What Businesses Must Understand About Recent Changes
Has Little GAAP Emerged?
By Kristi Reale, CPA, CVA
Should privately held businesses be held to the same financial-reporting standards and requirements as publicly traded companies?
For many decades, small, privately held companies have been faced with accounting challenges when attempting to meet the standards set by the Generally Accepted Accounting Requirements (GAAP). The standards set by GAAP are largely influenced by the requirements of those who use the financial reports of publicly traded companies, such as the SEC. However, these standards are often financially burdensome on smaller organizations and often have no significant impact on their financial position or reporting. This has sparked lobbying for the standards of GAAP to be adjusted so that standards for privately held companies (‘Little GAAP’) are less rigorous and more reasonable than those necessary to satisfy the needs of publicly traded companies (‘Big GAAP’).
The call for change was answered, at least in part, when the Financial Accounting Standards Board (FASB), a group responsible for setting financial reporting standards in the U.S., established its Private Company Council (PCC) in 2012 to improve the process of setting accounting standards specifically for private companies. The PCC reviews and proposes alternatives within GAAP to address the needs of users of private-company financial statements.
In 2014, the FASB launched a simplification initiative aimed at reducing the complexity and costs associated with financial reporting while improving the usefulness of the information reported to investors and other third parties. Some of those changes are listed below and may have an impact on the way your organization meets its reporting standards.These changes are technical, and it is suggested that you speak with your accounting professional to determine if these changes apply to your organization:
The following Accounting Standards Updates (ASUs) are a result of the establishment of the PCC and their simplification initiative. I have detailed many of the technical implications of these updates below, but also included the salient implications to your business. Whether or not you have a formal accounting background, it is important to educate yourself on the applicable changes, as they may have an impact on your business reporting.
ASU 2014-02 — Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill (a Consensus of the PCC)
ASU 2014-02 is available to private, for-profit companies and allows an accounting alternative to amortize goodwill on a straight-line basis over 10 years or less if a lesser time is deemed appropriate. Goodwill is the value of intangible assets such as brand-name recognition or patents, and has historically been tested for impairment.
Impairment testing, which measures whether a balance-sheet item is worth the amount stated on the balance sheet, is performed if a triggering event occurs that indicates the carrying value of goodwill may exceed its fair value. This new update is an important change (and simplification) to this process, as it allows a company to write off the value of its goodwill. This ASU applies to new and existing goodwill on the books.
It is important to note that electing the ASU to amortize goodwill does not eliminate impairment testing.
ASU 2014-07 — Consolidations (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements (a Consensus of the PCC)
This ASU is available to private, for-profit companies effective for annual periods beginning after Dec. 31, 2014 and effects the variable-interest entity (VIE) consolidation guidance, which historically required companies to create a consolidated financial statement when certain requirements were met. One common example exists when a business owner owns both an operating entity and real-estate entity. When the operating entity rents from the real-estate company, they would be required to consolidate their financial statements.
The ASU permits the private-company lessee (reporting entity) to not apply the variable-interest entity consolidation guidance to a lessor if all of the following conditions are met:
• The lessee and the lessor are under common control;
• There must be a substantial leasing arrangement between the entities;
• Substantially all of the activity between reporting entity and VIE is related to leasing; and
• Any obligations of the lessor are guaranteed or collateralized by the lessee.
Disclosure requirements consist of all required GAAP disclosures for leases, related parties, and guarantees.
It is important to note that this ASU is an accounting-policy election and must be applied by the private-company lessee to all current and future lessor entities that meet the requirements for applying this approach in the future.
ASU 2014-18 — Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (a Consensus of the PCC)
This ASU provides an alternative to reduce the cost and complexity of identifying intangible assets in a business combination. If this ASU is elected, customer-related intangibles such as customer lists and commodity supply contracts or non-compete agreements would not be recognized separately, but rather become part of goodwill. Applying this ASU and combining other intangibles with goodwill can eliminate a bargain purchase situation (negative goodwill.)
If this ASU is elected, the reporting entity must elect ASU 2014-02 (the first ASU mentioned in this article) to amortize goodwill over 10 years. Disclosure requirements for intangible assets acquired in a business combination have not changed. If elected, it is applied prospectively. No previous intangibles on the books may be reclassified to goodwill.
ASU 2015-01 — Income Statement — Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items (Simplification Initiative)
This ASU is effective for periods beginning on or after Dec. 31, 2015 and eliminates the concept of extraordinary items (example: earthquakes in Western Mass.) The term ‘extraordinary item’ has been changed to ‘unusual or infrequently occurring’ items.
Reporting requirements for items that are unusual, infrequent, or both are as a separate component of income from continuing operations (‘above the line’). This supports a trend of reporting most items of income and expense as part of an entity’s results from operations. Also, the nature and financial effects of each event or transaction are shown on the income statement or disclosed in the notes to the financial statements.
ASU 2015-11 — Inventory (Topic 330): Simplifying the Measurement of Inventory (Simplification Initiative)
This ASU is effective for periods beginning on or after Dec. 31, 2016 and does not apply to entities using the LIFO (last in, first out) or retail method to measure inventory. ASU applies to FIFO (first-in, first-out) or average cost inventory measurement.
This ASU states that an entity should measure its inventory at the lower of cost or net realizable value (formerly of market). Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
When evidence exists that the net realizable value of inventory is lower than its costs, the difference should be recognized as a loss in the earnings period in which it occurs.
ASU 2015-03 & 2015-15 — Interest; Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (Simplification Initiative)
The objective of this ASU was to simplify the presentation of costs incurred upon the issuance of debt. For example, when a business takes out a loan (debt), there are often loan-acquisition costs and other expenses (debt issuance costs), which are pre-paid at the beginning of the loan and are historically identified as assets on the books and amortized over the life of the loan as an expense. Confusion often arose among readers of financial statements when the debt-issuance costs were reported as an asset. Therefore, this ASU states that debt-issuance costs should be presented as a direct deduction from the carrying amount of the related debt liability. This requires debt-issuance costs to be changed from an asset to a contra-liability. The recognition and measurement of these costs has not changed.
This ASU is available to private companies for periods beginning on or after Dec. 15, 2016. Early application is permitted, and retrospective application is required.
ASU 2015-17 — Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (Simplification Initiative)
Previous GAAP presentation required entities to separate deferred-income tax asset and liabilities in current (short-term, within a year) and non-current (more than a year) amounts on the balance sheet. This ASU changes the GAAP presentation to require deferred-income tax assets and liabilities to be classified as non-current (long-term) on the balance sheet. The ASU does not change the requirement that deferred assets and liabilities be presented as a single amount, and income tax disclosures are not changed.
This ASU is effective for periods beginning on or after Dec. 31, 2017; early application is permitted as well as retrospective application to all prior periods presented. In the first year of change, financial statements should disclose the nature and reason for changes and effects on prior periods.
It appears that the FASB is finally trying to simplify the reporting requirements for private businesses. The above was just a sample of some of the ASUs that were released as part of this initiative. By staying informed, you can plan ahead and take advantage of these options for your business.
Prior to making any financial-statement decisions or accounting elections, you should consult your financial expert or a certified public accountant.