It would be understandable if leaders of some private companies have not had the time to consider adopting the private company GAAP alternatives created by FASB's Private Company Council (PCC). Implementation of new standards on revenue recognition and lease accounting has provided GAAP users with plenty to do over the past few years in addition to their regular workload.
The good news is that even though the four private company GAAP alternatives that have been created were issued in 2014, it's not too late to take advantage of the opportunities they provide to simplify private company accounting. In 2016, following the PCC's initiative, FASB eliminated the effective dates for the four private company GAAP alternatives, providing the opportunity for private companies to adopt these four alternatives at any time. The alternatives are:
- Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill.
- ASU No. 2014-03, Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps — Simplified Hedge Accounting Approach.
- ASU No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements.
- ASU No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination.
Each alternative may offer substantial relief and cost savings for private companies as they perform their accounting. Others may benefit, too. In December, the PCC proposed extending to not-for-profits the private company alternatives on accounting for goodwill and accounting for identifiable intangible assets in a business combination (see "News Digest: FASB Proposes Extending 2 GAAP Alternatives to Not-for-Profits," page 8). The comment period was still open when this issue of the JofA went to press.
The Financial Accounting Foundation created the PCC in 2012 in response to feedback from private company accounting personnel who were overwhelmed in their efforts to comply with rules that appeared to be made to keep investors informed on the complicated financials of public companies that had little in common with the GAAP statements that small private companies submitted to their banks in an effort to secure financing. Public companies are more able to afford large accounting staffs and sophisticated systems to apply complicated FASB rules to their financial statements; the same could not be said for all private companies, particularly those with modest operations and budgets.
The PCC employs a decision-making framework that considers the needs of private company financial statement users as it advises on both possible private company alternatives within GAAP and on impacts to private companies for those items under FASB's active consideration. As an advisory group, the PCC researches the benefits and potential consequences of providing private companies with modified pathways of applying GAAP. Private company stakeholders' perspectives on whether GAAP requirements are useful to them drive these alternatives within the context of the decision-making framework. The PCC provides FASB with ongoing advice for projects on the board's agenda, and FASB has worked with the PCC to issue the private company GAAP alternatives that can make accounting easier.
BUSINESS COMBINATIONS: GOODWILL (TOPIC 350)
The first private company alternative issued was a major change to accounting for goodwill (ASU 2014-02). Users of private company financial statements told the PCC that they generally ignore goodwill and its impairment when analyzing financial strength and operating performance. This led to a more simplified approach to impairment. Under private company treatment, rather than carrying goodwill on the books at its original value and testing it for impairment annually, private companies may elect to amortize goodwill on a straight-line basis over 10 years (or less, if the company demonstrates that another useful life is more appropriate).
Companies choosing this alternative need to test goodwill for impairment at either the entity level or the reporting-unit level when a triggering event occurs indicating the fair value of an entity (or a reporting unit) may be below its carrying amount. Triggering events are defined in FASB ASC Paragraph 350-20-35-3C and include events such as deteriorating economic conditions; changes in the market for a company's products or services; regulatory or political developments; increases in raw material, labor, or other costs; negative or declining cash flows; declining revenue or earnings (actual or planned); changes in relevant parties; or a sustained decrease in share price. Requiring a goodwill impairment test only when a triggering event occurs means that impairment testing may be done less frequently than annually.
With goodwill being amortized, the likelihood that impairment will be recognized decreases over the amortization period. Combined with the entity-level assessment of goodwill, this less-frequent testing should result in significant cost savings for private companies while not resulting in material information loss for users. Private companies adopting this alternative will show progressively less goodwill (through amortization expense) but are less likely to have impairment losses over time.
HEDGE ACCOUNTING (TOPIC 815)
This alternative simplifies hedge accounting for private companies, other than financial institutions (ASU 2014-03). Many private companies have difficulty in obtaining fixed-rate financing, but they are able to effectively convert their variable-rate financing to a fixed rate by entering into receive-variable/pay-fixed interest rate swaps. Topic 815 classifies swaps and other arrangements such as these as derivative instruments and permits the use of hedge accounting if certain requirements are met. Hedge accounting is generally considered the preferred accounting treatment, as gains or losses on the item being hedged (in this case, the original variable-rate debt) are offset by losses or gains on the hedging instrument (the receive-variable/pay-fixed interest rate swap). This reduces income statement volatility. Because the rules for hedge accounting can be difficult for companies with limited resources to apply, private companies might shy away from using hedging strategies to reduce risk, even when they do in fact qualify.
"The simplified hedge accounting approach provides private companies with a practical expedient," FASB Chairman Russell Golden, CPA, said in comments provided for this article. "It basically allows private companies to apply hedge accounting without undue cost and effort when they are trying to fix their interest rates." If certain conditions are met (specified in ASC Paragraph 815-20-25-131D), private companies can measure the swap at settlement value rather than fair value. Settlement values are easier to determine than fair values, so this alternative leads to much less cost and complexity in accounting for these swaps. Under the simplified hedge accounting approach, interest expense on the income statement is similar to the amount that would result if the private company had been able to obtain fixed-rate financing (instead of variable-rate financing and a receive-variable/pay-fixed interest rate swap).
VIEs UNDER COMMON CONTROL (TOPIC 810)
Another complex topic, variable-interest entities (VIEs), is the subject of this GAAP alternative for private companies (ASU 2014-07). "The inaugural PCC members identified VIE issues related to leasing arrangements as an important issue for private companies years ago," Candace Wright, CPA/CFF, the PCC chair and a director with Postlethwaite & Netterville, a Louisiana-based accounting and business advisory firm, said in comments provided for this article. One common example of a VIE is a separate company established for the purpose of owning a particular asset (e.g., real estate), and leasing that asset back to the private company. In many cases, the lessor VIE is under common control with the lessee private company, but the separate entity arrangement is done for tax, estate planning, or legal liability reasons, rather than to structure off-balance-sheet financing arrangements.
Although the guidance for VIEs often requires these particular lessor VIEs to be consolidated with the private company lessee, many users of private company financial statements commented that such consolidation is irrelevant to them; instead they needed supplemental information so that they could "back out" the VIE from the consolidated financial statements. The result is that private companies may incur significant costs to account for these VIEs in a manner that their financial statement users deem irrelevant.
The current private company alternative in ASU 2014-07 alleviates this cost/benefit imbalance by allowing private company lessees to avoid applying VIE guidance to (and thus to not consolidate) lessor entities under the following conditions: the private company lessee and the VIE lessor are under common control; a lease arrangement exists between the two entities; substantially all of the activity between the two entities is related to the lease; and any debt of the VIE lessor the private company lessee guarantees or provides collateral for cannot exceed the value of the leased asset at inception of the guarantee.
Instead of consolidating the VIE lessor, the private company lessee provides disclosures related to the risks that it faces with respect to the VIE. For example, disclosures may include the amounts and key terms of any VIE liabilities that the private company may be responsible for and a qualitative description of the circumstances in which the private company would have to provide financial support to the VIE. These disclosures would accompany disclosures required by other ASC topics (e.g., guarantees, leases, and related-party disclosures) and could be combined in a single note. Applying this alternative should increase the decision-usefulness of the private company financial statements for users, as they will no longer have to "de-consolidate" the VIE lessor from the consolidated financial statements.
In November 2018, FASB issued ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities, which extends this treatment to all VIEs under common control rather than limiting it to lease arrangements. Companies that elect the alternative must apply it to all current and future VIEs under common control that meet the qualifying criteria. ASU 2018-17 will supersede ASU 2014-07 and is effective for private companies for fiscal years beginning after Dec. 15, 2020, with early adoption permitted.
"Even though the original private company alternative addressed many stakeholders' concerns, current PCC members pointed out that there were many other arrangements outside of leasing that could still be improved," Wright said. "In the past few years, we have worked with the FASB to develop a new standard that improves VIE guidance for all qualifying common control arrangements. This new standard reduces costs without compromising the relevance of the financial reporting information. It is truly a win-win for preparers, auditors, and users of private company financial statements."
BUSINESS COMBINATIONS: ACQUIRED INTANGIBLE ASSETS (TOPIC 805)
This private company alternative (ASU 2014-18) affects the accounting for intangible assets that are acquired in a business combination, are part of an equity-method investee, or are part of adopting "fresh-start" accounting in a reorganization. In these situations, all identifiable intangible assets typically are separately recorded at fair value (as of the relevant date). However, feedback from private company stakeholders indicated the costs associated with separately identifying and valuing all intangible assets outside of goodwill often may exceed the benefits to be derived, specifically for: (1) customer-related intangible assets that are not capable of being sold or licensed separately from the rest of the business and (2) noncompetition agreements. Providing information about these particular intangible assets is often costly for private companies and not especially useful for their stakeholders, so the private company alternative allows those items to be included in goodwill. Companies that adopt this alternative are also required to amortize goodwill as described in the first private company alternative above (but the reverse is not true; private companies that choose to amortize goodwill are not required to also follow this alternative).
PCC's INFLUENCE ON GAAP FOR ALL
In addition to researching and making recommendations on private company alternatives for existing GAAP requirements, the PCC also advises FASB as new standards are promulgated. In some cases, FASB has chosen the "alternative" approach for all entities. This reduces reporting-related costs for all entities and lessens the big GAAP vs. little GAAP divergence. "The FASB tries very hard to maintain 'one GAAP,' but we must contend with the obvious legal and regulatory differences between public and private companies," Golden said. "We also have to be aware of the incredible diversity within a galaxy of private companies that includes the nation's largest private companies in contrast with your local coffee shop."
The PCC advisory role has fostered a culture of collaboration between FASB and the PCC, leading to improved financial reporting for private and public companies. For example, the PCC provided significant input and assistance on current FASB projects such as implementation costs incurred in a cloud computing arrangement, simplifying the balance sheet classification of debt, employee share-based compensation, and financial performance reporting. In each of these instances, PCC members have participated in (1) providing input during FASB discussion, (2) stakeholder outreach discussions, and (3) town hall-style presentations. "In addition to developing the private company alternatives, our work with the PCC has driven a significant shift in the FASB mindset," Golden said. "Once an afterthought, private company considerations are now an important part of the FASB's ongoing process. As part of every project, the FASB now considers whether a proposed change for private companies might also make sense for public companies and not-for-profit organizations — so it's really making financial reporting better for all."
VOICE YOUR OPINIONS
As FASB and the PCC research and collect input for GAAP alternatives to be available to private (or perhaps all) companies, private companies and their financial statement users are encouraged to participate in the process. "Actionable advice doesn't solely come from PCC members," said Wright. "Private company stakeholders also provide valuable insights through Private Company Town Halls and submitted comments. While FASB and the PCC welcome input from all types of stakeholders, we are especially eager to receive more input from users of private company financial statements." FASB proposals that are open for public comment are available on the board's website at fasb.org; the board's technical agenda is available at fasb.org.
FASB members participate in all PCC meetings to facilitate their understanding of the private company issues the PCC discusses. After FASB approves the PCC's exploration of an alternative GAAP application, the PCC issues an exposure draft of the proposed alternatives and receives comments. If the PCC gives a final affirmative vote, FASB considers it. Alternatives only become standards when FASB votes to endorse them. You can email the PCC feedback or input on issues that affect you as a private company user, preparer, or auditor at comments@privatecompanycouncil.org.
As the PCC and FASB move forward creating standards for all GAAP users, the comments they receive from the public can help shape the accounting of the future.
About the authors
Terri L. Herron, CPA, Ph.D., is a professor of accounting and the director of the Master of Accountancy program at the University of Montana. Joshua Herbold, CPA, Ph.D., is an associate professor of accounting and chair of the Accounting & Finance department at the University of Montana. Private Company Council member Rick Reisig, CPA, a shareholder with Anderson ZurMuehlen, contributed to this article.
To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA's editorial director, at Kenneth.Tysiac@aicpa-cima.com or 919-402-2112.
AICPA resources
Articles
- "FASB Proposes Extending 2 GAAP Alternatives to Not-for-Profits," JofA, Dec. 20, 2018
- "FASB Expands Private Company Consolidation Relief," JofA, Oct. 31, 2018
- "Private Company Accounting Following a New Path," JofA, Sept. 1, 2017
- "FASB Eliminates Effective Dates for Private Company Alternatives," JofA, March 7, 2016
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- U.S. GAAP: Review for Business & Industry (#163974, online access)
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