Goodwill under UK GAAP
FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland deals with the issue of goodwill in Section 19 Business Combinations and Goodwill. Goodwill has always been a somewhat ‘thorny’ issue due mostly to its subjective nature. Debates on the topic have never really met with overall consensus; for example, under UK GAAP goodwill must be amortised, whereas under IFRS® it is tested for impairment at each reporting date instead.
Goodwill is defined in the Glossary to FRS 102 as:
| Future economic benefits arising from assets that are not capable of being individually identified and separately recognised. |
Goodwill usually arises in a business combination, i.e. when a parent entity acquires a subsidiary. At the date of acquisition, a fair value exercise of the subsidiary’s net assets is carried out and is compared to the purchase consideration, with the resulting excess being treated as goodwill (or negative goodwill in the case of a bargain purchase).
Internally generated goodwill can never be recognised on the balance sheet, and this is clearly set out in FRS 102, para 18.8C(f). In addition, The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410), Sch 1, Note 3 only permits goodwill to be recognised when it has been acquired for valuable consideration. (See Note 2 in The Small Companies and Groups (Accounts and Directors’ Report) Regulations 2008 (SI 2008/409), Sch 1).
Positive goodwill
Positive goodwill arises when the cost of a business combination exceeds the net assets acquired. FRS 102, para 19.22 states:
| The acquirer shall, at the acquisition date:
a) recognise goodwill acquired in a business combination as an asset; and b) initially measure that goodwill at its cost, being the excess of the cost of the business combination over the acquirer’s interest in the net amount of the identifiable assets, liabilities and contingent liabilities recognised and measured in accordance with paragraphs 19.15 to 19.15C. |
After initial recognition at cost, goodwill must then be subsequently amortised on a systematic basis over its useful life. There is no option under UK GAAP to assign an indefinite useful life to goodwill. This is notably different than under IFRS 3 Business Combinations which does not permit goodwill amortisation; instead entities preparing financial statements under IFRS are required to test goodwill for impairment at each reporting date.
Under IFRS, there is an accounting policy choice available to measure the non-controlling interests’ share of goodwill at fair value. This is not permitted under UK GAAP.
Goodwill is usually amortised on a straight-line basis over its useful life. FRS 102 states that in exceptional cases where an entity is unable to make a reliable estimate of the useful life of goodwill, that life must not exceed ten years.
FRS 102 uses the phrase ‘in exceptional cases’, hence the expectation is that in most cases management will be able to reliably estimate the useful life of goodwill and hence the cap is only expected to be used in a minority of cases. When management are unable to reliably estimate the useful life of goodwill, the amortisation period cannot be longer than ten years, but it can be shorter.
Impairment of goodwill
As with all other assets, goodwill must be reviewed at each reporting date to identify if it is showing indicators of impairment. Where there are indicators of impairment, an impairment test must be carried out which involves establishing a recoverable amount and comparing this recoverable amount to carrying amount to determine the value of any impairment. FRS 102, Section 27 Impairment of Assets deals with the issue of asset impairment. Additional impairment requirements in respect of goodwill are in paragraphs 27.24 to 27.27.
FRS 102 confirms that goodwill, on its own, cannot be sold. It does not create cash flows to an entity which are independent of the cash flows of other assets. Consequently, the fair value of goodwill cannot be measured directly so it must be derived from the fair value of the cash-generating unit (CGU) to which the goodwill forms part.
For non-wholly owned subsidiaries (i.e. where there is a non-controlling interest (NCI)), part of the recoverable amount of the CGU will belong to the NCI. FRS 102, para 27.26 requires the carrying amount of that unit to be notionally adjusted before being compared to recoverable amount. This is done by grossing up the carrying amount of goodwill which is allocated to the unit to include goodwill that belongs to the NCI. The notionally adjusted goodwill is then compared with the CGU’s recoverable amount to determine the value of any write down.
FRS 102 states that an impairment loss for a CGU is allocated in the following order:
- first to goodwill; then
- to the other assets of the unit pro rata on the basis of the carrying amount of each asset in the CGU.
| Example – Impairment loss of goodwill with NCI
Warrington Ltd acquired 80% of the net assets of Wolves Ltd on 15 January 2020 (which is the date of acquisition) for £340,000. At the date of acquisition, the fair value of Wolves’ net assets and contingent liabilities was £300,000.
At the year end 31 December 2021, the finance director carried out an impairment test on the subsidiary and established a fair value of £200,000 for the CGU as a whole. Wolves’ assets are being depreciated over their useful lives of ten years with £nil residual value at the end of this useful life. Goodwill is amortised on a five-year, straight-line basis. Part of the £200,000 recoverable amount belongs to the NCI. FRS 102, para 27.26 requires the carrying value of Wolves to be notionally adjusted by the goodwill attributable to the NCI. Once this has been done, the notionally adjusted goodwill is compared to recoverable amount to determine the value of the impairment write down for goodwill as follows:
*Goodwill attributable to the parent’s interest of 80% was £100,000, so goodwill attributable to the NCI is ¼ of 80%, hence £25,000. At the end of the year it is £20,000 (£25,000 x 4/5).
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Once an impairment loss on goodwill has been recognised, it cannot be reversed in a subsequent accounting period (FRS 102, para 27.28). This is consistent with the prohibition in company law (SI 2008/409 and SI 2008/410, Sch 1, para 20(1A)).
Conclusion
Goodwill lends itself to a degree of subjectivity and it is important that preparers understand the detail of FRS 102, Section 18 Intangible Assets other than Goodwill (which deals with the amortisation aspects of goodwill) and Section 19. Goodwill amortisation should only be amortised using the cap of ten years when management are unable to reliably estimate the useful life of goodwill. Impairment losses on goodwill cannot be reversed in a subsequent accounting period and there are some technical aspects that need careful consideration which have been examined above where goodwill impairment is concerned.
Category: Accounting and standards, Audit
