Intangibles are the gold of the 21st century with estimates suggesting that 80% of a listed company’s share price is no longer supported by the presence of tangible assets on its balance sheet.
This is not a new problem but it is an evolving finance conundrum for accountants and those seeking to leverage finance against these assets. With Financial Reporting Standard 102 (FRS 102) coming into effect from the end of 2015 (where a company’s accounting year is the calendar year) and April 2016 (where it is the fiscal year) it is about to get a whole lot more important for SMEs who will now follow substantially the same rules as multinationals.
It’s therefore a good time to brush up on the identification and valuation of this category of assets, which is responsible for driving the majority of value in most companies. The main changes fall under two headings.
Buying or ‘merging’ companies Currently, when two companies are combined, either merger accounting (adding the two existing balance-sheets together) or acquisition accounting (placing a fair value on all acquired company’s assets) might be permissible. FRS 102 states acquisition accounting must be used in nearly all cases (bar group reorganisations).
Also, acquisition accounting rules are being updated. Any excess paid over and above the fair value of the fixed assets and liabilities can no longer simply be characterised as ‘goodwill’. Instead, it needs to be broken down into goodwill and identifiable intangible assets, in a very similar manner to IFRS 3 (with some minor wording differences).
This means that the sources of intangible value that have never previously appeared on an acquired company’s balance-sheet will need to be identified and quantified.
The useful life of intangible assets and 'goodwill' FRS 102 preserves the option, previously available under SSAP 13 (which it replaces), of either amortising qualifying development costs of new products and services over a suitable period, or expensing these costs during the year in which they are incurred.
However, UK GAAP currently permits ‘goodwill’ to have an indefinite life, as long as the value is tested annually for impairment. Under FRS 102, the concept of an indefinite life falls away and a lifespan has to be specified for amortisation purposes.
If an asset’s lifespan cannot be determined reliably, a ‘default’ figure of five years must be used. This is much shorter than existing UK GAAP, under which it would have been customary to amortise some assets over a much longer period (up to 20 years).
Combine these changes with the reduced role of ‘hard’ assets, which are increasingly outstripped by spending on intangibles, and the number of businesses looking to reflect their real investment profile on their balance-sheet looks set to rise.
In line with this ACCA has been piloting some work to understand the impact intangibles are having on innovation within SMEs. The initial study was conducted in Malaysia; the outcomes of the UK study will be available shortly.