Σ 目 M N E ווי A Appendix A Private Company Accounting 口 The FASB has traditionally taken the position that there should be one set of GAAP. However, due to growing concern about differential costs and benefits of a "one size fits all" reporting package, the FASB has considered providing alternative accounting treatments for private companies in areas that include (1) recognition and measurement, (2) presentation and disclosure, and (3) transition methods for financial accounting standards and effective dates. Since 2012, the FASB has worked with the Private Company Council (PCC) to improve the process of setting accounting standards for private companies. A.1 The Private Company Council (PCC) Background on the PCC The PCC is comprised of 9–12 members with balanced representation from private company auditing, preparer, and user communities. The PCC has two principal responsibilities: 1. The PCC determines, using the Private Company Decision-Making Framework (PCC Framework), whether alternatives to existing GAAP are necessary to address the needs of users of private company financial statements. 2. The PCC serves as the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB's technical agenda.¹ Following a FASB endorsement process, alternatives for private companies developed by the PCC are incorporated into GAAP. Private Company Accounting Private Company Decision-Making Framework One of the PCC's first responsibilities was to work with the FASB to develop mutually agreed-on criteria for private company alternatives. The result of that joint effort was the Private Company Decision-Making Framework: A Guide for Evaluating Financial Accounting and Reporting for Private Companies (the PCC Framework), issued in December 2013. This guide assists the Board and the PCC in determining whether and in what circumstances to provide alternative recognition, measurement, disclosure, display, effective date, and transition guidance for private companies reporting under GAAP. In making these assessments, the Board and the PCC first should determine whether the alternative recognition or measurement guidance being evaluated provides relevant information to users of private company financial statements at a reasonable cost. That analysis should focus on (a) the relevance of the information in meeting the objective of financial reporting for typical users of private company Financial statements, (b) the characteristics that differentiate users of private company financial statements from users of public company inancial statements, and (c) the cost and complexity of applying the guidance. A-1 MAN < > W A.2 Priv... G read.wiley.com M ists M M + G h 目 • In addition to developing the PCC Framework, the FASB also issued an Accounting Standards Update on the definition of a public business entity. The FASB and the PCC use that definition to identify the types of companies that are excluded from the scope of the PCC Framework. In general, a company is considered a public business entity if is required to file or furnish financial statements to the SEC or to file or furnish financial statements with a regulatory agency (domestic or foreign) other than the SEC in preparation for the sale of or for purposes of issuing securities. ☐ er an • The PCC also has become a springboard for efforts to reduce complexity in GAAP for all types of organizations, not just private companies. The FASB has adopted a practice of considering w GAAP alternative proposed by the PCC may make sense for public as well as private companies along with not-for-profit organizations. For example, the FASB issued an Accounting Standards Update to address financial reporting complexity for both public and private development-stage companies. ૧ Two issues addressed by the PCC relate to the accounting for intangible assets and the amortization of goodwill. = A.2 Private Company Alternatives for Intangible Assets and Goodwill Accounting for Identifiable Intangible Assets = In December 2014, the FASB issued an Accounting Standards Update, developed with the PCC, that provides an alternative to exempt private companies from separately recognizing and measuring non- competition agreements and customer-related intangible assets (such as customer relationships) that are not capable of being sold or licensed independently in a business combination.² Additional Background As discussed in Chapter 11, in a business combination the acquirer separately recognizes all intangible assets that are identifiable, at their acquisition-date fair values. An intangible asset is identifiable if it meets either of the following criteria. 1. It arises from contractual or other legal rights regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. Private Company Accounting 2. It is separable, that is, capable of being separated from the company and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the company intends to do so. For example, in the Tractorling example presented in Chapter 11, Diversified included patents (which meet the identifiable definition) in its calculation of the net identifiable assets. In its reexamination of this accounting for private companies, the PCC found that separate information on certain customer-related intangible assets is not decision-useful because the assets may not be transferable and estimates of their fair values are highly subjective. As a result, the PCC recommended, and the FASB endorsed, an alternative that, if elected, indicates that private company acquirers shall not recognize separately from goodwill the following intangible assets. • Customer-related intangible assets unless they are capable of being sold or licensed independently from other assets of a business. • Non-competition agreements. Examples of customer-related intangible assets include (1) mortgage servicing rights, (2) commodity supply contracts, (3) core deposits, and (4) customer information (for example, names and contact information). Alternative Accounting Example To illustrate in the context of the Tractorling example in Chapter 11, recall that goodwill is recorded only when an entire business is purchased. To record goodwill, a company compares the fair value of the net tangible and identifiable intangible assets with the purchase price of the acquired business. The difference is considered goodwill. Goodwill is the residual-the excess of cost over fair value of the A-2 < ૨ 3 MORGON < > MAN W A.2 Priv... MAN G MORGAN M ists A M ILLUSTRATION A.1 Determination of Goodwill-Master Valuation Approach Diversified records this transaction as follows. Cash Accounts Receivable Inventory Property, Plant, and Equipment Patents Σ Cash $ 25,000 Accounts receivable 35,000 Inventory 122,000 Property, plant, and equipment, net 205,000 Assigned to Patents 18,000 purchase price Liabilities (55,000) of $400,000 Fair value of net identifiable assets Purchase price 350,000 400,000 Value assigned to goodwill $ 50,000 25,000 35,000 122,000 205,000 18,000 50,000 Σ O Goodwill Liabilities Cash 55,000 400,000 To illustrate the private company alternative, assume that instead of patents, Tractorling employees had a non-compete agreement with Tractorling management that would preclude them from working for any competing companies for one year following the acquisition (with an estimated fair value of $18,000) should they leave the company. Such agreements are common in business combinations to ensure a smooth transition period. • If Diversified was a public company, as with the patents, it would recognize this non-compete agreement separately from goodwill on the post-acquisition balance sheet. halance • However, a private company that chooses the alternative accounting would not recognize a separate intangible asset for the non-compete agreement but instead include the $18,000 in the Goodwill A-3 ☹d < > D W A.2 Priv... G M MORGAN Diversified records this transaction as follows. Cash Accounts Receivable Inventory 防 ists K M Σ 25,000 35,000 122,000 205,000 18,000 50,000 Σ Liabilities Cash 55,000 400,000 To illustrate the private company alternative, assume that instead of patents, Tractorling employees had a non-compete agreement with Tractorling management that would preclude them from working for any competing companies for one year following the acquisition (with an estimated fair value of $18,000) should they leave the company. Such agreements are common in business combinations to ensure smooth transition period. • If Diversified was a public company, as with the patents, it would recognize this non-compete agreement separately from goodwill on the post-acquisition balance sheet. • However, a private company that chooses the alternative accounting would not recognize a separate intangible asset for the non-compete agreement but instead include the $18,000 in the Goodwill balance. That is, rather than the entry recorded above, a private company would make the following entry. Cash Accounts Receivable Inventory Property, Plant, and Equipment 25,000 35,000 122,000 205,000 68,000 २ Property, Plant, and Equipment Patents Goodwill G Goodwill Liabilities Cash 55,000 400,000 Note that the Goodwill balance ($50,000+ $18,000) includes the amount attributed to the non-compete agreement. Private companies that elect this accounting alternative must also elect the private company alternative to amortize goodwill (discussed in the next section). Accounting for Goodwill A-3 ດ २ E B R < > W A.2 Priv... MOAN G Accounting for Goodwill read.wiley.com M ists M M + G h B A L ve an The FASB also issued guidance developed with the PCC that provides an alternative for private companies in the accounting for goodwill. 3 Under the alternative, rather than considering goodwill to indefinite life, private companies can elect to amortize goodwill on a straight-line basis over a period not to exceed 10 years. In addition, goodwill under this alternative will be tested for impairment ☐ triggering event occurs and based on a comparison of the carrying value of the goodwill to the fair value of the company or reporting unit. Additional Background a As discussed in Chapter 11, companies consider goodwill to have an indefinite life and therefore should not amortize it. Although goodwill may decrease in value over time, predicting the actual life of goodwi and an appropriate pattern of amortization is extremely difficult. In addition, investors find the amortization charge of little use in evaluating financial performance. Furthermore, the investment community wants to know the amount invested in goodwill, which often is the largest intangible asset on a company's balance sheet. Therefore, companies adjust its carrying value only when goodwill is impaired. As part of its research and outreach efforts on intangible assets and goodwill, the PCC obtained feedback from private company stakeholders that the benefits of the current accounting for goodwill after initia recognition do not justify the related costs. Feedback from users of private company financial statements indicated that the current goodwill impairment test provides limited decision-useful information because most users of private company financial statements generally disregard goodwill and goodwill impairment losses in their analysis of a private company's financial condition and operating performance The PCC also received input from preparers and auditors of private company financial statements indicating concerns about the cost and complexity involved in performing the current goodwill impairment test. Even though the recent introduction of the optional qualitative assessment has provided some cost reduction in testing goodwill for impairment, many of those stakeholders stated that the level of cost reduction has not been significant. Private Company Alternative In response to this input, the PCC proposed (and the FASB endorsed) an alternative accounting for private companies. Under the alternative, private companies that elect the accounting alternative will: 1. Amortize goodwill on a straight-line basis over 10 years, or less than 10 years if a shorter useful life is more appropriate. 2. Test goodwill for impairment when a triggering event occurs that indicates that the fair value of a company (or a reporting unit) may be below its carrying amount. When a triggering event occurs, a company has the option to first assess qualitative factors to determine whether the quantitative impairment test is necessary. If that qualitative assessment indicates that it is more likely than not that goodwill is impaired, the company must perform the quantitative test to compare the company's fair value with its carrying amount, including goodwill (or the fair value of the reporting unit with the carrying amount, including goodwill, of the reporting unit). If the qualitative assessment indicates that it is not more likely than not that goodwill is impaired, further testing is unnecessary. The goodwill impairment loss cannot exceed the company's (or the reporting unit's) carrying amount of goodwill. Alternative Accounting Example Private Company Accounting To illustrate the accounting under the private company alternative, refer to our Trenting exemple in the prior section, in which Diversified recorded goodwill of $68,000 (including the value of the non- compete agreement for Tractorling management). Under the private company alta, tum life of 10 years, Diversified will amortize goodwill through the following entry each year following the acquisition. Amortization Expense ($68,000 ÷ 10) Goodwill 6,800 6,800 < > Going forward, the recorded goodwill is evaluated for impairment only if there is a triggering event that indicates that the goodwill's fair value may be less than the carrying value. Thus, the alternative ccountine is similar to the accounting for limited life intangible assets 4 A-4/nAPPENDIX B (continued) d. What recommendation does the SEC request to resolve the issue? Response: IV. AMERICAN EXPRESS CO a. What filing or disclosure is the comment letter related to (for example, if the letter relates to the 10-K, what section of the 10-K does it relate to)? Response: b. Does the letter indicate that the disclosure violates Regulation G and/or Regulation S-K? If so, which one? Response: c. What are the specific issues with the non-GAAP reporting outlined in the letter? Use your own words to paraphrase/summarize rather than copying and pasting the wording verbatim from the letter. Response: d. What recommendation does the SEC request to resolve the issue? Response: Activity 3: FASB Conceptual Framework Predictive Value FUNDAMENTAL CHARACTERISTICS Relevance Confirmatory Value Completeness Materiality Faithful Representation Neutrality Free from Error (continued on next page)/nAPPENDIX B (continued) b. What is the equivalent GAAP measure? What is the dollar value of the GAAP measure? (hint: use the link in the tweet, which can also be found at https://twitter.com/FedEx/status/1504559854614106114? cxt=HHwWhMCy2evNouEPAAAA) Response: c. Is the non-GAAP measure higher or lower (in dollar value) than the GAAP measure? Response: d. Explain potential benefits investors may get from the disclosure of this non-GAAP measure. Focus on how the format and delivery of the disclosure may help inform the investing decisions of these stakeholders, rather than whether the particular disclosure would increase or decrease the likelihood of investing. Response: e. Explain a potential issue with this disclosure to investors. Focus on how the format and delivery of the dis- closure may help inform the investing decisions of these stakeholders, rather than whether the particular disclosure would increase or decrease the likelihood of investing. Response: vity 2: SEC Comment Letters I. CHEWY, INC. a. What filing or disclosure is the comment letter related to (for example, if the letter relates to the 10-K, what section of the 10-K does it relate to)? Response: b. Does the letter indicate that the disclosure violates Regulation G and/or Regulation S-K? If so, which one? Response: c. What are the specific issues with the non-GAAP reporting outlined in the letter? Use your own words to paraphrase/summarize rather than copying and pasting the wording verbatim from the letter. Response: d. What recommendation does the SEC request to resolve the issue? Response: II. CISCO SYSTEMS, INC. a. What filing or disclosure is the comment letter related to (for example, if the letter relates to the 10-K, what section of the 10-K does it relate to)? Response: b. Does the letter indicate that the disclosure violates Regulation G and/or Regulation S-K? If so, which one? Response: c. What are the specific issues with the non-GAAP reporting outlined in the letter? Use your own words to paraphrase/summarize rather than copying and pasting the wording verbatim from the letter. Response: d. What recommendation does the SEC request to resolve the issue? Response: III. TJX COMPANIES INC/DE/ a. What filing or disclosure is the comment letter related to (for example, if the letter relates to the 10-K, what section of the 10-K does it relate to)? Response: b. Does the letter indicate that the disclosure violates Regulation G and/or Regulation S-K? If so, which one? Response: c. What are the specific issues with the non-GAAP reporting outlined in the letter? Use your own words to paraphrase/summarize rather than copying and pasting the wording verbatim from the letter. Response:/nAPPENDIX B Student Template Activity 1: GAAP and Non-GAAP Measures Reported by Companies Non-GAAP Measures in Company Annual Reports 1. PepsiCo, Inc.'s non-GAAP measures included in 2020 10-K Management's Discussion and Analysis (MD&A) a. What are the names of the non-GAAP measures you identified? What are the dollar or numeric values of these measures? Response: b. What are the equivalent GAAP measures for the non-GAAP measures you identified in Part a? What are the dollar or numeric values of the GAAP measures? Response: c. Are the non-GAAP measures you located in Part a higher or lower (in dollar or numeric value) than the equivalent GAAP measures you identified in Part b? Response: d. What are the main items being added or subtracted from the GAAP measures to calculate the non-GAAP measures (e.g., are there specific expense/revenue items that are added or subtracted)? Response: e. Explain potential benefits investors may get from the disclosure these non-GAAP measures. Focus on how the disclosures may help inform the investing decisions of these stakeholders, rather than whether the par- ticular disclosures would increase or decrease the likelihood of investing. Response: 2. Coca-Cola, Inc.'s versus PepsiCo, Inc.'s non-GAAP measures Explain potential issues with Pepsi including non-GAAP measures and Coca-Cola excluding non-GAAP mea- sures in these communications to investors. Also explain any other potential issues with how Pepsi has reported these non-GAAP measures. Focus on how the disclosures may help inform the investing decisions of these stake- holders, rather than whether the particular disclosures would increase or decrease the likelihood of investing. Response: Non-GAAP Measures in Other Disclosure Mediums 1. FedEx Tweet a. What is the dollar value of Adjusted Net Income (a non-GAAP measure) in Q3 of FY22 by FedEx reported in the tweet? Response:

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