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FRS 102 and goodwill amortisation

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16th Jun 2014
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With a reduction in the presumed life of goodwill from 20 to five years under the new reporting standard FRS 102, many accountants are concerned about how goodwill is to be written off. This short overview from Steve Collings clarifies some of the some ambiguities.

There are some notable differences between the way in which goodwill (and other intangible assets) are accounted for in FRS 102 ‘The Financial Reporting Standard applicable in the UK and Republic of Ireland’, which comes into effect for accounting periods commencing on or after 1 January 2015, and that of existing UK GAAP.

Many clients will have goodwill on their balance sheet that has been accounted for under the provisions in FRS 10 ‘Goodwill and intangible assets’ and this short article aims to clear up some of the most commonly asked questions where accounting treatments are markedly different in FRS 102 with an emphasis placed on the value, and amortisation period, to be used on transition to FRS 102.

Please note that this article does not consider any tax reliefs associated with goodwill amortisation. HMRC have issued an Overview Paper for FRS 102 which may be a useful guide for those wanting an idea of the tax impact of FRS 102.

FRS 10 treatment

FRS 10 at paragraph 19 includes a rebuttable presumption that the useful life of purchased goodwill may be assessed to be more than 20 years (or indefinite) only if:

(a)          The durability of the acquired business or intangible asset can be demonstrated and justifies     estimating the useful economic life to exceed 20 years; and

(b)          The goodwill or intangible asset is capable of continued measurement (so that annual   impairment reviews will be feasible).

When a client determines the useful economic life of goodwill to be more than 20 years (and hence rebuts the presumed life in FRS 10), paragraph 37 in FRS 10 requires impairment reviews to be carried out at the end of each reporting period (regardless of whether amortisation is being charged).

In the majority of cases, goodwill will be amortised over a period of less than 20 years and management does have reliable evidence based on reasonable assessments of the acquired business to support such amortisation periods.

Section 19 FRS 102 treatment

Paragraph 19.23(a) of FRS 102 says: “An entity shall follow the principles in paragraphs 18.19 to 18.24 for amortisation of goodwill. Goodwill shall be considered to have a finite useful life, and shall be amortised on a systematic basis over its life. If an entity is unable to make a reliable estimate of the useful life of goodwill, the life shall not exceed five years.”

This paragraph lends itself to a couple of commonly asked questions. The first being “what about goodwill that has got an infinite life?” and the second, “what about goodwill that currently has more than five years left at the date of transition?”

What is important to emphasise is that the paragraph is NOT saying that all goodwill will have useful economic life of five years. Many entities will be amortising goodwill over a longer period (for example 10 years) and this should continue under FRS 102 if this is a reliable estimate of the goodwill’s useful economic life. The five-year cap is only when a reliable estimate cannot be made and this will clearly involve professional judgement.

In terms of goodwill having an infinite life under Section 19, this will not be possible. Goodwill having an infinite life is, in reality, fairly uncommon - although admittedly I would not rule out the possibility of some companies carrying goodwill under the assumption that its useful economic life is infinite.

Under FRS 102 the life of goodwill is not considered infinite and therefore a change in accounting will be needed. Management will need to assess the goodwill’s useful economic life and amortise it over that life. If management is not able to make a reliable estimate of the useful life, the default period is not to exceed five years.

Impact at the date of transition

At the date of transition to FRS 102, the entity needs to consider the basis for their previous estimate of goodwill and ask the question, “Is it reliable?” The guidance in FRS 102 says that information is reliable when it is free from material error and bias and represents faithfully that which it either purports to represent or could reasonably be expected to represent.

The principles in existing UK GAAP say that assets should not be carried in the balance sheet at any more than their recoverable amount. Under existing UK GAAP, it should be the case that if goodwill was considered to be excessive in the balance sheet when compared to recoverable amount, then a write-down to its recoverable amount would be required so that the asset is not overstated in the balance sheet.

In view of this principle, it is highly likely that the vast majority of companies will not change the amortisation period for goodwill. Crucially, it is a judgemental matter and a conclusion as to the useful economic life of goodwill needs to be formed in light of all relevant matters (for example the nature and stability of the acquired business and product lifecycles).

In essence, if the reliability of the goodwill’s useful economic life was not called into question under current GAAP and there have not been any events which affect this estimate at the date of transition to FRS 102, there would be no reason to change the amortisation period under FRS 102. In all cases professional judgement needs to be applied.

When an entity previously carried goodwill assuming an infinite life under FRS 10, but a useful economic life can be reliably estimated for the purposes of FRS 102, then the goodwill should be amortised over that useful economic life.

If, in rare situations, a reliable estimate does not exist at the date of transition to FRS 102, then the five-year cap would become applicable from the date of transition (ie 1 January 2014 for a 31 December 2015 year-end).  

Conclusion

For many clients the issue of goodwill amortisation may not pose a problem - the key is to identify if there is reason at the date of transition to FRS 102 to challenge or revise original estimates. Auditors will need to obtain sufficient appropriate audit evidence concerning any amortisation periods when goodwill is material to the financial statements and satisfy themselves that management’s period of amortisation is appropriate in the company’s circumstances.

The Financial Reporting Council has published some very useful Staff Education Notes which can help shed some light on complex issues. The notes are not definitive statements on how to apply sections of FRS 102 but are primarily designed to illustrate certain concepts. Staff Education Note 13 is a very useful document to read on the transition to FRS 102, especially in the subjective area of goodwill.

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By Jon Pickles
18th Jun 2014 23:34

infinite or indefinite

Is the author confusing the two? I can't imagine any circumstances where the life of an intangible asset could be considered to be "infinite". Plenty, however, where the life is "indefinite".

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By Broniec Associates
19th Jun 2014 16:16

Lax Accounting

It seems pretty clear to me that the goal is to get organizations to put a little work into providing the usefulness of the asset...rather than just giving everyone a 20 year pass. It changes nothing, unless you are unwilling to provide the detail required, which is what they are hoping a percentage of corporations will do. When we do accounts payable audits, we see the result of lax accounting every day.

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