Defining Issues. FASB Issues New Private Company Guidance. February 2014, No Key Facts

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1 Defining Issues February 2014, No FASB Issues New Private Company Guidance The FASB and Private Company Council (PCC) recently issued new guidance for private companies including the Private Company Decision-Making Framework (the Framework) and a new definition of a public business entity. Standard setters will use that definition to identify what entities should be excluded from the Framework and to determine the scope of new accounting standards that provide exceptions or alternatives to U.S. GAAP for private companies. 1 The FASB also recently issued its first jointly developed standards with the PCC on accounting for goodwill and interest rate swaps for private companies. 2 Key Facts Contents Private Company Council Background... 2 Private Company Decision-Making Framework... 2 Definition of a Public Business Entity... 3 Private Company Standards... 6 The Framework will be used by the FASB and PCC in making user relevance and cost-benefit evaluations in determining whether to provide accounting alternatives for private companies within U.S. GAAP. A new definition of a public business entity was established for use in determining the scope of new accounting standards. Private companies can elect the alternative to amortize goodwill. The alternative also allows private companies to test for impairment only when a triggering event occurs. Private companies can elect a simplified hedge accounting approach for plainvanilla interest rate swaps intended to hedge interest rate risk on variable-rate borrowings. The simplified hedge accounting approach is intended to make it easier for private companies to reflect an economic conversion of their variable-rate borrowings to fixed-rate borrowings. Other PCC Activities and Next Steps FASB and PCC s Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies, December 23, 2013, and FASB Accounting Standards Update No , Definition of a Public Business Entity: An Addition to the Master Glossary, both available at 2 FASB Accounting Standards Update No , Accounting for Goodwill, and FASB Accounting Standards Update No , Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps Simplified Hedge Accounting Approach, both available at network of independent member firms affiliated with KPMG International Cooperative, All

2 Key Impacts The Framework discusses five areas in which accounting and reporting guidance might differ for private and public companies: recognition and measurement, disclosures, display, effective date, and transition method. The definition of a public business entity does not affect existing requirements, which would continue to use the individual definition of a public entity that applies to a specific FASB Accounting Standards Codification (ASC) Topic. The alternatives for private companies in the goodwill standard are intended to reduce the likelihood of an impairment and simplify the impairment test when it is required. Under the simplified hedge accounting approach, companies would have more time to complete hedge documentation, assume no ineffectiveness in the hedging relationship, and measure the swaps at either settlement or fair value. The ASUs apply to years beginning after December 15, 2014, with early adoption permitted. Private companies are able to use the accounting alternatives in the ASUs for 2013 year-end reporting if they have not yet issued their financial statements. Private companies that have elected the private company alternatives and subsequently become public companies that are required to file financial statements with the SEC would be required to recast their financial statements to reflect public company standards. Private Company Council Background The PCC was established by the Financial Accounting Foundation in May 2012 to identify potential modifications to U.S. GAAP for private companies that address the needs of users and preparers of private company financial statements. The PCC also advises the FASB on private company matters related to areas under consideration by the FASB. 3 The PCC s decisions on potential modifications and exceptions to U.S. GAAP are subject to endorsement by the FASB. In November 2013, the FASB endorsed two final PCC proposals on accounting for goodwill and allowing a simplified hedge accounting approach. These ASUs were issued in January 2014 (see the Private Company Standards section). Private Company Decision Making Framework The FASB and PCC issued the Framework on December 23, The Framework is meant to act as a guide for the FASB and PCC in determining when accounting alternatives should be considered for private companies. The Framework addresses factors that differentiate private companies from public 3 Financial Accounting Foundation Board of Trustees, Establishment of the Private Company Council, Final Report, May 30, 2012, available at 2 network of independent member firms affiliated with KPMG International Cooperative, All

3 companies and the specific areas where recognition and measurement, disclosure, presentation, effective date, and transition requirements might differ for private and public companies. In developing the Framework, the Board and the PCC obtained input from private company stakeholders. The process included input from both users and preparers of private company financial statements. The Framework identifies the following five significant factors that differentiate financial reporting considerations of private companies from public companies. Number of users and access to management (generally not to be considered for recognition and measurement alternatives); Investment strategies of primary users; Ownership and capital structure; Accounting resources; and Learning about new financial reporting guidance. The Framework is not to be considered a new conceptual framework for private company financial reporting. Instead, it is to be used in conjunction with the recently issued definition of a public business entity to assist the Board and the PCC in determining whether and in what circumstances to provide accounting alternatives for private companies. Definition of a Public Business Entity The ASU establishes a new definition for a public business entity in the ASC Master Glossary that will be used to identify the types of business entities that will not be eligible to use private company exceptions and alternatives issued by the FASB. U.S. GAAP contains five other definitions of a public or publicly traded entity. These definitions will continue to apply to existing standards and the new definition of public business entity will be used to set the scope for new private company standards. A public business entity is an organization that meets any one of the following criteria: (a) It is required by the SEC to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers) with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing). (b) It is required by the Securities Exchange Act of 1934, as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency, other than the SEC. (c) It is required to file or furnish financial statements with a regulatory agency (foreign or domestic) in preparation for a sale or issuing securities that are not subject to contractual restrictions on transfer. (d) It has (or is a conduit bond obligor for) securities that are traded, listed, or quoted on an exchange or an over-the-counter market. (e) Its securities are not subject to contractual restrictions on transfer, and it is required to prepare U.S. GAAP financial statements (including notes) and 3 network of independent member firms affiliated with KPMG International Cooperative, All

4 make them publicly available on a periodic basis (e.g., interim or annual periods), pursuant to legal, contractual, or regulatory requirements. An entity must meet all these conditions. The definition excludes all not-for-profit organizations from the definition of a public business entity even if one or more of the criteria are met. However, the FASB will consider factors such as financial statement user needs and preparer resources on an individual standard basis when determining whether all, none, or only some not-for-profit organizations would be eligible to apply exceptions and alternatives available to private companies. The ASU also excludes from the definition of a public business entity employee benefit plans within the scope of ASC Topics 960, 962, and 965 even when one or more of the criteria are met. 4 An entity may be a public business entity solely because its financial statements or financial information is included in another entity s filing with the SEC. An entity that does not otherwise meet any of the criteria in the definition may apply private company accounting and reporting alternatives to its standalone financial statements that are not included in an SEC filing. A consolidated subsidiary of a public company is not considered a public business entity for purposes of its standalone financial statements. Some of the existing definitions of a public entity in U.S. GAAP consider a consolidated subsidiary of a public company to be a public entity. KPMG Observations An entity that is a public business entity only because its financial statements are included in another entity s SEC filing may have two different sets of U.S. GAAP financial statements one set that does not reflect private company alternatives that is included in the SEC filing and another set in which private company alternatives have been applied that are used for other purposes. If a subsidiary that is not a public business entity elects to apply private company alternatives in its standalone financial statements, the subsidiary s financial statements must be adjusted in consolidation to reflect public company GAAP (reverse the effects of the private company alternatives) if the parent company is a public business entity. In addition, if a private company equity method investee applies private company recognition and measurement alternatives, a public company equity method investor generally would be required to adjust its equity method share of earnings or losses to reverse the effects of the private company alternatives when those effects are material. 4 FASB ASC Topics 960, Plan Accounting Defined Benefit Pension Plans; 962, Plan Accounting Defined Contribution Pension Plans; and 965, Plan Accounting Health and Welfare Benefit Plans, all available at 4 network of independent member firms affiliated with KPMG International Cooperative, All

5 The amendments to the ASC Master Glossary became effective upon the issuance of the private company standards in January 2014 as those ASUs were the first to use the definition of a public business entity. In connection with its overall agenda prioritization efforts, the FASB directed the PCC to consider performing pre-work on the second phase of the project to examine whether to amend current U.S. GAAP by using the definition of a public business entity rather than current definitions of a public entity. 5 network of independent member firms affiliated with KPMG International Cooperative, All

6 Private Company Standards Accounting for Goodwill ASU provides private companies with an accounting alternative for the measurement of goodwill after it is initially recognized. Public business entities, not-for-profit entities, and employee benefit plans are excluded from the scope of the ASU. Private companies that elect the accounting alternative will amortize goodwill on a straight-line basis over ten years, or less than ten years if they can demonstrate that a shorter useful life is more appropriate. Under the alternative, companies are required to make an accounting policy election to test goodwill for impairment at either the entity level or the reportingunit level. Goodwill is tested for impairment only when a triggering event occurs that indicates that the fair value of the entity (or a reporting unit) may be below its carrying amount. When a triggering event is identified, companies have an option to first perform a qualitative assessment to determine whether a quantitative impairment test is necessary. If the qualitative assessment indicates that it is more likely than not that goodwill is impaired, companies must perform a quantitative test that compares the fair value with the carrying amount (or the fair value of the reporting unit with its carrying amount). A goodwill impairment loss is recorded in the amount the fair value of the company (or reporting unit) exceeds its carrying amount. The goodwill impairment loss should not exceed the company s (or reporting unit s) goodwill carrying amount. KPMG Observations While the ASU impacts the subsequent measurement of goodwill for private companies, the ASU does not change the exception to the recognition of a deferred tax liability under ASC paragraph (d) related to goodwill, which is not deductible for tax purposes. See also ASC paragraph We would expect that the amortization of non-tax deductible financial statement goodwill that is recorded under ASU would be treated as permanent item when determining the income tax provision. Transition and Effective Date The accounting alternative, if elected, is applied prospectively to goodwill existing as of the beginning of the period of adoption and new goodwill recognized in fiscal years beginning after December 15, Early adoption is permitted and private companies will be able to apply the alternative for 2013 year-end financial reporting if their financial statements have not yet been made available for issuance. 6 network of independent member firms affiliated with KPMG International Cooperative, All

7 Companies that elect the accounting alternative for goodwill would apply all of the related subsequent measurement and disclosure requirements upon election. Simplified Hedge Accounting Approach ASU introduces as a practical expedient a simplified hedge accounting approach that allows certain private companies to assume no ineffectiveness for qualifying interest rate swap hedging relationships and provides an option to measure the swap at settlement or fair value. Settlement value excludes nonperformance risk. Alternatively, the current hedge accounting guidance may be followed. Under the simplified hedge accounting approach, there is no requirement to complete hedge documentation at the inception of the hedging relationship and companies will be able to complete the documentation any time prior to the date on which the first annual financial statements are available to be issued after the hedge inception. To qualify for the simplified hedge accounting approach, the following conditions need to be met: (a) Both the variable rate on the swap and the variable-rate borrowing are based on the same index and reset period. In complying with this condition, companies are not limited to benchmark interest rates. (b) The terms of the swap are typical and considered to be plain-vanilla, and there is no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap. (c) The repricing and settlement dates for the swap and the borrowing match or differ by no more than a few days. (d) The swap s fair value at inception is at or near zero. (e) The notional amount of the swap is equal to or less than the principal amount of the borrowing that is being hedged. (f) All interest payments on the borrowing during the term of the interest rate swap (or the effective term of the interest rate swap underlying a forwardstarting swap) are designated as hedged whether in total or in proportion to the principal amount of the borrowing being hedged. Financial institutions, not-for-profit entities, employee benefit plans, and public businesses are not eligible to apply the simplified hedge accounting approach. 7 network of independent member firms affiliated with KPMG International Cooperative, All

8 Although the simplified hedge accounting approach is only permitted to be applied to plain-vanilla swaps, the PCC acknowledged that forward-starting interest rate swaps may qualify if the occurrence of the forecasted interest payments to be swapped is probable and the required conditions are met. Borrowings with interest rate caps or floors may qualify for the simplified hedge accounting approach if there is a comparable feature in the swap. Borrowings where the borrower has an option to select the interest rate index ( U Pick- Em Debt ) may qualify as long as the interest rate of the swap and borrowing are based on the same index at the inception of the swap and thereafter. The guidance will be effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, Therefore, calendar year-end companies will be required to make the elections included in this guidance beginning with their 2015 annual financial statements and for their 2016 interim financial statements. Early adoption is permitted for annual or interim periods for which financial statements have not yet been made available for issuance. For example, companies may choose to apply this guidance in their 2013 financial statements that have not yet been made available for issuance. 8 network of independent member firms affiliated with KPMG International Cooperative, All

9 Companies can elect to apply the guidance on a swap-by-swap basis. Companies have an option to record the transition adjustments with either a modified retrospective approach or a full retrospective approach. Under the modified retrospective approach, the corresponding adjustments to reflect the application of hedge accounting from the date the swap was entered into (or acquired) will be recorded to the assets, liabilities, and opening balance of accumulated other comprehensive income and retained earnings in the period of adoption. Under the full retrospective transition approach, the financial statements for each individual period will be adjusted and the corresponding adjustments to the assets, liabilities, and opening balance of accumulated other comprehensive income and retained earnings will be recorded as of the beginning of the earliest period presented. KPMG Observations Only plain-vanilla interest rate swaps are eligible for the simplified hedge accounting approach. The term plain-vanilla is not defined under U.S. GAAP and judgment will be required to determine what types of swaps would be considered to be plain-vanilla. Companies applying the simplified hedge accounting approach should be cautious when completing hedge documentation after the inception of the hedging relationship. Companies that subsequently determine that they don t qualify for the simplified hedge accounting approach will not be eligible to apply other forms of hedge accounting because the documentation was not completed contemporaneously. The simplified hedge accounting approach would not be limited to hedges of benchmark interest rates. Therefore, companies following this approach would be able to hedge more interest rate indices such as the prime rate. Background. The PCC received feedback that it is often difficult for private companies to obtain fixed-rate borrowings. Companies may enter into receivevariable, pay-fixed interest rate swaps to economically convert the variable-rate borrowings into fixed-rate borrowings, and Topic 815 permits companies to apply hedge accounting if certain requirements are met. 5 However, many private companies contend that they do not have the resources to understand or apply hedge accounting. In addition, some question the relevance and cost of determining and presenting the fair value of plain-vanilla interest rate swaps. In response to this feedback, the PCC introduced a simplified hedge accounting approach to make it easier for private companies to apply hedge accounting by alleviating certain aspects of the requirements relating to fair value, documentation, and measurement of hedge ineffectiveness. 5 FASB ASC Topic 815, Derivatives and Hedging, available at 9 network of independent member firms affiliated with KPMG International Cooperative, All

10 Other PCC Activities and Next Steps At its November 12, 2013, meeting, the PCC approved a proposed standard that would give private companies an alternative to not apply the variable interest entity (VIE) consolidation guidance to certain leasing arrangements. The FASB will consider the proposed standard for endorsement at a future meeting. The FASB staff is performing additional research at the direction of the PCC related to Issue Number 13-01A, Accounting for Identifiable Intangible Assets in a Business Combination. The issue had previously been released for public comment. The PCC is expected to discuss the issue at its April 2014 meeting. The PCC removed Issue Number 13-03B, Accounting for Certain Receive- Variable, Pay-Fixed Interest Rate Swaps Combined Instruments Approach from its agenda. The PCC considered adding projects related to the measurement and accounting for stock-based compensation and the presentation of cumulative amounts for development stage entities (DSEs). Based on the FASB staff s research, the PCC decided not to add the stock-based compensation project to its agenda. Further, the FASB decided to add the DSE project to its agenda and issued a proposed ASU that would eliminate the cumulative financial reporting requirement for both public and private DSEs. 6 Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Enrique M. Tejerina, Brent D. Krueger, Jack Pohlman, and James D. Simon Earlier editions are available at: Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the standards or any other potential or applicable requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP. 6 FASB Proposed Accounting Standards Update, Elimination of Certain Financial Reporting Requirements, November 7, 2013, available at 10 network of independent member firms affiliated with KPMG International Cooperative, All