By: Michael T. Wherry, CPA
Over the past couple of years, a handful of Accounting Standard Updates (ASU) issued by the Financial Accounting Standards Board (FASB) related to business combinations and consolidations have had an impact on our clients. Since increased merger and acquisition activity has been seen in 2018, a short summary of the key ASUs is in order.
ASU 2014-17 Business Combinations: Pushdown Accounting was issued to provide guidance on pushdown accounting which is relevant when an acquisition occurs. While the pushdown accounting guidance is optional for nonpublic entities, in our experience, pushdown accounting is beneficial to adopt in certain circumstances upon a change of ownership. The pushdown accounting guidance “pushes” the acquisition activity to the separate statements of the subsidiary instead of at the acquiring company. This enables a stock / membership interest purchase to be treated as an asset purchase for financial statement reporting purposes. We have applied this guidance when the following items have occurred in an acquisition.
- A section 338(h)(10) election is made which enables the buyer a step-up in asset basis from a tax perspective.
- The selling entity is a partnership, and the partnership terminates at the time of the closing.
- A merger is consummated, and the surviving entity is the new entity.
In all of these cases, for financial statement purposes, a change in reporting entity has occurred and a new entity is created at the time of closing. In these situations, while a stock / membership interest purchase occurred the tax treatment mirrors an asset purchase. Thus, the financial statements should reflect this same treatment to be consistent.
ASU 2014-02 Intangibles-Goodwill and Others: Accounting for Goodwill was issued which allows nonpublic entities to elect to amortize goodwill over ten years. Goodwill is still required to be tested for impairment on an annual basis but, since goodwill is being amortized, the risk of impairment deceases. From a composite score perspective, no impact on the calculation of equity occurs as all intangible assets are subtracted from equity in the calculation. The amortization of goodwill does increase expenses which is detrimental to the Net Income ratio and the Primary Reserve Ratio. However, if the company can absorb the annual amortization expense, this decreases the future risk of a large goodwill impairment loss which will be a “hit” to net income at one time. In addition, the decrease in the carrying value of goodwill due to the annual amortization lowers total assets in the Equity Ratio which helps this ratio.
ASU No. 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination, was issued which enables a nonpublic entity to not have to identify the following intangibles: (1) customer-related intangible assets unless they are capable of being sold or licensed independently from the other assets of the business and (2) noncompetition agreements. For our clients, this would normally relate to student lists and covenants-not-to compete. Intangible assets other than customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of a business and noncompetition agreements will continue to be recognized. Therefore, intangibles related to trademark and accreditation are most likely still required to be separately identified. If ASU 014-18 is adopted, it must be used for all future transactions. In addition, if ASU 2014-18 is adopted, then the entity must also adopt ASU 2014-02 (see above) to amortize the total intangible asset over ten years.
ASU 2018-17 Consolidation: Targeted Improvements to Related Party Guidance for Variable Interest Entities was issued which will enable nonpublic entities to no longer have to consolidated Variable Interest Entities (VIE) under common control with certain exceptions (i.e. voting control) and certain criteria being met. A VIE is basically a related party entity which was not owned via equity control and yet common control existed via other forms. The consolidation of VIEs came into existence in the mid-2000s partially as a result of the Enron scandal. The guidance was very technical, nuanced, and subjective and, as a result, created reporting inconsistencies in practice. ASU 2014-07, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements was previously issued which allowed a common control landlord VIE to not have to be consolidated. Thus, the FASB has basically expanded this guidance to all VIEs. The new VIE consolidation guidance does have continued disclosure requirements about how the company is involved with the VIE. This VIE consolidation guidance is effective for fiscal years beginning after December 15, 2020 with early adoption permitted. M&A will be evaluating the impact of this ASU on our clients.
The FASB continues to issue a myriad of ASUs on an annual basis and we are reviewing these items to determine the impact on our clients.