Mergers and acquisitions can be downright daunting. They require dealer-owners to agree on a fair price, negotiate terms, obtain financing and receive approval from manufacturer representatives. But there’s now one less thing for private dealerships to worry about after the deal closes. The Financial Accounting Standards Board (FASB) has simplified its rules for the subsequent measurement of goodwill.
Goodwill — also known as “blue sky” — is an intangible asset. Think of goodwill as the “it factor” that differentiates you from other dealers. It comes from years of cultivating relationships with repeat buyers and a reputation for offering fair prices and reliable, friendly customer service. You can’t touch goodwill, but it’s potentially very valuable.
Accountants have a more formal definition, of course. FASB defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination [. . .] that are not individually identified and separately recognized.” The only time goodwill appears on a balance sheet is following a merger or an acquisition.
Accounting for business combinations and impairment
Current Generally Accepted Accounting Principles (GAAP) require buyers to allocate the purchase price to the assets acquired and liabilities assumed based on their fair values. It’s straightforward for most working capital and debt accounts. You simply transfer book value from the seller’s balance sheet to the buyer’s balance sheet. But other assets, such as used vehicle inventory, customer lists and franchise agreements, may require outside appraisals.
Any purchase price that’s not assigned to identifiable assets and liabilities is booked as goodwill. GAAP requires goodwill to be tested for impairment after the deal closes at least annually (or more frequently if certain conditions exist).
Goodwill impairment occurs when the fair value of the company or reporting unit falls below its book value. If goodwill is determined to be impaired, its book value is reduced on the balance sheet and an impairment loss is reported on the income statement. This could, theoretically, send up a red flag with investors and lenders.
Simplified alternative for private companies
With the issuance of Accounting Standards Update (ASU) 2014-02, Intangibles —Goodwill and Other (Topic 350): Accounting for Goodwill, FASB now offers privately held companies an alternative goodwill measurement method. That’s because — after soliciting feedback from private company lenders, owners and accountants — FASB learned that many stakeholders disregard goodwill and impairment losses when assessing operating performance.
So for years beginning after Dec. 15, 2014 — or earlier if you prefer — private dealers will have the option to amortize existing and newly acquired goodwill on a straight-line basis over a 10-year period (or less, if you can justify a shorter useful life).
By electing to use the alternative method, you’ll lower the carrying value of the goodwill, which makes taking an impairment loss less likely. Also, you’ll no longer be required to perform impairment testing annually.
Occasional impairment testing
Goodwill impairment is more likely to happen under certain conditions. So FASB does require private dealerships to test for impairment when “triggering events” take place. Examples of triggering events include unanticipated competition, the loss of a key person, and the issuance of a new regulation that has a significant adverse effect on auto dealerships.
Goodwill impairment equals the excess of the carrying amount of the entity over its fair value. This measurement standard is simpler than GAAP for nonprivate entities, because private firms aren’t required to hypothetically reallocate fair value to all of the entity’s identifiable assets and liabilities.
In addition, private companies can measure impairment at the entity level. So, if you have multiple franchises that are doing well overall but an acquired franchise is underperforming, the modified rules give you extra time to turn things around before reporting an impairment loss.
More changes in the works
The amendments found in ASU 2014-02 will certainly reduce the time, costs and headaches associated with goodwill impairment testing. But they also could signal a more important trend: FASB is slowly recognizing that, for private companies, the costs of preparing statements in accordance with GAAP sometimes outweigh the benefits.
In fact, the same day it simplified the goodwill requirements, FASB also modified how private companies can report simple interest rate swaps with amendments found in ASU 2014-03, Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps — Simplified Hedge Accounting Approach.
These new alternatives are good news for dealers who struggle to stay atop increasingly complex GAAP rules. Stay tuned in case FASB issues more exceptions for private companies in the months ahead.
Bargain purchases sidestep goodwill accounting issues
If you buy a distressed dealership, you might be able to negotiate an exceptionally low price. But what happens when the combined fair value of the acquired assets (net of assumed liabilities) exceeds the purchase price? This is called a bargain purchase.
In a bargain purchase you still allocate value to identifiable assets and liabilities based on their respective fair values. Generally Accepted Accounting Principles (GAAP) also require you to report a one-time extraordinary gain on the purchase date. But no goodwill is reported — even if the acquired dealership had previously established a solid reputation and loyal customers.