Ten Things Valuation Specialists Should Know about Fair Value Measurements and Private Companies
Private companies are subject to several frameworks for financial reporting purposes. In this article, Mark Zyla explains the role of the Private Company Council (PCC) and provides a summary of several recommendations the PCC has made to the FASB regarding accounting for goodwill and business combinations.
Private companies have expressed concerns about the cost and complexity of applying fair value measurements in both accounting for business combinations and accounting for goodwill. Many users of financial statements of private companies believe that the costs of implementation outweigh the benefits to them. To address concerns of private companies, the Financial Accounting Standards Board (FASB) recently formed an advisory body, the Private Company Council (PCC). The role of the PCC is to provide advice to the FASB on the impact of accounting standards on private companies. The PCC has since made several recommendations to FASB, beginning with accounting for goodwill and accounting for business combinations. These recommendations may eventually impact fair value measurements for certain private companies.
There are 10 things that valuation specialists should know about the current status of fair value measurements and private companies.
- The process for alternative accounting for private companies is where the PCC first makes a recommendation to the FASB for alternative accounting for private companies under current accounting standards, which it believes would benefit private companies. Â The FASB and the PCC then mutually agree if alternative accounting is warranted for private companies.Â Then specific alternative accounting is proposed by the PCC. The proposed alternative accounting for private companies is then sent out for public comments. If there are not any substantive comments, and if agreed to in general by the FASB, the proposal is endorsed by the FASB with a formal vote.
The new alternative accounting can then be elected to be used by a private company, but there is no requirement for a private company to do so. If elected, the alternative is still considered generally accepted accounting principles (GAAP).Â There is not any â€śBig GAAP, Little GAAPâ€ť in financial reporting.
- Currently, in the United States, private companies have several alternative frameworks for financial reporting. Those frameworks include:
- International Financial Reporting Standards (IFRS) for small and medium-size enterprises (SMEs)
- The PCCâ€™s alternative elections under GAAP
- AICPAâ€™s framework for SMEs
The first three frameworks are considered GAAP in the U.S.Â The AICPAâ€™s framework, introduced in July 2013, is considered an â€śother than comprehensive basis of accounting,â€ť which is not considered GAAP.
- In December 2013, the FASB endorsed a PCC proposal to provide alternative accounting for goodwill. Under the new alternative, private companies can elect to amortize goodwill for up to ten years or for a shorter period, if that period is more appropriate.Â Â Goodwill would only be tested for impairment if a triggering event occurs.Â If such an event occurs, the test is only a one-step test at either the entity or reporting unit by comparing the fair value of the entity or reporting to its carrying value.Â If fair value is less than carrying value, the difference is the amount of impairment.Â The alternative accounting is effective for fiscal years beginning after December 15, 2014.Â However, private companies may early adopt the alternative accounting.
- The PCC is also currently recommending an alternative for private companies for accounting for identified intangible assets acquired as part of a business combination. Under this second PCC proposal, a private company could elect to only measure the fair value of non-competition agreements and customer-related intangible assets that are capable of being sold or licensed independently in a business combination.
If these particular intangible assets could not be sold independent of other assets, then they would not be considered identifiable intangible assets. This proposed alternative accounting would have to be elected by the private company, but it is not required to do so. Â The FASB is currently considering endorsing the PCCâ€™sÂ alternative accounting proposal for business combinations.Â If endorsed by the FASB, this alternative will be considered part of GAAP.Â A decision to endorse this proposal by the FASB is expected before the end of this year.
- If a private company makes an election for the alternative accounting of either accounting for goodwill, or if endorsed by the FASB, the accounting for identified intangible assets (and the company subsequently decides to undergo an IPO), the company would likely have to restate their financials as if they had never made the election. The cost of a restatement would likely be much greater than complying with existing GAAP.
- Even if the FASB endorses the current PCC proposal for alternative accounting for private companies involving identified intangible assets in business combinations, outside valuation specialists would still likely be needed by management to measure the fair value of intangible assets that can be sold independently of the entire enterprise such as technology and trade names.
- A private company is likely to elect alternative accounting if the company makes acquisitions infrequently and is expected to remain private. A private company is unlikely to elect alternative accounting if the company plans to undergo an IPO in the future or perhaps expects to be acquired by a public company.Â Alternative investment funds, such as private equity and venture capital firms that are required to measure their investments at their relative fair value, should consider their exit strategy before making the election for alternative accounting.
- If the FASB endorses a proposal for private companies, it then adds a similar proposal as an item to its own agenda to consider the same accounting for public companies. For example, the FASB has an agenda item to extend the simpler accounting for goodwill to public companies. While the FASB plans to discuss this issue, most observers believe that the FASB will retain current accounting for goodwill and business combinations for public companies.
- At the end of the day, do these changesâ€”designed to allow alternative accounting for private companiesâ€”produce significant cost savings? If a private company is making an acquisition, the relative fees of a valuation specialist are often much less than the fees of investment bankers, accountants, and lawyers involved with the transaction.Â It remains to be seen, but if elected, these accounting alternatives result in significant cost savings overall.
- Â Valuation specialists should pay close attention to various PCC proposals. As mentioned, the PCC invites comment letters on proposals.Â The current proposal for accounting for business combinations changed fairly dramatically from the original proposal due in large part to comment letters received about the feasibility of fair value measurements under the original proposal. Valuation specialists can have a voice in the process.
Mark L. Zyla is managing director of Acuitas, Inc., an Atlanta, Georgia-based valuation and litigation consulting firm. He is author of Fair Value Measurements: Practical Guidance and Implementation, 2nd edition, published in 2013 by John Wiley and Sons. Mr. Zyla can be reached at firstname.lastname@example.org or (404) 873-9800.