The move to create exceptions to accounting rules for private companies is sparking a debate over simplification, with purists on one side fretting over a dual set of rules, and others pushing for more simplification for public companies too.

The Financial Accounting Standards Board wrote a new chapter in accounting history recently when it approved two changes to Generally Accepted Accounting Standards to provide private companies with exceptions to existing accounting rules related to goodwill and hedging.

The changes, recommended by FASB's new Private Company Council, allow private companies to bypass complex hedge accounting for certain interest rate swaps and to write down goodwill in equal amounts over 10 years in place of complex testing and measurement of goodwill impairment. If testing becomes necessary, private companies will be allowed to apply a much simpler equation to determine whether the writedown should be adjusted.

FASB's endorsements of those PCC recommendations will not produce accounting requirements within GAAP in the traditional sense, says Kirsten Schofield, a partner with PwC. “It's an alternative, not a requirement, so a private company doesn't have to do this,” she says. “If a company doesn't meet the definition of a public company, they will qualify for this alternative.”

As FASB approved the rule change, it also promised to look closer at whether similar simplifications should be extended to public companies or not-for-profit entities. The board opened a new project to look at the goodwill issue and said it could consider the hedging simplification in the context of its existing comprehensive project to overhaul hedge accounting. “I would be supportive of a project that would effectively give us a converged solution for both private and public companies,” said FASB member Larry Smith. “What that solution is, I'm not entirely sure. I have some concerns over certain aspects of the decisions made with respect to goodwill impairment for private companies, so I am not sure I would go down that route.”

FASB Chairman Russ Golden has said in recent statements that the PCC agenda is driving discussions about how to simplify accounting not just for private companies, but for everyone. The PCC is preparing to propose more changes for private companies to accounting for variable interest entities and intangible assets, and has discussed uncertain tax positions.

Largely due to prodding from the PCC, FASB is looking at changes for development stage companies and share-based compensation, Golden said recently. “FASB is first and foremost focused on identifying how GAAP can be improved, simplified, and made more relevant for all companies and organizations,” he said. “We may endorse some differences for private companies, but in other cases we'll look to incorporate improvements across the board.”

According to Sydney Garmong, a partner with Crowe Horwath, FASB is not just looking to simplify accounting for private companies, but also if some accounting standards can be streamlined for all companies. “The board really is looking for broad simplification where it can be provided,” she says. FASB is also paying close attention to the differences in feedback from large and small companies, adds Garmong.

“Are we creating things that are so costly to implement that the benefits users are getting simply aren't there? We need to balance the users' needs against the cost to preparers.”

—Rick Day,

Partner,

McGladrey

There's an argument to be made for reducing complexity, says Rick Day, a partner with McGladrey. “There's certainly an outcry over cost and benefit,” he says. “Are we creating things that are so costly to implement that the benefits users are getting simply aren't there? We need to balance the users' needs against the cost to preparers.”

Creating a Double Standard?

Yet many accounting experts are circumspect on carve-outs for specific types of organizations, including the effect it could have on public company financial reporting. “This is a slippery slope they are going down,” says Denise Moritz, senior manager at accounting firm WeiserMazars. “One of the dangers is comparability. There's a reason for the way things have been for so many years. People want things to be consistent and comparable. If you change the metric, how is one investor going to look at one financial statement compared to the next?”

FINANCIAL REPORTING OVERVIEW

Below, PwC provides an overview of financial reporting developments.

What's new?

On Nov. 25, 2013, FASB endorsed the first two accounting alternatives previously approved by the Private Company Council. The final standards will provide private companies with (1) an alternative accounting model for goodwill, and (2) a simplified hedge accounting approach for qualifying interest rate swaps.

Separately, FASB voted to add a project to its technical agenda to consider alternatives to the existing goodwill impairment model for public companies and not-for-profit entities. Alternative views to be deliberated include an amortization model, a simplified impairment model without amortization, or a direct write-off of goodwill model.

What are the key provisions?Accounting for Goodwill Subsequent to a Business Combination

Under the goodwill alternative, a private company would be able to amortize goodwill on a straight-line basis over a period of ten years, or a shorter period if the company can demonstrate that another useful life is more appropriate.

Goodwill would be subject to impairment testing only upon the occurrence of a triggering event. Upon adoption, a company will need to make a policy election regarding whether it will assess goodwill for impairment at an entity-wide level or a reporting unit level.

Upon the occurrence of a triggering event, private companies will continue to have the option to first assess qualitative factors to determine whether a quantitative impairment test is necessary. If a quantitative impairment test is required, a one-step impairment test would be performed. The amount of the impairment would be measured by calculating the difference between the carrying amount of the entity (or reporting unit, as applicable) and its fair value. A hypothetical purchase price allocation to isolate the change in goodwill (i.e., step two) would no longer be required.

The goodwill alternative would be applied on a prospective basis. A private company that elects to adopt this alternative would begin amortizing existing goodwill as of the beginning of the period of adoption.

Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps—Simplified Hedge Accounting Approach

Under the simplified hedge accounting approach, a private company would be able to apply hedge accounting to its receive-variable, pay-fixed interest rate swaps as along as its swaps meet certain conditions that indicate that the terms of the swap and the related debt are aligned. If these conditions are met, a company that elects to apply this alternative would be able to assume the cash flow hedge is fully effective.

A private company will have until the issuance of their financial statements to complete the necessary hedging documentation. A private company will also be able to recognize the swap at its settlement value, which measures the swap without non-performance risk, instead of at its fair value.

The simplified hedge accounting approach will be applied on either a modified retrospective basis or a full retrospective basis, with such election to be made on a swap-by-swap basis.

Source: PwC.

Mark Bielstein, an audit partner with KPMG, says if differences are to be created, they should be based on the information needs of users of financial statements, not just the needs of preparers to apply simpler rules. “When you create alternatives and elections in applying specific accounting standards, that might also increase complexity for the users of financial information,” he says. He wonders about the conceptual basis, for example, of amortizing goodwill over 10 years as will now be permitted for private companies. “If users of private company financial statements don't use information related to goodwill, that would seem to indicate maybe it would be better to write it off immediately,” he says.

Differences in how accounting standards are applied might require users of financial statements to take a closer look at each company's accounting policy disclosures, says Chris Smith, a partner with BDO USA. “Users will have to be aware of those if they want to compare public company and private company financial statements, and it's not a bad thing to get people focusing more on those disclosures.” Yet he's concerned about the burden that public companies will bear. “Private company financial statements have a way of creeping into filings with the Securities and Exchange Commission,” he says.

The divergence of rules for public and private companies could also complicate merger and acquisition activity. When a public company is acquiring a private company, or when a private company is an equity-method investee in a public company, those private company financial statements may be needed in SEC filings. “When there are differences between GAAP used by private companies and what is accepted by the SEC, that burden usually falls on the public company to make sure it is converted,” Smith says.

EY has already issued an alert to explain the issues private companies should consider before they dive in to elect FASB's newly approved simplifications.

Kelley Wall, a director at consulting firm RoseRyan, says private companies would be wise to move cautiously. Any private company considering some kind of liquidity event in the future, such as an initial public offering, would need to present financial statements that comply with SEC rules. “It might be more work at the back end,” she says, if a company chooses a simpler accounting method in the interim. If a company wants to position itself for acquisition, that's another reason to remain under existing GAAP rules, she says. An impairment that has been amortized for a few years could be tricky to unwind and re-report under conventional methods after the fact. “Going back five years in hindsight could be very difficult,” she says.

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