Two private company GAAP alternatives and their impact on dealerships

On November 25, 2013, the Financial Accounting Standards Board (FASB) endorsed two US Generally Accepted Accounting Principles (GAAP) alternatives for private companies. Since the creation of the Private Company Council (PCC) in May 2012, the PCC’s main goal has been to improve the process of setting accounting standards for private companies. The new options listed below represent the first GAAP alternatives specific to private companies since the PCC’s creation. The final standards are expected to be issued by the end of the year.

GAAP alternatives endorsed to date will:

  1. Provide private companies with an alternative method for accounting for goodwill.
  2. Provide private companies with a simplified hedge accounting approach for certain interest rate swaps.

The goodwill accounting alternative:

Currently, an often cumbersome annual assessment of goodwill impairment is required for all companies. The new alternative will provide private companies flexibility in accounting for goodwill subsequent to a business combination. The key elements are as follows:

  • Private companies will have an option to amortize goodwill on a straight-line basis over a ten-year period. A shorter period may be used if the reporting entity can demonstrate that another useful life is deemed more appropriate.   
  • Goodwill would be tested for impairment only when a triggering event occurs, rather than annually.
  • Upon adoption, the company would elect to test goodwill for impairment either at the entity or the reporting unit level, rather than being required to test goodwill for impairment at the reporting unit level only.
  • If a triggering event occurs, private companies would still have the option to first assess qualitative factors (commonly referred to as “Step Zero”) to determine whether quantitative impairment testing is needed. If quantitative impairment testing is needed, the company would perform a one-step impairment test. The amount of any impairment would be measured as the difference between the carrying amount of the entity or reporting unit, as applicable, and its fair value. Consequently, the currently-utilized two step approach would no longer be required.

Note: If the company elects the above accounting treatment for goodwill, this alternative would be applied on a prospective basis, meaning that companies would begin amortizing existing goodwill as of the beginning of the reporting period where the optional guidance is adopted.

Many automotive dealerships have recorded goodwill (commonly referred to as “blue sky”) upon acquisition of dealership franchises, thus the goodwill alternative should be carefully considered. A few pros and cons are as follows:

Pros:
  • Amortization of goodwill versus potentially time-consuming and costly annual impairment analysis.
  • As many automotive dealerships have defined its various franchise points included in a single legal entity as separate reporting units for purposes of goodwill testing, the option to perform annual impairment analysis at the entity-level versus the reporting unit level would likely result in time and cost savings.
  • Option for one-step impairment analysis versus the traditional two-step impairment analysis would likely result in reduced cost and complexity.
  • All options allow the dealership to continue to issue GAAP financials with an unmodified and unqualified opinion, unlike switching to an income tax basis or the Small and Medium-sized Entity (SME) framework.
Cons:
  • Recognition and measurement difference between public companies.
  • Financial statements users, such as lenders, may not accept the alternative.
  • The alternative does not apply to other intangibles; therefore, other indefinite-life intangibles, such as franchise rights, still require an annual impairment analysis.
  • Dealerships will need to assess the potential impact on loan covenants. Many dealerships have net worth, debt to equity, and shareholder distribution to net income covenants. Amortization expense of the goodwill will reduce net income and net worth on an annual basis, potentially resulting in a failed loan covenant when the dealership would have otherwise passed.

The simplified hedge accounting approach:

This alternative allows private companies to elect a simplified approach for accounting for certain receive-variable, pay-fixed interest rate swaps. The key elements are as follows:

  • If certain conditions are met indicating that the terms of the swap and debt are aligned, the swap is assumed to be effective.
  • Hedge documentation could be completed within a few weeks of inception, rather than when the swap is entered into.
  • The company could elect to apply this approach to any swaps, both those in existence at the time of adoption or entered into afterwards.
  • Although the current swap disclosures would still be required, the company would be permitted to substitute the settlement value of the swap for the fair value wherever applicable.

Note: If the company elects the above accounting treatment for swaps, this alternative would be applied using either 1) a modified retrospective approach (opening balances of the current period presented would be adjusted to reflect application) or 2) a full retrospective approach (financial statements for each prior period presented and the opening balances of the earliest period presented would be adjusted to reflect the period-specific effects of application).

Dealerships often enter into debt agreements for which the lender then requires an interest rate swap agreement. As such, dealerships should weigh the pros and cons, some of which follow:

Pros:
  • Reduction of costs related to measuring fair value of interest rate swaps
  • Reduction of fluctuations in the income statement
Cons:
  • Recognition and measurement difference between public companies.
  • Financial statements users, such as lenders, may not accept the alternative.

Both of these accounting alternatives would provide simplified accounting and potential cost savings for many dealerships. However, dealerships must assess the potential ramifications of adoption, particularly whether or not users of the financials, including lenders and investors, will accept the new accounting, as well as the future plans of the dealership.

On the horizon:

An additional private company alternative proposed by the PCC would exempt dealerships from consolidating variable interest entities under common control leasing arrangements, if certain requirements are met. As dealerships commonly rent the dealership real estate from a separate entity that is controlled by parties related to those controlling the dealership entity, Baker Tilly will provide you with updates as this proposal progresses. 

For additional information, connect with one of our Baker Tilly Dealership Group team members or e-mail us at autodealers@bakertilly.com.