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Financial Reporting and the Law

The activities of the Private Company Council (PCC) could create new compliance challenges for public companies that make acquisitions if the acquired entities or investees have financial statements prepared in accordance with any private company accounting standards. In December 2013, the PCC—an organization created in 2012 by the Financial Accounting Foundation’s board of trustees to examine whether private companies should have different accounting standards—and the FASB announced their issuance of a Private Company Decision-Making Framework. The FASB also adopted a definition of a “public business entity.” The framework and the new definition are intended to assist the FASB and PCC in determining whether to provide alternative standards for private companies reporting under U.S. GAAP. The only entities that will be able to rely on the accounting standards for private companies are those that do not fall under the new definition of “public business entity.”

In January 2014, the FASB announced the issuance of accounting standards updates for a different goodwill standard and a simplified hedge accounting standard that private companies may use. The accounting standards will permit private companies to do the following:

  • Amortize goodwill over a period of 10 years, unless the company can justify a period of less than 10 years, and test impairment using a simplified goodwill impairment test that will have to be conducted only when a triggering event occurs.
  • Simplify the accounting for interest rate swaps that are entered into for the purpose of economically converting variable-rate interest payments to fixed-rate payments.

Both of the new standards will be effective for fiscal years beginning after December 15, 2014 as well as for interim periods within those years; early adoption is permitted.

As a result of the PCC’s goodwill recommendation, the FASB added a project to its agenda on the accounting for goodwill by public business entities and directed its staff to study the alternative adopted for private companies. In response to another PCC recommendation, the FASB issued a proposal in November 2013 to eliminate the current requirement that development-stage companies must present inception to date as well as other unique disclosures. We expect that the FASB will continue to consider whether PCC recommendations are also appropriate for public business entities.

Public companies may be unable to acquire private companies that have relied on the new private company accounting standards because of the SEC’s requirements for financial statements of certain acquired private companies (mandated by Rule 3-05 of Regulation S-X). In addition, public companies may not be able to make investments in such private companies because the new definition of “public business entity” includes any entities whose “financial statements or financial information are required to be or are included in a filing” with the SEC. The FASB listed SEC Rules 3-05, 3-09, and 4-08(g) of Regulation S-X as examples of when entities’ financial statements or financial information are included in an SEC filing. We are hopeful that this means entities will not be considered to be public business entities if their results are reflected in a public company’s financial statements pursuant to the equity method of accounting but are not significant to the public company for purposes of Rule 3-09 or 4-08(g).

Accordingly, in making investments, a public company will need to do the following:

  • Examine the extent to which the private company’s financial statements reflect any such exceptions and modifications.
  • Evaluate the impact on the public company’s ability to file with the SEC the financial statements of the acquired entity or investee or include the investee’s financial information in its financial statements in accordance with Regulation S-X. However, this may be difficult if the private company does not have the records necessary to prepare financial statements in accordance with public company accounting standards.