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FASB Issues GAAP Alternative Standards on Goodwill, Interest-Rate Swaps for Privately-Held Companies

The Financial Accounting Standards Board (“FASB”) issued two updates to Generally Accepted Accounting Principles (“GAAP”) that offer alternatives to certain private companies in the areas of Accounting for Goodwill and Derivatives and Hedging—Accounting for Interest Rate Swaps. These alternative standards streamline the method for goodwill impairment and make it easier for certain interest rate swaps to qualify for hedge accounting.

The Private Company Council (“PCC”) was formed in 2012 to improve the process of setting accounting standards for private companies that prepare their financial statements in accordance with GAAP. Many private companies found that the cost and complexity of complying with GAAP pronouncements were high and time consuming. In addition, outside users of the financial statements were disregarding goodwill when analyzing a company’s financial condition and operating performance. The updated standards allow private companies the option to use these alternative standards in areas such as recognition and measurement, disclosures, and display and presentation. Private companies also have the option whether or not to adopt each new alternative standard.

Goodwill

Goodwill is the residual asset recognized in a business combination, such as a purchase or merger, after recognizing all other identifiable assets acquired and liabilities assumed. Under current GAAP, goodwill is not amortized, but is tested for impairment at least annually, or when certain conditions exist. Goodwill is considered impaired when the implied fair value of goodwill in a company’s reporting unit is less than the amount recorded on the company’s books. In order to test for impairment, companies first perform a qualitative evaluation to determine whether a reporting unit’s fair value is less than its carrying amount. If the company’s evaluation determines that it is more likely than not that the fair value is less than the carrying value, the company then performs a two-step calculation, in which the company first calculates the fair value of the reporting unit and compares that amount with the carrying amount. If the fair value is less than the carrying amount, the company then needs to measure the amount of goodwill impairment by performing a hypothetical application of the acquisition method.

Under the alternative standard, a private company can amortize goodwill on a straight-line basis over 10 years, or less if a lower useful life is appropriate. The company can also revise the remaining useful life if circumstances change, but the cumulative amortization period cannot exceed 10 years. If a company elects this alternative must make an accounting policy decision to test for goodwill impairment at either the company level or the reporting unit level. However, a Company only has to test for impairment when a triggering event, such as an adverse change in business climate or loss of key personnel, occurs that indicates that the fair value has been reduced below the carrying amount. The Company no longer has to apply the acquisition method to calculate impairment, which was very costly and complicated. Instead, the amount of the impairment equals the amount by which the carrying amount of the company or reporting unit exceeds its fair value.

The disclosures required under the alternative standard are similar to existing GAAP. However, a company that elects the alternative standard is not required to present changes in goodwill in a tabular reconciliation.

Interest Swaps

Many lenders require private companies to enter into an interest-rate swap, which converts a variable-rate loan into a fixed rate loan. The interest-rate swap is considered a derivative instrument. Current GAAP guidance requires a company to recognize all of its derivative instruments in its balance sheet as either assets or liabilities and measure them at fair value.

In order to mitigate volatility in its income statement, a company may elect cash flow hedge accounting if certain requirements are met. However, many private companies do not have the resources and expertise to comply with the requirements for cash flow hedge accounting.

This alternative standard allows nonfinancial institution private companies to apply a simplified hedge accounting approach to their receive-variable, pay-fixed interest rate swaps as long as the terms of the swap and the related debt are aligned. Under this method, a company presents interest rate expense in its income statement as if the company had directly entered into a fixed-rate loan, instead of a variable-rate loan plus a swap.

The alternative standard also allows a private company to recognize the swap at its settlement value, which does not take into consideration nonperformance risk, rather than fair value. This may result in cost savings for the company, as settlement value is generally easier to determine than fair value. The variability of the fair value or settlement amount will be recorded as accumulated other comprehensive income, which is a component of equity. The new standard can be applied to both existing and new qualifying swaps because the election of hedge accounting can be made on a swap-by-swap basis.

Other Matters to Consider

Private companies considering the adoption of the new GAAP alternative standards should consult with their financial statement users, such as banks, to see if the users will accept financial statements using the new alternative standards. Also, a private company that subsequently becomes subject to public company reporting would need to recast prior periods as the alternative standards cannot be adopted by public companies. In addition, FASB is currently working on a project that addresses the subsequent accounting for goodwill for public companies and not-for-profit organizations, which could result in a future change to accounting for goodwill for all entities, including private companies.

Effective Dates

Both new alternatives will be effective for annual periods beginning after December 15, 2014, and interim periods beginning after December 15, 2015. Early adoption is permitted, so private companies can elect these alternative standards on their 2013 financial statements, as long as the financial statements were not made available for issuance before the new standards were released.

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