Financial reporting for privately held construction firms has become increasingly difficult and time-consuming for executive management teams.
The Private Company Council (PCC) is an advisory body to the Financial Accounting Standards Board (FASB), which is responsible for setting generally accepted accounting principles (GAAP). The PCC has been tasked with identifying certain onerous accounting topics facing privately held companies and exploring alternative accounting treatment to simplify the accounting complexity and reduce resources needed to comply with current GAAP. Additionally, they have taken on several projects of importance to construction executive management teams. The following four accounting alternatives are available to privately held construction firms.
Accounting for Goodwill (ASU No. 2014-02)
Goodwill results from purchase price paid for assets in a business combination in excess of the fair value of the assets acquired. Construction firms have been able to apply acquisition accounting with relative ease to identify the amount of goodwill to record in a business combination. However, the ongoing effort and related cost associated with evaluating goodwill for impairment at each reporting period is overly burdensome for private companies. The accounting alternative simplifies ongoing accounting by providing an option to amortize goodwill during a 10-year period, while also providing a simplified impairment analysis should a triggering event occur. A triggering event is further defined in the standard, but is essentially an occurrence of an event that would indicate fair value has fallen below its carrying amount. Straight-line amortization of goodwill reduces the time and complexity in accurately reporting the financial position of the construction firm.
Accounting of Identifiable Intangible Assets in a Business Combination (ASU No. 2014-18)
In addition to goodwill, construction firms are required to identify other intangible assets purchased in a business combination under GAAP. Utilizing the accounting alternative offered to private companies, construction firms no longer need to separately recognize customer–related intangible assets that are not capable of being sold or licensed and non-compete agreements. These intangible assets are now classified as goodwill and will be amortized over a 10-year period. Construction firms that elect to implement this accounting alternative also are required to implement the accounting alternative for goodwill discussed above.
Accounting for Variable Interest Entity Consolidation in Common Control Lease Activities (ASU No. 2014-07)
It is common for construction firms to use a separate legal entity, such as a partnership, LLC or trust, to hold real estate or equipment that is leased to the operating entity. The ownership structure of that separate entity is typically similar to that of the operating entity. GAAP requires consolidation of certain entities under common control and accounting for the consolidation is time-consuming, costly and often provides very little meaningful information to users of the financial statements. Under the accounting alternative, lessees (construction firms) are not required to evaluate lessors (separate legal entity) for consolidation if the following criteria are met:
- lessee and lessor are under common control;
- lessee has leasing arrangement with lessor;
- substantially all activities between the lessee and lessor are related to leasing activities; and
- if lessee guarantees or provides collateral for obligation of the lessor related to the asset leased by the lessee, then the principal amount of the obligation does not exceed the value of the asset leased.
Accounting for Certain Receive-Variable, Pay Fixed Interest Rate Swaps (ASU No. 2014-09)
Construction executive management teams often find significant uncertainty in their day-to-day operations and may wish to limit their exposure to variable borrowing costs on significant capital improvements. Construction firms that enter into basic interest rate swap agreements can elect to apply the accounting alternative to reduce cost and complexity in accounting for the transaction. Certain criteria must be met to apply the simplified accounting alternative:
- variable rate of the swap and the borrowing are based on the same index and reset period;
- the terms of the swap are typical and there is no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap;
- the repricing and settlement dates for the swap and borrowing match each other (or differ by no more than a few days);
- the fair value of the swap at is at or near zero;
- the notional amount of the swap matches the principal amount of the borrowing being hedged where the amount of the borrowing being hedged may be less than the total principal amount of the borrowing; and
- all interest payments on the borrowing that occur during the term of the swap are designated as “hedged” whether in total or in proportion to the principal amount of the borrowing being hedged.
The accounting alternative further simplifies the accounting treatment by permitting the construction firm to record the interest rate swap at settlement value rather than fair value, as well as assume the hedge is effective with changes in settlement value recorded through other comprehensive income.
Construction executive management teams should discuss these accounting alternatives with their CPAs well in advance of any reporting period to understand the impact these alternatives will have on financial reporting. Once an in-depth understanding is obtained, construction firms should further discuss any elected accounting alternative with their bank, surety and other key professional advisors. When properly implemented, most construction firms will realize ongoing savings from these accounting alternatives and other projects identified by the PCC.