In 2014, the Financial Accounting Standards Board (FASB) began issuing accounting standards updates (ASUs) to simplify accounting standards for private companies in a wide variety of industries.
The Private Company Council (PCC) was established in 2012 to improve the process of setting accounting standards for private companies.
To support this aim, the PCC works with the FASB to identify where in the US generally acceptable accounting principles (GAAP) the cost and complexity of application can be reduced without diminishing the usability of the financial information available to the users of financial statements. The FASB then issues ASUs to establish simplified accounting standards for private companies.
Select Accounting Alternatives
The accounting alternatives for private companies can reduce the costs and complexity of complying with requirements in the areas of accounting for:
- Identifiable assets acquired in a business combination. Private companies don’t have to separately recognize and measure certain intangible assets—those assets instead are included in goodwill. This alternative also requires the company adopt the goodwill alternative below.
- Goodwill. Goodwill is amortized over a period not to exceed 10 years and the previously required annual impairment assessment is now a trigger-based impairment assessment. Private companies can also elect to perform impairment tests on a company-wide basis as opposed to a reporting-unit basis, with the loss measured in a one-step process as opposed to the historic two-step process.
- Interest rate swaps. It’s now easier to apply cash-flow hedge accounting to certain interest-rate swap agreements that are frequently used to achieve the economics of converting variable-rate debt to fixed-rate borrowings, as long as certain conditions are met.
- Variable interest entities. Exceptions to the variable interest entity guidance now exist for certain common control leasing entities. Specifically, the burden to evaluate the impact of the variable-interest entity guidance to qualifying commonly controlled leasing entities has been lifted as long as certain conditions are met, which is especially useful for owners of food processors and agribusinesses that often set up entities for the sole purpose of leasing property back to the operating entity.
The adoption of these accounting alternatives is optional for private companies, allowing them to continue following existing GAAP where desired. These companies can also elect to apply alternatives on a case-by-case basis—adopting the accounting alternative for variable interest entities and continuing to follow existing GAAP for interest rate swaps, for example. However, the adoption of the goodwill alternative is required if the company adopts the identifiable assets acquired in a business-combination accounting alternative.
Private companies in the process of deciding whether to adopt one or more of the accounting alternatives will want to evaluate the following:
- Present eligibility and future plans
- Needs of financial statements users
- Impact on key financial metrics and debt covenants compliance
Present Eligibility and Future Plans
A private company first needs to determine if it’s eligible to adopt a desired accounting alternative or alternatives under the FASB’s definition of a public business entity, which extends beyond registrants of the US Security and Exchange Commission.
It’s also important to evaluate the company’s strategic goals and future plans. If a company becomes public via an initial public offering, also known as an IPO, it’s required to unwind any accounting alternatives—a costly task that could negate any savings from prior adoption of the accounting alternatives.
Needs of Financial Statement Users
If an eligible private company’s financial statement users include a private equity owner that’s contemplating an IPO, then adoption of the accounting alternatives may be objected to by the owner due to the potential cost of unwinding.
Additionally, a public company that’s an equity method investor in an eligible private company is required to unwind the impact of the accounting alternatives while determining its share of loss or income and other financial statement presentation and disclosures applicable to its investment in the private company.
Key Financial Metrics and Debt Covenants Compliance
An eligible company can benefit from working with its lender to evaluate whether the adoption of one or more accounting alternatives will impact debt covenants compliance, and if so, whether modifications are necessary.
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For more information on how adopting simplified accounting standards could benefit your private company, contact your Moss Adams professional.