No more valuing intangible assets for purchase accounting?

We wouldn’t go that far, but the Financial Accounting Standards Board (FASB) endorsed three accounting proposals that simplify US GAAP for private companies:

  1. Recognition of intangible assets in purchase accounting (read here …)
  2. Goodwill impariment testing (read here …)
  3. Pay-fixed interest rate swaps (read here …)

1. Intangible Asset Recognition: Private companies are not to be required to separately recognize certain intangible assets acquired in a business combination.  Only intangible assets arising from non-cancelable contracts or other legal rights have to be recognized.  Examples of intangibles that blend into goodwill include non-contractual customer relationships, unpatented technology and in-process research and development.  Intangibles such as contractual customer relationships, tradenames, patents, and non-compete agreements will still require recognition.

The new alternative may enable companies to simplify or eliminate intangible asset valuation. Consumer product or business service companies may be able to reduce the recognized value of its key intangible – customer relationships. Many acquisitions of technology or life-science companies will still require a full scope valuation albeit with some modifications to technology and/or customer relationship valuations. The proposal will likely lead to a noticeable reduction in the dollar amount of intangible assets recognized separately from goodwill. In many cases the number of different intangible assets will not change; leaving the scope of the valuation analysis mostly unchanged.

2. Impairment Testing: Goodwill can be amortized and Step 2 is not required! Companies will be able to amortize goodwill over the useful life of the primary asset acquired in a business combination, not to exceed 10 years. A primary asset is the most significant long-lived asset acquired in the business combination. Testing will be required when triggering event occurs, not periodically, and on entity-wide level, not reporting unit level.

Step 2 is a hypothetical purchase price allocation required to calculate the precise amount of goodwill to remain on the books if company is not performing well. The proposal will eliminated Step 2 completely. Just like that underUnder the guidance of IFRS, goodwill impairment is measured simply as a difference between fair value and book value of equity. Elimination of Step 2 will bring real savings to companies.

3. Pay-fixed interest rate swaps: For swap contracts used solely for converting variable rate borrowings into fixed ones, two simpler approaches are proposed. The first approach is a combined instrument approach in which the swap and the borrowing are accounted for as one combined financial instrument. The second approach is a simplified shortcut approach in which the swap and the related borrowing are accounted for as two separate financial instruments. The second approach assumes no ineffectiveness of the swap; and the instrument can be recorded at the settlement value instead of fair value. The proposal does not apply to financial institutions, but is very helpful in reducing the scope of valuation analysis for other private entities.

In summary, Intangible Asset recognition proposal will likely reduce values of intangibles recognized and increase goodwill. However, unless the rule completely eliminates the need for intangible asset valuation, the scope of valuation analysis will not decrease dramatically. Goodwill Impairment proposal is more significant, in that it eliminates Step 2, a hypothetical purchase price allocation. All three proposed changes will be optional for companies to adapt. Larger or IPO-bound entities can elect to stay with traditional accounting methods. A significant number of middle-market enterprises will welcome an opportunity to simplify their Fair Value accounting.

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