Will FASB Simplify How Public Companies Report Intangibles?
Under U.S. Generally Accepted Accounting Principles (GAAP), private companies can now elect to amortize goodwill and certain intangible assets acquired in business combinations instead of testing them for impairment. They can also forgo the recognition of noncompete agreements and customer-related intangibles unless these agreements or intangibles can be sold or licensed independently.
But the Financial Accounting Standards Board (FASB) is still conducting research to decide whether to extend these simplified merger and acquisition reporting options to public companies — or to provide modified alternatives.
Before implementing Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, in 2001, companies accounted for mergers and acquisitions using one of two methods: 1) pooling-of-interests method or 2) purchase method.
Companies used the pooling method whenever 12 criteria were met; otherwise, they were required to use the purchase method. The purchase method recognized all intangible assets acquired in a business combination (either separately or as goodwill). But the pooling method recognized only intangible assets previously recorded by the acquired entity. To eliminate reporting inconsistencies among entities, SFAS 141 required that all business combinations be accounted for by a single method — the purchase method.
Users of financial statements also indicated a need for better information about intangible assets, which had become an increasing proportion of the assets acquired in business combinations. So SFAS 141 required the allocation of the purchase price paid to the assets acquired, including intangibles, and the liabilities assumed.
In conjunction with this statement, FASB issued SFAS 142, Goodwill and Other Intangible Assets, which ended amortization of acquired goodwill and other indefinite-lived intangibles in 2001. This statement requires companies to test these intangibles annually for “impairment.” Impairment testing should also happen whenever a triggering event occurs that could lower the asset’s value. Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations.
In its 2013 review of these standards, the Financial Accounting Foundation found that companies complained about the high cost of testing goodwill for impairment. FASB responded in January 2014 by allowing private companies to instead amortize goodwill for a period of up to 10 years. Last December, FASB provided another simplified accounting alternative for private companies that report certain intangibles in business combinations. (See the sidebar “Good news for private company M&A.”)
Possible public company alternatives
At its November 2014 meeting, FASB decided to conduct further research into the measurement of goodwill by public companies. This research is expected to focus on two alternatives:
- Identifying the most appropriate useful life if public companies are allowed to amortize goodwill, and
- Simplifying the impairment test.
FASB Chairman Russell Golden favors the amortization option, due to inconsistency in the current treatment of goodwill and the high costs impairment testing imposes on companies. Some board members favor a shorter period than the 10-year amortization period allowed for private companies or the 20-year period considered by Japan. A shorter period might generate significant complaints from public companies. But some FASB members contend that acquired goodwill is a wasting asset and its value can be maintained only if public companies replace it with internally generated goodwill, which GAAP doesn’t recognize.
An alternative to amortization that FASB is considering is to model the impairment testing for public companies after the International Financial Reporting Standards impairment testing rules, which don’t require the extra step of allocating the purchase price to acquired intangibles. The staff will consider International Accounting Standards Board activities on goodwill and intangible assets. This review will include the implications of public companies potentially subsuming noncompete agreements and customer-related intangible assets that can’t be sold or licensed independently into goodwill.
Good news for private company M&A
On Dec. 23, 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. This guidance provides an accounting alternative for private companies engaged in mergers or acquisitions (M&A), exempting them from separately reporting noncompete agreements and customer-related intangible assets that can’t be sold or licensed independently. Instead, companies can elect to combine these items into the value of goodwill.
Private companies that elect to use the alternate reporting method provided under ASU 2014-18 must also elect to amortize goodwill in accordance with ASU 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill. Instead of testing goodwill annually for impairment, this alternative allows private companies that acquire goodwill in a business combination to elect to amortize it straight-line over 10 years (or fewer if management can justify a shorter useful life). However, the reverse isn’t required: Private companies that elect to amortize goodwill needn’t necessarily combine noncompetes and other customer-related intangibles into goodwill under ASU 2014-18.
The latest update on reporting intangibles goes into effect for deals entered into during fiscal years that begin after Dec. 15, 2015. But early adoption is permitted. Once elected, the accounting alternative must be applied to all future transactions.
Work in progress
No specific timeline has been determined in terms of when the FASB staff will complete its outreach to companies, investors and auditors — or when it will resume discussions on the public company goodwill project.
For the latest developments on the rules related to reporting business combinations and amortizing goodwill, contact Dan Ward, Manager, Audit Services, at 314.983.1237 or firstname.lastname@example.org.