The Financial Accounting Standards Board (FASB) recently issued guidance that should ease the financial reporting burden on nonprofits that enter “business combinations,” such as mergers and acquisitions. The title of the guidance is a mouthful, but it probably tells you everything you need to know: Accounting Standards Update (ASU) No. 2019-06, Intangibles — Goodwill and Other (Topic 350), Business Combinations (Topic 805), and Not-for-Profit Entities (Topic 958): Extending the Private Company Accounting Alternatives on Goodwill and Certain Identifiable Intangible Assets to Not-for-Profit Entities.
In other words, the guidance enables all nonprofits to take advantage of two simplified and cheaper alternatives to U.S. Generally Accepted Accounting Principles (GAAP) that have been available to for-profit businesses since 2014.
Accounting for Goodwill
Under original standards, GAAP requires organizations that merge with or acquire another organization to identify and recognize the fair value (usually the current market price) of every asset and liability obtained in the deal, including goodwill. The value of goodwill is determined by deducting the value of all other assets and liabilities from the purchase price.
In the nonprofit context, goodwill might be found, for example, when an organization acquires a for-profit entity — think of a nonprofit hospital buying a physicians’ practice. Or it might exist after the acquisition of a nonprofit that’s in a loss position if the combined organization depends primarily on fee-for-service revenue. According to the FASB, the latter happens both in the health care industry and in other industries in which goodwill is less prevalent.
GAAP generally requires you to carry goodwill on your books at its initial fair value less any “impairment.” It doesn’t allow goodwill to be amortized, or gradually reduced in value, over multiple years.
Goodwill is impaired if its fair value falls to an amount less than its book value. GAAP requires impairment testing at least annually at a reporting unit level. That means that organizations with operating units that have their own discrete financial information, separate from the overall organization, must test for impairment for each separate unit. The testing process can prove complicated and costly.
The goodwill GAAP alternative originated in ASU No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill. It generally allows an organization to amortize goodwill after its acquisition on a straight-line basis (reducing the value by the same amount each during a period of 10 years, or less if you establish that another useful life is more appropriate).
Making a Policy Decision
If you opt for the alternative, you must make an accounting policy decision to test goodwill for impairment at either the organization level or reporting-unit level. But the alternative requires testing only when a triggering event happens. Examples of triggering events include:
- A decline in general economic conditions,
- Increased costs,
- Negative or declining cash flows,
- A decline in actual or planned revenue,
- The loss of key personnel, and
Nonprofits that choose to apply the alternative could see significant cost savings because amortization is allowed and the annual impairment testing requirement is eliminated. Amortization generally reduces the odds of impairments, and testing likely will be necessary less often. When testing is required, the ability to conduct a single test at the organization level should reduce the expense.
Recognizing Intangible Assets
Under original GAAP, organizations that acquire certain customer-related intangible assets or noncompete agreements in a merger or acquisition must recognize them on financial statements separately from goodwill. These intangible assets include such things as customer and donor lists and relationships.
The intangible assets alternative was issued in ASU No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. It permits organizations that elect to adopt the goodwill alternative to also elect not to recognize customer-related intangible assets and noncompete agreements separately from goodwill. It doesn’t apply, though, to noncustomer intangibles, such as patents, trade names, franchise rights and favorable leases.
Here’s the appeal of this alternative: You can recognize fewer separate intangible assets and therefore have fewer assets to value individually. And you simply subsume covered intangibles and noncompetes into goodwill.
Note that this alternative isn’t available unless you elect the goodwill alternative. You can, however, elect the goodwill alternative without electing the intangible assets alternative.
This guidance has already taken effect. If you elect the goodwill alternative, you will apply it going forward to both existing goodwill and goodwill generated in future mergers or acquisitions. The intangible asset alternative would apply prospectively to future business combinations only. It wouldn’t affect existing intangible assets.