ASU 2014-03: Goodwill Accounting Alternative Explained

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-02, which introduced a simplified goodwill accounting alternative for private companies. This guidance emerged from recommendations by the Private Company Council (PCC) to reduce the cost and complexity of accounting for goodwill, an intangible asset recorded during a business combination.

This alternative framework addresses concerns from private companies that found the previous requirements for annual goodwill impairment testing to be burdensome. The guidance provides a more straightforward method for both amortizing goodwill over time and assessing it for a potential decrease in value. Simplifying these processes makes financial reporting more practical for private entities while still providing useful information to users of their financial statements.

Eligibility for the Accounting Alternative

The option to use the simplified accounting rules for goodwill is available to private companies and most not-for-profit organizations. A private company is any entity that is not a public business entity. A public business entity is one that is required to file financial statements with the Securities and Exchange Commission (SEC) or has securities traded on a public exchange.

This means companies whose shares are traded on stock markets like the NYSE or NASDAQ are excluded. The eligibility was later extended to not-for-profit entities, such as charities, foundations, and private universities, allowing them to benefit from the simplified approach. Employee benefit plans and financial institutions are generally excluded from this alternative.

The purpose of limiting this election is to provide relief to organizations that do not have the extensive resources of publicly traded corporations. For these private entities, the cost of performing annual impairment tests often outweighed the benefits to their financial statement users. The election is designed for entities where the primary users of financial statements are owners, managers, and lenders rather than public investors.

The Goodwill Accounting Alternative Explained

The accounting alternative changes two aspects of handling goodwill: amortization and impairment testing. Entities that elect this option are required to amortize their goodwill, which means gradually expensing its value over a period of time. The default amortization period is ten years on a straight-line basis. This approach treats goodwill like other long-lived assets that are systematically expensed over their useful lives.

An entity can choose a shorter amortization period if it can demonstrate that another useful life is more appropriate for the specific circumstances. For example, if the goodwill is associated with a specific technology or asset that has a defined life of seven years, the company could justify amortizing the goodwill over that shorter seven-year period. However, the amortization period cannot exceed ten years. This requirement to amortize goodwill is a departure from the previous model where goodwill was not amortized and was instead tested for impairment annually.

The second component is a simplified approach to impairment testing. Instead of an annual test, an entity only tests for impairment if a “triggering event” suggests that the entity’s fair value may have fallen below its carrying amount. Examples of triggering events include an adverse change in the business climate, unanticipated competition, or a loss of personnel.

An additional alternative gives private companies and not-for-profits a choice in when to evaluate for triggering events. They can monitor for such events as they occur or elect to perform the evaluation only at the end of each reporting period.

If a triggering event is identified, the entity performs a one-step impairment test. This test compares the fair value of the entity with its carrying amount, including goodwill. If the carrying amount exceeds the fair value, an impairment loss is recorded for the difference, up to the total carrying amount of goodwill. This simplified process replaces a more complex, two-step test that was previously required.

Adopting and Disclosing the Alternative

An entity makes the choice to adopt the goodwill accounting alternative when it first completes a business combination or acquires a not-for-profit activity. The decision to adopt is an accounting policy election and must be applied prospectively. This means the new rules apply to all goodwill on the balance sheet at the date of adoption and any new goodwill recognized in the future. The entity cannot pick and choose which goodwill to apply the alternative to; the decision is an all-or-nothing change in accounting policy.

Once an entity elects to use this alternative, it must provide specific disclosures in the footnotes to its financial statements. The disclosure must include a statement confirming that the entity has adopted the private company accounting alternative for goodwill. This informs readers that the company is following a different set of rules for this asset compared to public companies.

The disclosures must also include the amortization period being used for goodwill. If an impairment loss is recorded, the financial statements must describe the facts and circumstances that led to the impairment and the amount of the loss. These disclosure requirements ensure that users of the financial statements understand the accounting treatment of goodwill and its impact on the company’s financial position.