[IMGCAP(1)]Last December, based on a recommendation from the Private Company Council, the Financial Accounting Standards Board issued a notable accounting standards update for intangible assets in business combinations.
Update No. 2014-18, Business Combinations (Topic 805), “Accounting for Identifiable Intangible Assets in a Business Combination,” provides an accounting alternative that reduces the cost and complexity associated with the measurement of certain identifiable assets, without significantly diminishing decision-useful information for users of private company financial statements.
The update applies to private companies, excluding public companies and not-for-profit entities.
Proper accounting treatment of acquisitions under business combinations (Topic 805) requires that tangible and intangible identifiable assets be recorded at their acquisition date fair value. The fair value of the identifiable intangible assets is required to be determined based on valuation techniques that calculate values for customer relationships, trademarks, non-compete agreements, patents, technology, trade names and other identifiable intangible assets.
The valuation techniques are complicated. Often a company has to engage the services of a professional valuation firm to estimate the proper fair value of each of the identified intangible assets. After allocating the purchase price to the fair value of all tangible and identified intangible assets acquired, any remaining balance would generally be recorded as goodwill.
The update permits a private company to elect to treat the customer relationship and non-compete agreement as goodwill and, thus, eliminate the complex calculations to determine their fair value. For customer relationships to qualify, they must not be capable of being sold or licensed independently from the other assets acquired, even if the buyer does not intend to sell them.
Examples of customer-related intangible assets that may meet the criteria for separate recognition as stated in the update include, but are not limited to, mortgage-servicing rights, commodity supply contracts and customer information. These items tend to be contract-related and represent relationships and information that can be sold to third parties without input from the customer or their agreement to the transfer. If the transfer of a customer relationship is dependent on the decision of a customer, it would be clear that a reporting entity is not capable of selling that customer-related intangible asset separately from the other assets of the business.
Consider a business that is acquired for $1,000,000 and the identified assets include equipment and inventory with appraised fair values of $200,000 and $300,000, respectively; customer relationships (that don’t meet the criteria for separate recognition); and a non-compete agreement. The customer relationships and non-compete agreement could be included in the $500,000 balance to be recorded as goodwill. There may be no need for valuation techniques to be applied.
Special Requirements and Results
The PCC attached certain requirements to this election that must be considered as follows:
1. Once this accounting alternative is elected, all future acquisitions will require this treatment along with items 2 and 3 below.
2. The entity must adopt the private company alternative to amortize goodwill over 10 years per FASB Accounting Standards Update No. 2014-02, Intangibles Goodwill and other (Topic 350): Accounting for Goodwill, codified in Subsections of Topic 350-20 of the FASB Accounting Standards Codification.
3. Existing goodwill must now be amortized over 10 years or its estimated useful life, if shorter.
The results of this alternative should reduce costs that a company would be required to incur to value customer relationships, in-place workforce (needed to value customer relationships), and non-compete agreements. Companies acquired with only customer relationships and non-compete agreements as their identifiable intangible assets will still need a determination of the fair value of the entire acquisition, in order to properly account for potential bargain purchase gains or overpayment losses. In many valuation reports, the arm’s length purchase price is deemed to be the fair value of the acquisition. The calculation of the discounted cash flows is also generally constructed to support this value.
The alternative can be elected to the first qualifying transaction. The PCC set an effective date of fiscal years beginning after Dec. 15, 2015, but allowed early adoption. The alternative is available for interim and annual financial statements not issued as of the December 2014 publication of the alternative, which includes Dec. 31, 2014 year ends even if the transaction occurred before the issuance of the update.
The PCC created this accounting alternative to try to assist small companies in saving money on valuation costs for business acquisitions. Companies need to evaluate the requirements when they consider this alternative to see if it is right for them.
James M. Sausmer, CPA/ABV, CVA, is a partner with WeiserMazars LLP in their Edison, N.J., office.
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