ASU 2014-02: Goodwill Accounting for Private Companies

Accounting Standards Update (ASU) 2014-02 represents a shift in how certain companies account for goodwill. Issued by the Financial Accounting Standards Board (FASB), this standard emerged from the efforts of the Private Company Council (PCC) to address the cost and complexity of existing goodwill accounting rules. The update provides a simplified accounting alternative for private companies and not-for-profit organizations. This alternative framework allows for the amortization of goodwill over a defined period and introduces a more straightforward impairment testing process, giving entities flexibility in their financial reporting.

Eligibility for the Accounting Alternative

The accounting alternative provided by ASU 2014-02 is available to entities that meet the definition of a “private company” as outlined in the FASB Master Glossary. This includes companies not required to file financial statements with the U.S. Securities and Exchange Commission (SEC), and in 2019, the FASB extended this alternative to all not-for-profit entities. The standard excludes public business entities.

For a qualifying entity, the decision to adopt this simplified goodwill accounting is an accounting policy election. An eligible company or not-for-profit can choose to apply the amortization and simplified impairment model or continue using the traditional impairment-only approach. Once an entity elects to use the alternative, it must be applied to all existing goodwill and any goodwill that arises from future business combinations.

Amortization of Goodwill

A central component of the accounting alternative is the requirement to amortize goodwill. Entities that elect this option will amortize the value of their goodwill on a straight-line basis, which evenly distributes the expense over a set period. This approach treats goodwill similarly to other long-lived assets that are expensed over their useful lives.

The default amortization period prescribed by the standard is 10 years. For instance, if an entity recognizes $200,000 of goodwill from an acquisition, it would record an amortization expense of $20,000 each year for a decade. This systematic reduction of the goodwill asset also reduces the entity’s net income.

An entity is not strictly bound to the 10-year period and can use a shorter amortization period if it can demonstrate that a different useful life is more appropriate. This decision requires justification based on the facts and circumstances of the acquired business and must be well-documented.

The amortization of goodwill can have a noticeable impact on an entity’s financial statements. By reducing the carrying amount of goodwill annually, the likelihood of a future impairment charge may be lessened because the book value of the asset is already being systematically written down.

Simplified Impairment Testing

While ASU 2014-02 introduces amortization, it offers a simplified and less frequent impairment testing model. Under this alternative, goodwill must be tested for impairment only when a “triggering event” occurs. A triggering event is an event or change in circumstances that indicates the fair value of the entity may have fallen below its carrying amount, such as an adverse change in the business climate or the loss of key personnel.

When a triggering event is identified, the entity performs an impairment test. The standard provides flexibility, allowing the entity to test for impairment at either the overall entity level or at the reporting unit level. Testing at the entity level is less complex and costly than performing the analysis for multiple reporting units.

An entity has the option to first perform a qualitative assessment, often called “Step 0.” This step evaluates whether it is “more likely than not” that the fair value of the entity or reporting unit is less than its carrying amount. If this assessment indicates an impairment is likely, or if the entity bypasses this step, it must proceed to a quantitative test.

The quantitative test compares the fair value of the entity or reporting unit with its carrying amount, which includes goodwill. If the carrying amount exceeds the fair value, an impairment loss is recognized for the difference. The recognized loss cannot be greater than the total carrying amount of goodwill.

Required Disclosures

When a private company or not-for-profit elects the accounting alternative under ASU 2014-02, it must provide specific disclosures in its financial statement footnotes. The entity must explicitly state in its accounting policies that it has elected the simplified accounting alternative for goodwill. This disclosure alerts readers that the entity is not following the traditional impairment-only model. Additionally, the entity is required to disclose the amortization period it is using for goodwill. If an impairment loss is recognized during the reporting period, the financial statements must also disclose the total amount of that loss.