In January 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that provides private companies with an alternate method of reporting goodwill under Generally Accepted Accounting Principles (GAAP). Adopting FASB’s standard could reduce the cost and complexity of preparing financial statements for private companies following business combinations. However, this alternate method may prove troublesome if your business is subsequently acquired by a public company and the event triggers revised accounting rules.

Goodwill is a non-physical asset that represents the additional “value” the buyer receives for the acquired company’s brand, customers, reputation, employees or anything else of indeterminable value not listed as a transferring asset in the agreement.

Simpler method

When a company’s sale price exceeds the fair value of its assets and liabilities, the buyer records goodwill on its balance sheet. According to ASU 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, private companies can now elect to write down goodwill over a 10-year period (amortize) — sometimes over a shorter period if circumstances warrant. This means that over the course of, say 10-years, the value of the goodwill asset could decrease to $0.

By contrast, public companies must run annual impairment tests to determine whether the carrying value of goodwill exceeds its current “fair value.” If so, the company must reduce the carrying value of goodwill on the balance sheet and report an impairment loss on the income statement.

Regardless of whether a company is public or private, all businesses must test for goodwill impairment if a triggering event — such as the loss of a key person or an unexpected increase in competition — occurs. With impairment, if nothing unexpected occurs to warrant the decrease in value, the original value of the goodwill could remain on the books until the business ceases.

Worst-case scenario

Electing this alternate reporting method may appeal to private businesses hoping to save time and money. However, if a private business is acquired by a company that’s required to include its acquisition’s historical financials in a new SEC filing, the accounting can get complicated.

Under current rules, a public buyer has to revise all of the acquired private company’s previous goodwill amortization, which could require a major accounting expenditure. So if you adopt the new accounting standard, it might make your private business less attractive to certain public company buyers.

Hard decision

FASB currently doesn’t offer a transition plan for private businesses that adopt the new accounting standard and are subsequently purchased by public companies. However, many analysts expect that FASB will extend the alternate reporting method for goodwill to public companies (as well as nonprofits) in the future.

If you’re considering selling your private business, discuss with CJA the benefits of adopting the alternate reporting method for goodwill against the potential headaches of retroactively undoing it.

This information is, in part, © 2014 TRTA