously been reported in a disposal group classified as held for sale. Excerpt from ASC For each goodwill impairment loss recognized, the following information shall be disclosed in the notes to the financial statements that include the period in which the impairment loss is recognized: a. A description of the facts and circumstances leading to the impairment b. The amount of the impairment loss and the method of determining the fair value of the entity or the reporting unit (whether based on prices of comparable businesses, a present value or other valuation technique, or a combination of those methods) c. The caption in the income statement in which the impairment loss is included d. The method of allocating the impairment loss to the individual amortizable units of goodwill. Excerpt from ASC The quantitative disclosures about significant unobservable inputs used in fair value measurements categorized within Level 3 of the fair value hierarchy required by paragraph (bbb) are not required for fair value measurements related to the financial accounting and reporting for goodwill after its initial recognition in a business combination. Questions? PwC clients who have questions about this Dataline should contact their engagement partner. Engagement teams who have questions should contact the Business Combinations team in the National Professional Services Group ( ). Authored by: Lawrence Dodyk Partner Phone: lawrence.dodyk@pwc.com John Stieg Senior Manager Phone: john.c.stieg@us.pwc.com 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. To access additional content on financial reporting issues, visit PwC s online resource for financial executives.