A company effects a business combination, paying over and above the fair value at the time, creating an intangible asset (i.e. goodwill). Now, the company has an asset on its balance sheet that is subject to its own unique accounting rules, while not having particular relevance to users of those financial statements. Current U.S. generally accepted accounting principles (GAAP) require the assessment on at least an annual basis, as to whether or not the goodwill is impaired. The test for impairment can add significant cost and complexity to financial reporting for private companies, without an equal benefit. (Click here to read more about GAAP in my earlier blogs)
This process can be especially tedious for an asset that typically does not have much relevance for users of private company financial statements.
Earlier this year, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) on accounting for goodwill to help alleviate some of that.
In response to feedback from users of private company financial statements, the FASB has provided an alternative that focuses more on the user relevance and cost-benefit considerations of private companies. This ASU affects all entities, except public companies and not-for-profit entities.
This alternative to accounting for goodwill applies to goodwill existing at the beginning of the period in which it is elected, and to new goodwill recognized after adopting this alternative.
The main provisions of the ASU are fairly straight forward:
- Any company that elects to adopt the alternative should amortize goodwill on a straight-line basis over 10 years, or less than 10 years if they can demonstrate that a shorter useful life is more appropriate. If this alternative is adopted, the company is required to make an accounting policy election to test goodwill for impairment when a “triggering event” occurs. These triggering events can include such things as a significant change in general economic conditions, deterioration in the environment in which the company operates, cost factors, such as significant increases in costs that would have a negative effect on earnings, or a downturn in the overall financial performance of the company such consistently negative or declining cash flows.
- The effective date for this ASU is essentially for years beginning in 2015 and after for new goodwill, and it should be applied prospectively for existing goodwill. However, private companies can adopt this alternative treatment (which is still GAAP) early and can apply the provisions of this update to their financial statements for any periods for which they have not yet been issued.
The benefits to private companies and the users of their statements of adopting the practice of amortizing goodwill can be can be numerous. It can reduce the expense of financial reporting by eliminating the need for required annual impairment testing. This can also produce more useful financial statements that still comply with GAAP.
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