[IMGCAP(1)]For the first time, private companies will be able to make two accounting elections that will simplify their reporting requirements and still be in compliance with U.S. GAAP.

Users of financial statements should be aware of this election as it will cause differences between public company and private company reporting.

On January 16, the FASB issued its final standards for two accounting alternatives approved by its Private Company Council, or PCC. The first alternative provides private companies with an alternative accounting model for goodwill. The second alternative provides a simplified hedge accounting approach for qualifying interest rate swaps. The alternatives are effective for annual periods beginning after December 15, 2014, and early adoption is permitted.

In 2011, the PCC was created by FASB to improve the standard-setting process for private companies and determine whether and under what circumstances alternatives are warranted for private companies. According to FASB, “The PCC determines alternatives to existing nongovernmental U.S. GAAP to address the needs of users of private company financial statements, based on criteria mutually agreed upon by the PCC and the FASB. Before being incorporated into U.S. GAAP, PCC recommendations will be subject to a FASB endorsement process.

The PCC also serves as the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB’s technical agenda.”

Who Can Elect the Alternatives
Under the new guidance, any nonpublic entity is eligible to adopt the goodwill alternative. A nonpublic entity that is not a financial institution is eligible to adopt the simplified hedge accounting approach to certain interest rate swaps.

In the Accounting Standards Update (ASU) No. 2013-12, Definition of a Public Business Entity: An Addition to the Master Glossary, FASB updates the definition of a public business entity, or PBE.

The criteria for the definition of a PBE are for the most part the same as existing definitions in the Codification. However, some differences do exist, and thus, there may be limited cases in which entities previously considered nonpublic will qualify as PBEs. On the other hand, since a subsidiary of a public company is not automatically by extension a PBE under the ASU, there may be instances in which an entity previously viewed as public will not qualify as a PBE for purposes of its financial statements.

Goodwill Alternative
The goodwill alternative, Accounting for Goodwill Subsequent to a Business Combination, allows a private company to amortize goodwill over a period of 10 years, or less under certain circumstances, and to apply a simplified impairment model to goodwill. Once this election is made, it will need to be used for all transactions resulting in goodwill.

The main provisions of the goodwill alternative are as follows:

• Amortization of goodwill - A company can amortize goodwill over a period of 10 years,
or less than 10 years if the entity can show that another useful life is more appropriate. The amortization period will need to be determined  for each transaction resulting in goodwill.

• Frequency of impairment testing - An entity is required to test goodwill only when a
triggering event occurs, unlike the current rules, which mandate that goodwill must be
tested annually, or more frequently if impairment indicators exist.

• Method of impairment testing - The impairment test can be performed at either the
entity level or the reporting unit level.       

• Quantification of impairment – If an impairment test is required, the amount of
impairment would be measured by calculating the difference between the carrying
amount of the entity (or reporting unit) and its fair value. Step two of the impairment test
would no longer be required.  

Issues for Private Companies Planning to Go Public
Companies preparing to go public or that may consider going public in the future need to weigh whether electing one of the alternatives makes sense since FASB and the SEC have not provided any transition guidance. Without specific transition guidance, companies that become PBEs after using the alternatives would have to retrospectively apply the public entity requirements.

A public company that acquires or invests in a private company which has applied one or more private company accounting alternatives in its historical financial statements should be aware that when it includes the private company’s financial statements in a regulatory filing, the private company’s financial statements would also need to be retrospectively adjusted to unwind previously elected accounting alternatives.

Will Financial Statement Users Accept the Alternatives?
One of the concerns among those opposed to the PCC’s accounting alternatives is whether users of financial statements will accept statements that use the alternatives. Private companies often prepare financial statements in accordance with U.S. GAAP to satisfy the terms of their lending agreements.

In a comment letter to the FASB and the SEC, one of the nation’s largest banks expressed significant concerns about accounting alternatives for private companies. The bank said that financial statements of companies that are otherwise comparable will look different if the accounting alternatives are elected because of recognition and measurement differences between the alternatives and U.S. GAAP. The bank went on to say that this lack of comparability will increase its costs for performing credit and lending analyses and make its investment decisions more difficult. The PCC has acknowledged that stakeholders may not accept financial statements that use accounting alternatives for private companies.

Jane Myung, CFA, is senior vice president of Valuation Research Corporation, where she specializes in financial valuations, including valuations of business enterprises and intangible assets.

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