January 28, 2014 NDS 2014-02 New Developments Summary Accounting alternative for private company goodwill ASU 2014-02 codifies simplified accounting alternative for subsequent measurement of goodwill and provides definition of private company Summary The FASB recently codified in Accounting Standards Update (ASU) 2014-02, Accounting for Goodwill a consensus of the Private Company Council, alternative accounting guidance developed by the Private Company Council that allows private companies to elect to amortize goodwill on a straight-line basis over either 10 years or less than 10 years if a shorter useful life is more appropriate. Further, an entity that elects the alternative must also elect whether to test goodwill for impairment at the entity level or the reporting unit level. Under the new guidance, impairment testing is performed upon the occurrence of a triggering event indicating that the fair value of the entity (or reporting unit) might be less than its carrying amount, and there is no annual goodwill impairment test. When a triggering event occurs, an entity has the option to perform a qualitative assessment to determine whether a quantitative test is needed. If that assessment demonstrates that it is not more likely than not that an impairment exists, no further testing is required. On the other hand, if impairment of goodwill is more likely than not, a quantitative test is required that compares the fair value of the entity (or reporting unit) with its carrying amount. The amount by which the carrying amount exceeds fair value represents the impairment loss to be recognized, up to the carrying amount of goodwill. Disclosures under the accounting alternative are similar to those under existing U.S. GAAP, except that a tabular reconciliation of goodwill changes is not required. The ASU also adds the definition of a private company to the FASB Accounting Standards Codification Master Glossary. If elected, the new guidance should be applied prospectively and is effective for annual periods beginning after December 15, 2014, and for interim periods within annual periods beginning after December 15, 2015, although early adoption is permitted. Existing goodwill is amortized from the beginning of the period of adoption and new goodwill from the date of acquisition. The guidance therefore may be adopted for any period for which financial statements have not been made available for issuance before January 16, 2014, the date the ASU was released. For example, a private company with a 2013 calendar or earlier year-end is permitted to elect the alternative for its financial statements, provided that those financial statements were not yet made available for issuance.
New Developments Summary 2 Contents A. Background... 2 B. Definition of a private company... 3 C. Scope and accounting policy elections... 3 Overall election... 3 Electing to test for impairment at the entity level or reporting unit level... 4 D. Amortization of goodwill... 4 E. Goodwill impairment testing... 5 When to test for impairment... 5 Performing the impairment test... 5 Sequence of tests... 6 F. Derecognition of goodwill... 6 G. Goodwill arising from equity method and joint venture investments... 6 H. Presentation and disclosures... 7 Financial statement presentation... 7 Disclosures... 7 I. Transition and effective date... 8 J. Other considerations... 8 Exit strategy, including IPO and sale to public acquirer... 8 Stakeholder concerns... 9 Investors include a public business entity... 9 FASB project regarding goodwill... 9 Other potential issues related to implementation... 9 Appendix... 11 Flowchart overview accounting alternative for goodwill impairment... 11 Comparison of existing guidance and the accounting alternative... 12 A. Background The Private Company Council (PCC) added the subsequent accounting for goodwill to its agenda early in 2013. Feedback from stakeholders, preparers, and others indicated that (1) the cost and complexity of accounting for goodwill exceed the benefits, (2) many users of private company financial statements disregard goodwill and related impairments, and (3) the optional qualitative assessment of goodwill impairment available since 2011 has resulted in some, but not significant cost savings. In its deliberations related to the subsequent accounting for goodwill and a separate issue on the initial recognition of intangible assets, the PCC recognized that although goodwill is a residual asset and the amount of goodwill initially recorded in a future business combination might change if there are modifications to the initial recognition of intangible assets, it was appropriate to complete the subsequent accounting for goodwill that is addressed in Accounting Standards Update (ASU) 2014-02, Accounting for Goodwill a consensus of the Private Company Council. The separate issue on intangible assets remains active on the PCC s agenda. New Developments Summary (NDS) 2014-01 provides background on the PCC, the Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies (Guide), and the definition of a public business entity that was added to the FASB Accounting Standards Codification (ASC) Master Glossary by ASU 2013-12, Definition of a Public Business Entity. ASU 2014-02 is one of the first accounting alternatives developed by the PCC, and
New Developments Summary 3 entities considering its adoption should be familiar with both the Guide and the public business entity definition prior to deciding whether to adopt it. B. Definition of a private company Heretofore, there had been no authoritative definition of a private company, although historically the FASB has used several different means to describe whether an entity would be public or nonpublic for purposes of applying U.S. GAAP. ASU 2014-02 adds a new definition of private company to the ASC Master Glossary, which is important because alternative accounting guidance developed by the PCC, including accounting for goodwill presented in ASU 2014-02, is available only to private companies. The definition of a private company added to the Master Glossary is as follows: An entity other than a public business entity, a not-for-profit entity, or an employee benefit plan within the scope of Topics 960 through 965 on plan accounting An entity should carefully consider whether it meets that definition, which would require determining that it does not meet the criteria of a public business entity. In other words, an entity meeting the definition of a private company would not meet any of the criteria in the definition of a public business entity added by ASU 2013-12 to the Master Glossary (see NDS 2014-01 for further information). In applying the definitions of private company and public business entity, please keep in mind that an entity may be considered a public business entity solely because its financial information or financial statements are included in another entity s filing with the SEC. In that situation, the entity is a public business entity only for purposes of financial statements that are filed with the SEC. Said another way, the entity is not a public business entity for purposes of its stand-alone financial statements that are not filed or furnished with the SEC and would therefore be permitted to elect the accounting alternative for goodwill for those stand-alone financial statements. Choosing to apply private company alternatives An entity that concludes that it meets the definition of a private company may elect the accounting alternative for goodwill; however, we believe the entity should consider factors such as future plans and stakeholders requirements and expectations, among others, as discussed in Other considerations, prior to electing this alternative or other private company alternative guidance that will be issued in the future. C. Scope and accounting policy elections Overall election A private company may make an accounting policy election to apply the accounting alternative in ASU 2014-02 for the subsequent measurement of goodwill arising from the following transactions and activities: Goodwill recognized in a business combination under ASC 805-30, Business Combinations: Goodwill or Gain from Bargain Purchase, Including Consideration Transferred
New Developments Summary 4 Goodwill recognized as a result of applying the equity method of accounting under ASC 323, Investments Equity Method and Joint Ventures, and fresh-start reporting under ASC 852, Reorganizations Note that the amount of recognized goodwill is determined by applying the guidance under the foregoing ASC Topics, and the election of the accounting alternative under ASU 2014-02 has no impact on the initial amount recognized. Rather, the alternative applies to goodwill only after it has been initially recognized. An entity electing the accounting alternative is subject to apply all of its subsequent measurement, derecognition, presentation, and disclosure requirements, and the alternative must be applied to all existing goodwill as well as to all newly recognized goodwill that results from future transactions. In other words, an entity is not allowed to selectively apply the alternative accounting to certain of its goodwill, but must apply it to goodwill from all historic and future transactions. Electing to test for impairment at the entity level or reporting unit level The second accounting policy election, to be made simultaneously when adopting the alternative, is to elect whether to test goodwill for impairment at either the entity level or the reporting unit level. Because private companies are not subject to segment reporting specified by ASC 280, Segment Reporting, the determination of reporting units for goodwill impairment testing has been difficult for many entities. An entity electing the reporting unit level would continue to be subject to the requirements in ASC 350-20-35, Intangibles Goodwill and Other: Goodwill, and in ASC 350-20-55 to identify reporting units, perform impairment testing at that level, and account for impairments at that level. Some entities, especially those that potentially face the task of transitioning back to goodwill accounting suitable for public companies, may decide that electing to test at the reporting unit level would make that future task less difficult. Other entities may decide that electing the more simplified impairment testing at the entity level is the appropriate decision. Further, we believe that once an entity elects either the entity level or reporting unit level, a change to the other level would require a determination that the change is preferable under ASC 250, Accounting Changes and Error Corrections. Absent clarification or guidance from the FASB (or the SEC staff), it is uncertain whether a future change from, for example, the reporting unit level to the entity level would be considered preferable. D. Amortization of goodwill Under ASU 2014-02, goodwill resulting from business combinations, reorganizations that result in freshstart reporting, and equity method investments is amortized on a straight-line basis over 10 years. If the entity demonstrates that a period of less than 10 years is more appropriate, the shorter useful life may be used. An example of when less than 10 years could be more appropriate is when an acquiree has a license or other intellectual property that expires in eight years, and that asset is the key driver of the acquiree s value. The acquirer might then demonstrate that an eight-year amortization period for the goodwill from this acquisition is more appropriate. Useful life determinations such as this require significant judgment based on the particular facts and circumstances in each case. The useful life of a unit of goodwill may be revised based on events and changes in circumstances that occur; however, for each unit of goodwill, the cumulative amortization period cannot exceed 10 years. If the remaining useful life is revised, the carrying amount at that time is amortized on a straight-line basis over the revised period.
New Developments Summary 5 E. Goodwill impairment testing When to test for impairment The accounting alternative requires testing for impairment upon the occurrence of a triggering event an event or circumstance that might indicate the entity s (or reporting unit s) fair value is less than its carrying amount. Existing guidance in ASC 350-20-35-3C provides examples of such events or circumstances; however, other relevant facts and circumstances affecting the fair value or carrying amount should be considered in determining whether a triggering event has occurred. The process for assessing whether a triggering event has occurred should be similar to those under existing guidance for evaluating goodwill impairment between annual tests. An entity should monitor whether such an event has occurred and proceed to test for impairment when one is identified. Performing the impairment test Once a triggering event has been identified, an entity has a choice to perform a qualitative assessment or a quantitative calculation of impairment. This choice is available each time a triggering event occurs, and an entity may change its approach (qualitative or quantitative) for each such event. An entity may assess qualitative factors with the objective of determining whether it is more likely than not that the fair value of the entity (or reporting unit) is less than its carrying amount. The entity would approach this assessment by considering factors included in ASC 350-20-35-3C (the same factors referred to above for identifying a triggering event), as well as other relevant facts and circumstances. The new guidance emphasizes the need to consider other facts and circumstances in a qualitative assessment, and not to rely solely on those listed in ASC 350-20-35-3C. Although the guidance refers to the same factors for identifying a triggering event and for performing a qualitative assessment, there is a distinction in application. In a qualitative assessment, an entity must positively assert whether it is more likely than not that goodwill is impaired. Reaching that conclusion requires consideration of all events and circumstances, not solely those that led to identifying a triggering event. The assessment follows the guidance for performing a qualitative assessment that has existed since 2011. If the result of the assessment is that it is more likely than not that the fair value of the entity (or reporting unit) is less than its carrying amount, including goodwill, a quantitative calculation of fair value would then be required. An entity has the unconditional option to proceed directly to a quantitative calculation rather than perform a qualitative assessment. Again, this choice is consistent with existing guidance and mirrors Step 1 of that impairment test. We believe that a number of entities, especially those electing to test goodwill at the entity level, will conclude that performing a qualitative assessment does not provide a cost or efficiency benefit compared with performing a quantitative calculation. In part, this is because many private companies have periodic fair value calculations performed for purposes of stock compensation, stakeholder requirements, issuances of securities, and other reasons, and any such valuation would need to be considered in a qualitative assessment. Further, the effort required to make a qualitative assessment requires considerable gathering and documenting of information related to marketplace and business environment factors, and rates and assumptions used by market participants, among other information. Entities might determine that because of these requirements, a quantitative valuation could be more efficient. If an entity determines that the fair value is less than the carrying amount of an entity (or reporting unit), including goodwill, the entity would measure and recognize an impairment loss equal to the amount by which the carrying amount exceeds fair value, not to exceed the entity s (or the reporting unit s) carrying amount of goodwill. Determining the amount of impairment differs from existing guidance in that a Step 2 hypothetical business combination calculation is not part of the computation. Entities subject to ASC 740,
New Developments Summary 6 Income Taxes, must include deferred income taxes in the carrying amount of the entity (or reporting unit), regardless of whether the fair value determination assumes a taxable or nontaxable sale or acquisition transaction. Under the alternative, a goodwill impairment loss is allocated to individual amortizable units of goodwill of the entity (or reporting unit) based on their relative carrying amounts or another reasonable and rational basis. We believe entities may choose to allocate an impairment loss to the subsidiary, division, or operation in its internal structure where the goodwill is recorded rather than to allocate the loss more broadly. Reversal of a recognized impairment loss is prohibited under ASU 2014-02. Rather, the adjusted amount of goodwill is amortized over the remaining useful life of goodwill. Sequence of tests Under the accounting alternative and consistent with existing guidance, when goodwill and another asset or asset group are tested for impairment concurrently, the other asset or asset group is tested (and any resulting impairment loss is recorded) before the goodwill impairment test is performed. A frequent example is when property, plant, and equipment is tested for impairment under ASC 360, Property, Plant, and Equipment. That test is performed before goodwill is tested. Often, a requirement to perform an impairment test under ASC 360 triggers the need to perform an impairment test on goodwill. F. Derecognition of goodwill ASU 2014-02 requires an entity to include goodwill associated with a portion of an entity (or reporting unit) that represents a business in the carrying amount of the business for purposes of determining the gain or loss on disposal. The accounting alternative calls for the use of a reasonable and rational approach to determine the amount of goodwill that is associated with the disposed business. Allocation of goodwill to disposed business We expect that entities will find the concept of allocating goodwill to a disposed business under the accounting alternative to be similar to the longstanding requirement to include an allocation of goodwill in the carrying amount of a portion of a reporting unit disposed of under ASC 350-20-40-1 through 40-4. The accounting alternative, however, does not specify how to determine that allocation, just that it should be reasonable and rational. This guidance is in contrast to the existing requirement in ASC 350-20-40-3 to allocate goodwill based on the relative fair values of the disposed portion and the remaining portion. Accordingly, we believe that as entities develop their accounting policies surrounding disposals, they would include a relative fair value approach among any other approaches under consideration. G. Goodwill arising from equity method and joint venture investments ASU 2014-02 changes the accounting for goodwill that results from equity method and joint venture investments that was not previously amortized. Under the accounting alternative, the amount of such goodwill is amortized over either 10 years or less than 10 years, if appropriate, similar to the amortization of goodwill arising from a business combination.
New Developments Summary 7 Note that the only change from current guidance for equity method and joint venture accounting is to amortize the goodwill. The amount of initial goodwill recognized continues to be determined by applying ASC 323, Investments Equity Method and Joint Ventures, and the election of the accounting alternative under ASU 2014-02 has no impact on the initial amount recognized. Further, ASU 2014-02 does not change existing guidance in ASC 350-20-35-59 that excludes from impairment testing the goodwill arising from equity method and joint venture investments. In other words, despite electing the accounting alternative, goodwill arising from these investments is not subject to the impairment testing described in Section E above. H. Presentation and disclosures Financial statement presentation An entity electing the accounting alternative is required to present the following in its financial statements: Aggregate net amount of goodwill as a separate line item on the balance sheet Amortization and aggregate amount of goodwill impairment in line items within continuing operations on the income statement, except for amounts related to discontinued operations Amortization and goodwill impairment related to discontinued operations, net-of-tax, if applicable, within discontinued operations on the income statement Although ASU 2014-02 specifies that goodwill is reported on a separate line item on the balance sheet, it does not similarly require a separate line item on the income statement. Rather, the only required distinction on the income statement is whether the amortization and impairment relate to continuing or discontinued operations. Disclosures The accounting alternative includes disclosure guidance in three areas: annual financial statements, periods in which there are additions to goodwill, and periods in which a goodwill impairment is recognized. Annual financial statements Notes to the financial statements should include the following disclosures for each period a balance sheet is presented: Gross carrying amounts of goodwill, accumulated amortization, and accumulated impairment loss Aggregate amortization expense Goodwill included in a disposal group held for sale and goodwill derecognized in the period that was not previously reported in a disposal group held for sale Periods with additions to goodwill When there are additions to goodwill in a period for which a balance sheet is presented, disclosures should include Total amount of additional goodwill Additional goodwill amount by major business combination or the application of fresh-start accounting
New Developments Summary 8 Weighted-average amortization period in total and the amortization period by major business combination or application of fresh-start accounting Periods with impairment loss For each period presented in which there is a goodwill impairment loss, an entity should disclose Facts and circumstances leading to impairment Amount of impairment and method of determining the fair value of the entity (or reporting unit) Income statement caption that includes the impairment loss How the impairment loss was allocated to the individual amortizable units of goodwill The guidance does not require quantitative disclosures about significant unobservable inputs used in Level 3 fair value measurements. I. Transition and effective date The guidance in ASU 2014-02 is adopted through a private company s accounting policy election. As described above, there are two accounting policy elections made simultaneously: one to adopt the overall accounting alternative, and another made at the same time to elect whether to test goodwill for impairment at either the entity level or the reporting unit level. The new guidance is effective prospectively for new goodwill recognized in annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015, although early adoption is permitted for any period for which financial statements have not been made available for issuance before January 16, 2014, the date ASU 2014-02 was issued. An entity electing the accounting alternative would begin to amortize existing goodwill as of the beginning of the period of adoption and to amortize new goodwill beginning on the date of acquisition. Therefore, a private company with a 2013 calendar or earlier year-end is permitted to elect the alternative for its financial statements, provided that those financial statements were not yet made available for issuance. J. Other considerations Private companies should carefully consider whether to adopt accounting alternatives not available to public business entities. Future plans and intentions play an important role in deciding whether to adopt an accounting alternative. Also, the FASB has undertaken a project to address accounting for goodwill that would have broad application. We believe an entity should consider the following matters, among others, as the decision is made. Exit strategy, including IPO and sale to public acquirer In particular, it is important for an entity to consider its investors exit strategy. If an entity is owned by a private equity investor that might exit via an initial public offering (IPO), then electing a private company accounting alternative might make a future transition to public company accounting very difficult. Similarly, if a potential exit strategy is a sale to a public business entity, then it might be inappropriate to choose a private company accounting alternative. The FASB and the SEC staff have not yet provided transition guidance for nonpublic business entities that apply an alternative and later become a public business entity. As a result, even though the private company alternatives developed by the PCC and the FASB are considered U.S. GAAP alternatives, an eligible private company should carefully consider whether the alternatives are suitable for its financial
New Developments Summary 9 accounting and reporting needs. It is not known when, or if, the FASB or the SEC staff will provide transition guidance in this context. For example, consider an entity that elects the accounting alternative in ASU 2014-02 but later determines that it needs financial statements appropriate for an IPO. The entity may be required to retrospectively reconstruct its goodwill accounting to apply the public entity accounting and reporting requirements to all periods presented. This might also occur if a public business entity acquires the entity. The task could be very difficult indeed. In deciding whether to elect the accounting alternative under ASU 2014-02, an entity should consider the new definition of a public business entity that includes entities that make exempt public offerings of securities under either the SEC s proposed crowdfunding rules or proposed amendments to Regulation A. Emerging growth companies (EGCs), as defined in the SEC s Jumpstart Our Business Startups (JOBS) Act, would also be considered public business entities. As such, they would be required to prepare their financial statements using standards applicable to public entities, even though the JOBS Act permits EGCs to take advantage of effective-date deferrals available to private companies when adopting new accounting standards. Stakeholder concerns Prior to making a decision whether to adopt the alternative, an entity should ensure that its stakeholders, including investors, lenders, and others, will agree to accept financial statements that reflect its application. We believe that some stakeholders might expect an entity to prepare financial statements that can be used for either public entity or private company purposes, and would find adopting the alternative unacceptable. Therefore, entities should have thorough discussions of the potential impact with those parties, and address the specific needs of each stakeholder prior to making a decision. Investors include a public business entity A private company should consider whether its investors include a public business entity holding an equity method investment. If so, any benefit from electing private company accounting alternatives would be offset, and then some, by the cost of complying with public business entity requirements for purposes of the equity method investor s accounting for its investment. FASB project regarding goodwill After the PCC began addressing the subsequent accounting for goodwill, the FASB added a project to its agenda on the subsequent accounting for goodwill for public business entities and not-for-profit entities. Although that project is not completed, the FASB ultimately could determine that any changes to accounting for goodwill for public and not-for profit entities should also be applied by private companies. Therefore, entities electing the alternative accounting guidance in ASU 2014-02 could face future changes to their subsequent accounting for goodwill. Other potential issues related to implementation An entity contemplating the election of the accounting alternative might identify other issues based on its particular facts and circumstances that are relevant to the decision to adopt. For example, an entity choosing to elect the alternative faces the decision of whether to adopt it for the year ended December 31, 2013 (presuming the entity is allowed to adopt early), or to adopt it at a later date. In making that decision, the entity might identify an issue related to a goodwill impairment already recognized in 2013 or to an annual impairment test that is under way, but not yet complete. Entities with these and any other issues should apply appropriate judgment and discuss with their advisers the particular facts and circumstances surrounding each case.
New Developments Summary 10 2014 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP bulletin provides information and comments on current accounting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this bulletin. For additional information on topics covered in this bulletin, contact your Grant Thornton LLP adviser.
New Developments Summary 11 Appendix The following flowchart is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, USA, and is reproduced with permission from ASU 2014-02. Flowchart overview accounting alternative for goodwill impairment Note 1: An entity has the unconditional option to skip the qualitative assessment and proceed directly to calculating the fair value of the entity (or the reporting unit) and comparing that value with its carrying amount, including goodwill.
New Developments Summary 12 Comparison of existing guidance and the accounting alternative The following table presents several key differences between existing guidance and the accounting alternative under ASU 2014-02 that would be relevant for an entity considering electing the alternative. The table does not address goodwill from equity method and joint venture investments because the only change to the accounting for that goodwill is amortization, as discussed in Section G above. Existing GAAP Effect of electing ASU 2014-02 accounting alternative Initial recognition of goodwill ASC 805-30 for business combinations ASC 852 for fresh start reporting No change Amortization Not allowed 10 years straight line, or shorter period if demonstrated as more appropriate Derecognition: disposal of business Generally, allocate goodwill based on relative fair values of business disposed to remainder of reporting unit Reasonable and rational allocation of goodwill to disposed business, with no required method of allocation Suitable for public business entity (for example, SEC filings) Yes No Unit of account Reporting unit Must elect to test at entity level or reporting unit level, and make that election at same time overall accounting alternative is elected Subsequent change from entity level to reporting unit level, or vice versa, would be ASC 250 accounting change
New Developments Summary 13 When to test Annual test and test upon occurrence of triggering event No annual test. Test only upon occurrence of triggering event Testing procedure Step 1 and Step 2, with option to first perform qualitative assessment Single step process to calculate fair value of entity or reporting unit and compare with carrying amount, with option to first perform qualitative assessment. No calculation of implied fair value of goodwill as required by Step 2 of existing GAAP Sequencing Other asset or asset group is tested (and any impairment loss recorded) before goodwill impairment test No change