GAAP: Recognition of intangibles and goodwill: old GAAP v FRS 102
A comparison of the recognition treatment of intangibles and goodwill between old UK GAAP and FRS 102, including the potential tax impact of the new standard.
Old UK GAAP
FRS 10 deals with both goodwill and intangible assets. The FRSSE deals with them in the same section.
Purchased goodwill is defined as the difference between the cost of an acquired entity and the aggregate of the fair values of that entity’s identifiable assets and liabilities.
FRS 10 and the FRSSE define intangible assets as non-financial fixed assets that do not have a physical substance but are identifiable and are controlled by the entity through custody or legal rights.
Identifiable assets, in line with companies legislation, are those that can be disposed of separately without disposing of a business of the entity. If an asset can only be disposed as part of a business, it is considered indistinguishable from that business’s goodwill and accounted as such.
FRS 10 and the FRSSE prohibit recognising an intangible asset if future benefits are expected to flow to the entity but the entity does not control the asset via legal rights or custody. That is the case, for example, for a portfolio of clients or a team of skilled staff, where it is expected that they will continue to request the firm’s services or offer their services, but the entity has insufficient control over the expected future benefits to recognise an asset.
An intangible asset acquired as part of a business acquisition should be capitalised separately from goodwill if its value can be reliably measured on initial recognition. Otherwise the intangible asset should be subsumed within goodwill.
FRS 102 deals with goodwill and other intangible assets in separate sections of the standard. Goodwill is included in the section that deals with business combinations.
Goodwill is defined as future economic benefits arising from assets that are not capable of being individually identified and separately recognised. In particular goodwill is the excess of the cost of a business combination over the acquirer’s interest in the net amount of the identifiable assets, liabilities and contingent liabilities recognised.
An intangible asset is defined as an identifiable non-monetary asset without physical substance. Such an asset is identifiable when:
a) it is separable, ie it can be separated or divided from the entity and sold, transferred, licensed etc. either individually or together with a related contract or asset or liability; or
b) 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.
FRS 102 requires an intangible to be recognised only if:
a) it is probable that the expected future economic benefits attributable to the asset will flow to the entity: and
b) the cost or value of the asset can be measured reliably.
An intangible asset acquired in a business combination is normally recognised as an asset because its fair value can be measured with sufficient reliability.
As a result of the definition of an intangible asset included in FRS 102, the recognition of intangibles separately from goodwill is more likely as that may happen even if they cannot be disposed of separately, which was a requirement under the old UK GAAP. In fact FRS 102 allows recognition if the asset arises from contractual or other legal rights. On the other hand, even if the entity does not have control of the asset via contractual or legal rights, an intangible may still be recognised under FRS 102 if it can be separately sold or transferred.
FRS 102 also implies that the fair value of an intangible asset acquired in a business combination can normally be reliably measured, therefore resulting in more intangibles being recognised separately from goodwill in case of a business acquisition than under old UK GAAP, where they were rarely separately recognised. The main impact on financial reporting may result in assets like customer relationships or order books acquired in a business combination to be recognised as identifiable intangibles under FRS 102, separate from goodwill and possibly amortised over different useful lives.
For example a company may acquire the business of another entity that specialises in developing and producing automated industrial machinery for quality control purposes and the purchase agreement may refer to a number of items being transferred like plant and machinery, fixtures, stock, registered intellectual property, know how, customers’ and suppliers’ lists, specifically skilled workforce, such as researchers and designers, and unregistered intellectual property. Under old UK GAAP a number of intangibles, such as customers’ and suppliers’ lists, skilled workforce and unregistered intellectual property, would not normally be recognised. Under FRS 102 they are likely to be recognised as separate intangibles as a result of the business combination. That is because FRS 102 implies that in a business combination the fair value of an intangible can normally be reliably measured and that it is not necessary, as under old UK GAAP, for intangibles to be both separable and controlled via custody or legal rights at the same time to be recognised.
The considerations outlined above will also apply for a small entity considering whether to adopt the FRSSE 2015 or the small entity provisions in FRS 102, as soon as they are available rather than wait for the period beginning on or after January 2016. That is the case because the FRSSE 2015 includes the same requirements in respect of recognition of intangibles and goodwill as the old UK GAAP.
Recognising more intangible assets of different types, with different amortisation periods, could produce more precise results but also require increased and more complex financial reporting work. Additionally material differences in amortisation will impact the results of the reporting entity and its distributable profits. An entity should obtain a detailed understanding, under FRS 102, of the intangibles being acquired as part of a business combination to plan the impact of the proposed transaction on the entity’s financial reporting.
Transition A first-time adopter of FRS 102 may elect not to apply the business combinations provisions to combinations effected before the date of transition. In such a case the entity shall recognise, reclassify and measure, as at the date of transition, all its assets and liabilities acquired or assumed in a past business combination in accordance with the various relevant provisions in FRS 102, apart from a few exceptions including:
intangible assets other than goodwill, as intangible assets subsumed within goodwill shall not be separately recognised
goodwill, as no adjustment shall be made to the carrying value of goodwill.
Tax impact As mentioned, more intangible assets are likely to be recognised separately from goodwill in a business combination under FRS102 than under old UK GAAP.
The relevant legislation for corporate intangible assets, including goodwill, is found in Part 8 of the Corporation Taxes Act 2009.
For tax purposes goodwill is defined by referring to the definition for accounting purposes. HM Revenue & Customs describe goodwill as:
'"Goodwill", in accounting terms, is simply the difference between the price a business fetches when it changes hands, and the value of its identifiable (including intangible) assets. But goodwill that only appears in the consolidated accounts of a group of companies, and not in company-level accounts, is outside the scope of the CTA09 rules.’
Therefore a goodwill asset recognised under an accounting standard in the individual accounts of a company will be automatically recognised under the UK corporation tax regime provided it was created or acquired on or after 1 April 2002.
HMRC describes intangible fixed assets including goodwill as:
‘The term “intangible asset” covers not only intellectual property, such as patents, copyrights, trademarks and know-how, but also a variety of other assets with commercial value such as agricultural quota, payment entitlements under the single payment scheme for farmers, franchises and telecommunication rights.’
For tax purposes Intangible assets including goodwill must satisfy two conditions:
the asset conditions; and
the FA02 rule.
To satisfy the asset conditions, the goodwill or an intangible fixed asset must be recognised as such in the company accounts, unless it falls under specific exclusions in legislation. To satisfy the FA02 rule, the company must have either created or acquired the asset directly or indirectly from an unrelated party on or after 1 April 2002.
The effect of changes to the business combination requirements in FRS 102 will increase the recognition of non-goodwill intangible assets. These assets will fall within the intangible assets regime under CTA 2009. The main feature of the intangible assets regime is that the tax treatment follows the accounting treatment. As there may be more assets classified as separate intangible assets, with different amortisation periods, the tax deductions will follow the accounting treatment and the possible variations in profits that may arise.