WHAT DO ESCAPE ROOMS AND PURCHASE PRICE ALLOCATIONS HAVE IN COMMON?

Written By: Dallin Bastian, Senior Analyst at EP

|||Purchase Price Allocation & Escape Rooms

Escape rooms have recently become one of the hottest trends in entertainment. I was initially reluctant to try one of these overpriced adventures, but after my wife and friends finally talked me into trying my first escape room, I became hooked and have completed more than 20 rooms since.

As I’ve played several escape rooms with people of varying skill levels, I’ve noticed those new to escape rooms (including me when I first started!) will make the puzzles more complicated than they are meant to be. Rather than focusing on the puzzle in front of them, they search in incredibly unlikely places for hints or clues – the pages of prop books, trying to write complicated calculus formulas from a pattern of numbers, or even trying to figure out a way to get under the floor boards or into the ceiling. These unnecessarily complicated strategies end up distracting from the true solutions and waste valuable time.

Adding unnecessary complexity to an already complicated business world can distract from a company’s mission and waste valuable resources. M&A activity is naturally a complex area of business. In any M&A transaction in which a majority interest is acquired, the acquirer is obligated to fair value all assets and liabilities of the acquired company to create an opening balance sheet for the new entity.  The process of fair valuing all assets and liabilities acquired is called a Purchase Price Allocation (“PPA”). Given that this process involves all tangible and intangible assets and liabilities of the company, it can easily turn into an intricate exercise.

Fortunately, the Financial Accounting Standards Board (“FASB”) was aware that PPA requirements can become particularly onerous for smaller private companies without the same accounting and finance resources as large public companies. The FASB and the Private Company Council (“PCC”) received feedback from private company stakeholders making it clear that the benefits from the detailed nature of the existing PPA accounting requirements did not justify the related costs. On December 23, 2014, the FASB issued an accounting alternative for private companies to improve financial reporting for intangible assets in a business combination.

This update (officially known as “FASB Accounting Standards Update No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination”) allows private companies to take a more simplified approach. Specifically, it allows for private companies to include customer-related intangible assets (i.e. customer and partner relationships) and noncompetition agreements in the value of goodwill rather than valuing them as separate intangible assets. 

To be clear, this simplified guidance only applies to customer-related assets that are not capable of being sold or licensed independently. In applying this guidance, companies need to carefully consider whether their customer-related assets fit this criterion. For example, customer information lists and mortgaging servicing rights, while customer related, are capable of being sold or licensed independently and would NOT qualify for the simplified treatment.

Private companies who elect to adopt this simplified approach should be aware of a corresponding requirement – if the simplified accounting alternative for PPAs is used, the company must also adopt the private company alternative to amortize goodwill rather than performing an annual impairment test. More information on this requirement can be found in the FASB Accounting Standards Update No. 2014-02: “Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill.”

As a final note, if transactions that have occurred in the past have been accounted for using the traditional PPA accounting guidance and customer-related assets or noncompete assets have been recognized, these assets should NOT be rolled into goodwill and should be treated according to the traditional guidance.

In dealing with the challenges of the modern business world, leaders should take advantage of any opportunity to simplify processes in their companies. Applying the simplified accounting alternative can assist with this when dealing with M&A activity and help companies escape the trap of unnecessary complexity.

2019-12-20T19:15:04+00:00