Mark L. Zyla
Are you up to speed on FASB’s business combination and goodwill proposals?

Exposure drafts would change the way private companies account for intangible assets.

September 3, 2013
By Mark L. Zyla, CPA/ABV

FASB recently issued exposure drafts of Accounting Standards Updates (ASUs) containing proposals designed to reduce the cost and complexity of accounting for intangible assets acquired by private companies and the subsequent testing of goodwill for impairment.

The EDs propose changes to Accounting Standards Codification (ASC) Topic 805, Business Combinations, and ASC Topic 350, Intangibles—Goodwill and Other, solely for private companies. The EDs were originally proposed by the Private Company Council (PCC), an advisory group to FASB formed in 2012 to improve the process of standard setting for private companies.

The proposed ASUs for intangible assets acquired as part of a business combination and the subsequent testing of goodwill for impairment were made in response to constituents’ concerns about the cost and complexity of complying with current accounting standards. In addition, many constituents believe that users of private company financial statements disregard goodwill and goodwill impairment losses when evaluating a company’s financial condition and operating performance. Furthermore, they felt that the relevance of separately recognized intangible assets diminishes in periods after the business combination, as the carrying amounts no longer reflect fair value. The upshot is that many constituents doubt the current standards produce decision-useful information.

Topic 805 proposals

The proposed changes to Topic 805 address the initial recognition of intangible assets acquired in a business combination. Under current accounting, an intangible asset is recognized as “identifiable” in a business combination if it meets one of two criteria: (1) It is separable, that is, it is capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so; or (2) it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

Under one proposed change to Topic 805, a private company involved in a business combination could elect to recognize (but would not be required to do so) only those acquired intangible assets that arise from contractual rights with noncancelable terms or that arise from other legal rights. In making the election, a private company would not recognize intangible assets that previously arose solely from the “transferable” or “separable” criteria recognition.

Also, the fair value measurement of contractual or legal intangible assets would consider only the remaining noncancelable terms without regard to renewals or cancellations. The proposed alternative accounting treatment for private companies would generally result in the recognition of fewer intangible assets. Because goodwill is a residual amount, a reduction in the recognition of intangible assets would also likely increase the value of goodwill.

Numerous types of intangible assets would still likely be recognized by a private company in a business combination if it made the election proposed under the ED. These include assets that are either licensed or registered, such as trademarks, trade names, domain names, patented technology, software, and certain trade secrets.

Other assets that would likely still be recognized include customer contracts, order backlog, licensing agreements, and other contracts such as noncompete agreements, supply contracts, management contracts, and “use” rights. Intangible assets that are likely to be recognized under current accounting but perhaps not recognized under the proposals in the ED include such assets as customer relationships and lists; research and development and other unpatented technology; and unregistered trade names.

Topic 350 proposals

The proposed changes to Topic 350 address the subsequent accounting for goodwill recognized through a business combination. The Proposed ASU would apply to all existing goodwill and to all new goodwill generated in business combinations if elected by a private company.

Under the proposal, goodwill would be amortized over the useful life of the entity’s primary long-lived asset, not to exceed 10 years. Impairment testing would not be required unless a triggering event indicates the fair value of an entity may be below its carrying value. Any impairment testing would no longer be done at the reporting unit level, but at the entitywide level. If goodwill impairment is indicated, the amount of the impairment loss would be equal to the entity’s carrying value less its fair value. Current accounting under Topic 350 requires a two-step calculation of the impairment loss using a hypothetical purchase price allocation that would no longer be required for private companies.

These proposals provide an alternative accounting treatment for the fair value measurement of acquired intangible assets by a private company in a business combination. The proposed alternative may simplify the financial reporting, and be less costly to certain private companies making acquisitions. However, there is no requirement for the private company to elect the alternative treatment.

Many private companies may choose to forgo the alternative accounting. In any event, the number of intangible assets recognized in a business combination by a private company may be smaller, but they certainly are not eliminated.

The proposed changes to Topic 805 and Topic 350 would be alternatives available only to private companies, although FASB is leaving open the possibility of discussing similar application to public companies.

The proposed accounting treatments would be applied prospectively to business combinations and new and existing goodwill as of a yet unspecified effective date. Early adoption of the Topic 805 proposals will likely be permitted. Constituent comments were due Aug. 23. The impact of these proposals will be one of the many topics of the AICPA’s Fair Value Measurements Workshop, which will be held in New York City, Sept. 26–27.

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Mark L. Zyla, CPA/ABV, CFA, ASA, is a managing director of Acuitas Inc., an Atlanta-based valuation and litigation consultancy firm.