FASB Issues New Standards to Simplify Private Company Accounting for Goodwill and Interest Rate Swaps in Certain InstancesJanuary 27, 2014
Marcus R. Harwood, CPA
On January 16, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Updates 2014-2 Intangibles – Goodwill and Other: Accounting for Goodwill (a consensus of the Private Company Council) and ASU 2014-3 Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps—Simplified Hedge Accounting Approach (a consensus of the Private Company Council). These new standards will allow private companies simplified alternatives to existing accounting principles for goodwill and certain receive-variable, pay-fixed interest rate swaps.
Private companies can elect to adopt the new standards but they are also permitted to continue following existing GAAP. Public companies and non-profit entities are not permitted to apply the new standards. The new standards are effective for fiscal years beginning after December 15, 2014, but early adoption is permitted and private companies may want to consider adopting the standards for fiscal year 2013.
ASU 2014-2—Goodwill can be amortized rather than tested for impairment annually
Under existing accounting standards, goodwill is not amortized but is instead tested for impairment at the reporting unit level both annually and whenever an event occurs that might cause an impairment of the asset. The alternative accounting method for goodwill permits private companies to elect to amortize goodwill on a straight-line basis over ten years or a shorter period if management concludes that another useful life is more appropriate.
Private companies that elect to amortize goodwill would no longer be required to perform annual goodwill impairment tests. In many cases, companies will prefer this option because the impairment test requires a valuation of the reporting unit on an annual basis which is often costly or time consuming.
An impairment test of goodwill would still be required if an event occurs or circumstances change that indicate that the fair value of the entity may be below its carrying amount; a triggering event. Upon the occurrence of a triggering event, the required impairment test would be performed under a simplified approach by companies that adopt the alternative accounting method. The two-step goodwill impairment test required in other circumstances is replaced with a one-step test. In the one-step test, the company estimates the fair value of the entity and compares the fair value with its carrying amount including goodwill. A goodwill impairment charge is recognized for the excess of the carrying amount of the entity over its fair value. The hypothetical purchase price allocation required in the two-step goodwill impairment test is not necessary in the one-step test.
ASU 2014-2 is effective for fiscal years beginning after December 15, 2014 but early adoption is permitted. A private company that elects to adopt the new standard will do so prospectively, and start amortizing existing goodwill over its remaining life as of the beginning of the period of adoption.
ASU 2014-3 - Simplified Hedge Accounting Approach
Existing accounting standards require that derivative instruments be recorded as an asset or liability at fair value on a company’s balance sheet with changes in the fair value of an entity’s derivatives included in net income. If a derivative qualifies for hedge accounting, changes in fair value can be reported in other comprehensive income, rather than net income. Unfortunately, the existing requirements to qualify for hedge accounting are difficult to meet.
The FASB has made a simplified hedge accounting approach available to private companies as an alternative to the existing rules. Companies that elect to adopt the simplified hedge accounting approach can assume no hedge ineffectiveness for receive-variable, pay-fixed interest rate swaps that hedge the cash flows of a variable rate borrowing if certain conditions are met. Under the simplified hedge accounting approach, the swap is recorded as an asset or liability at either its settlement amount or its fair value. Changes in the carrying amount of the swap are reported in other comprehensive income until settlement occurs.
Receive-variable, pay-fixed interest rate swaps held by private companies qualify for the simplified hedge accounting approach when all of the following criteria are met:
- The variable rate on the swap and the related debt are based on the same index or interest rate benchmark.
- The terms of the swap do not include a floor or cap on the variable interest rate unless the borrowing has a comparable floor or cap.
- The repricing and settlement dates for the swap and the borrowing match or differ by only a few days.
- The swap’s fair value at inception is at or near zero.
- The notional amount of the swap is equal to or less than the principal amount of the borrowing.
- The term of the swap is equal to or less than the term of the borrowing.
Under the simplified hedge accounting approach, the reporting entity is still required to document the hedging relationship and the risk management objective and strategy for undertaking the hedge. However, the documentation can be prepared at any time prior to the issuance of the company’s financial statements and need not be prepared at the inception of the hedge.
The new standard is effective for financial statements for periods beginning after December 15, 2014 but early adoption is permitted. A company can elect to adopt the alternative on a swap-by-swap basis. A company could choose to implement the new standard on either a retrospective basis or a modified retrospective basis.