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Goodwill Amortization: A Taste of 'Little GAAP'

Posted on Mon, Feb 10, 2014

After years of listening to complaints from private firms and their auditors that certain accounting rules were too costly and complex, the Financial Accounting Standards Board (FASB) has finally taken action. On January 16, the FASB simplified one of the accounting rules private firms most loved to hate: FASB Accounting Standards Codification Topic 350, Intangibles - Goodwill and Other.

Accounting for Swaps

Some private firms couldn't qualify for low-rate fixed loans after the recession. Instead, they turned to interest rate swaps to economically convert variable rate loans into fixed rate loans. But they discovered that accounting for interest rate swaps (considered derivatives under GAAP) was confusing and costly.

Old Rules: FASB Accounting Standards Codification Topic 815, Derivatives and Hedging, requires companies to recognize interest rate swaps on the balance sheet as either assets or liabilities and measure them at fair value.

Although GAAP permits hedge accounting under certain conditions, private firms often lack the expertise to elect the simplified method. This resulted in significant earnings fluctuations (and headaches) for private firms.

Simpler Alternative: Now the FASB offers a simplified hedge accounting approach for private firms (except financial institutions) that enter into qualifying interest rate swaps. Under the amended standard, a private company that uses a "plain-vanilla" interest rate swap when borrowing money may qualify for hedge accounting that treats the swap and loan as separate financial instruments.

Essentially, interest expense under the simplified hedge accounting approach is similar to the amount that would result if the entity had directly entered into a fixed-rate loan. On the balance sheet, the company also can measure the swap at settlement value, as opposed to fair value, which is harder to calculate.

This update reduces compliance costs and income statement volatility. Private firms can elect to apply the simplified hedge accounting approach on a swap-by-swap basis to new or existing swaps that qualify.

Like the goodwill standard, this change is effective for most firms after December 15, 2014, but early adoption is allowed.

What Is Goodwill?

Goodwill shows up on a company's balance sheet after a merger or an acquisition. It's what is left over after the company allocates the purchase price to tangible and identifiable intangible assets acquired and liabilities assumed.

Generally accepted accounting principles (GAAP) requires goodwill to be tested for impairment at least annually, or more frequently if certain conditions exist. If impairment occurs, the company must reduce the carrying value of goodwill on its balance sheet and report an impairment loss on its income statement.

The FASB's Change of Heart

When deciding whether to simplify the rules for private firms that report goodwill, the FASB solicited feedback from business owners, auditors, lenders and creditors. They discovered that many financial statement end-users disregard goodwill and impairment losses in their evaluations of private companies' financial condition and operating performance.

Because the existing rules provide only limited value to private company stakeholders, the FASB decided to bend them prospectively for any new and existing goodwill. Under the updated standard, private companies can elect to amortize goodwill on a straight-line basis over 10 years (or less if the firm can demonstrate that a shorter useful life is more appropriate). Amortization reduces the likelihood of impairment, because it's already being written off the books over ten years (or fewer).

Triggering Events

Instead of testing for impairment every year, private companies only need to test when a "triggering event" occurs. Examples include:

  • A significant adverse change in legal factors or the business climate;
  • An adverse action or assessment by a regulator,
  • Unanticipated competition;
  • A loss of key personnel;
  • A more-likely-than-not expectation that the business (or a large segment) will be sold or otherwise disposed;
  • Recoverability testing of a significant long-lived asset group; and
  • Recognition of a goodwill impairment loss for a subsidiary.

If a triggering event causes the fair value of the acquired business to fall below its carrying value, the private company will incur an impairment loss. This represents a major simplification.

Private firms are no longer expected to reallocate fair value to all the acquired business's assets and liabilities, a process that's similar to repeating the purchase price allocation the firm used when the businesses originally combined.

The amended standard gives private companies the option to measure impairment at the entity level. So, if an acquired division underperforms but the entity does well overall, the company might not need to record goodwill impairment.

In light of the simplified standard for private firms, the FASB added the subsequent accounting for goodwill for public companies and not-for-profit organizations to its agenda. So, broader changes could be in the pipeline eventually.

How Soon Can You Apply the New Rule?

FASB Accounting Standard Update 2014-02 officially goes into effect for annual periods beginning after December 15, 2014, and interim periods beginning after December 15, 2015. But early adoption is permitted. So contact an EHTC Accountant as soon as possible to take advantage of the reduced compliance costs when reporting new and existing goodwill.

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Tags: Audit, EHTC Article, CPA Firm, Echelbarger, Financial Accounting Standards Board, Goodwill, New Rule