Accounting for Business Combinations: Streamlined Standards for Private Companies

Private companies and nonprofits have some options for relief from costly accounting standards. You should make sure your organization is taking advantage of these options if they are appropriate for your business now and in the future.

In December 2014, FASB (Financial Accounting Standards Board) passed ASU 2014-18 – Business Combinations, which allowed private companies to elect an accounting alternative to the traditional GAAP (generally accepted accounting principles) standards pertaining to business combinations. The accounting alternative provides relief from burdensome and costly requirements for private companies that otherwise must prepare financial statements in accordance with GAAP. In May 2019, FASB passed ASU 2019-06, which extended the business combination accounting alternative to nonprofit entities as well.

Private company executives had long contended that the accounting standards for identifiable intangible assets acquired in a business combination may not justify the related costs. The accounting alternative reduces the cost and complexity associated with measuring certain identifiable intangible assets without significantly diminishing decision-useful information for users of private company financial statements.

Business Combinations Using Traditional GAAP Standards

Prior to the ASU 2014-18 alternative, a private company acquirer was required to work within the confines of GAAP (i.e., ASC 805: Business Combinations). Under ASC 805, private companies were required to recognize most of the assets acquired and liabilities assumed – including all intangible assets that are identifiable – that they acquired in the business combination at their acquisition-date fair value.

An intangible asset is deemed identifiable if it meets either of the following criteria:

• 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.
• It is separable – that 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.

It should be noted that most acquired customer-related assets would meet at least one of the two aforementioned criteria.

Overview of ASU 2014-18 – Business Combinations

Under ASU 2014-18, entities that choose the private company accounting alternative no longer recognize separately from goodwill (1) customer-related assets (unless they are capable of being sold or licensed independently from the other assets of the business) or (2) noncompetition agreements. In other words, most, if not all, customer-related assets and noncompetition agreements are subsumed into goodwill under the accounting alternative.

Entities that use the private company accounting alternative must also adopt the private company alternative to amortize goodwill (ASU 2014-02). However, entities that have elected to take the ASU 2014-02 alternative to amortize goodwill do not necessarily have to adopt the ASU 2014-18 accounting alternative.

Customer-Related Assets under ASU 2014-18

FASB has indicated that customer-related assets “generally are not transferable or separable from the entity … because their values depend on too many variables that may be overly subjective.” Consequently, if a private company elects the ASU 2014-18 accounting alternative, many of its customer-related assets will not have to be identified and valued separately but instead will be subsumed into goodwill. Even customer-related assets that arise from contractual or other legal rights do not have to be identified and valued separately if they are not capable of being sold or licensed separately.

While most customer-related assets will not meet the accounting alternative’s criterion for recognition, a private company must still analyze each of its customer-related assets (e.g., its customer backlog) to determine whether it can be separately sold or licensed.

Examples of customer-related assets that might be capable of being sold or licensed independently from other assets of a business include (1) mortgage serving rights, (2) commodity supply contracts, (3) core deposits, and (4) customer information (e.g., names and contact information).

Noncompetition Agreements under ASU 2014-18

FASB has indicated that although noncompetition agreements are important in a business combination, the fair values of such agreements are not “decision useful.” In addition, FASB noted that noncompetition agreements are “among the most subjective and difficult intangible assets to measure and that their value is disregarded by many users.” Accordingly, under the private company alternative, noncompetition agreements are subsumed into goodwill.

Who Can Elect the Business Combinations Accounting Alternative?

Neither publicly traded companies nor certain employee benefit plans are eligible to elect the ASU 2014-18 accounting alternative. But private companies and nonprofit entities of all types can realize the many benefits of choosing this option.

What Should I Consider Before Electing the Business Combinations Accounting Alternative?

Even if your company has the option to exercise the accounting alternative, that doesn’t necessarily mean it should do so. You must carefully consider your company’s future plans to determine which method is appropriate for your specific situation.

For example, if your private company operating under the accounting alternative decides to go public or is acquired by a public company, then its financial statements must be retrospectively adjusted to conform to GAAP. Amending your past financial statements to meet GAAP standards could be complex and expensive. So if there is a reasonable possibility your company will go public or be acquired by a public company, then electing ASU 2014-18 may not be the right decision for your company.

Regardless of what may or may not happen in the future, you should communicate with your company’s various stakeholders before using the business combinations alternative, to make sure this path is acceptable to them. Equity investors, lenders, regulators, and so forth may not accept financial statements that use the alternative.

Another consequence to keep in mind is that once your company elects to take the private company alternative for a business combination, you must also elect the alternative for goodwill amortization (ASU 2014-02). Similarly, if your company elects to take the private company alternative for a business combination, then you must subsequently apply the alternative to all future business combinations. In other words, you cannot pick and choose which acquisitions to apply the election to.

What Are the Advantages of Electing the Business Combinations Accounting Alternative?

If the private company alternative is right for your business, the cost savings could be considerable. Your organization may spend far less on a purchase price allocation because fewer assets will have to be identified and valued separately. Furthermore, you may enjoy additional benefits later on. That’s because entities that elect the private company alternative eliminate the possibility of future impairment testing on customer-related assets and noncompetition agreements.