Miriam Hanley – Technical Specialist
Revisions to FRS 102 arising from within the Financial Reporting Exposure Draft 67 (“FRED 67”) will see acquiring companies in business combinations being given the option to recognise fewer intangible assets than they had been required to previously. These revisions are being implemented by the Financial Reporting Council (“FRC”) in response to stakeholder feedback, among which was the stated desire to reduce “undue cost or effort”.
However, while this should represent good news for many CFOs (particularly those for whom the cost did appear to outweigh the benefit of performing the valuation exercise), it does not mean a return to the much more straightforward rules under FRS 10 (which allowed the excess of purchase price over the acquired net asset base to be allocated simply to goodwill). In fact, the new provisions remain significantly closer to the FRS 102 rules that are being replaced than the previous FRS 10 rules.
Where intangible assets apply
Under the previous version of FRS 102, intangible assets need to be recognised if they arise from legal or contractual rights, or are separable (i.e. capable of being sold separately from the remainder of the business). The changes being introduced to FRS 102 will mean that companies must recognise any intangible assets that arise from legal or contractual rights and are separable (although there remains an option to recognise assets that meet only one of the two criteria). It is clear therefore that the FRC have raised the hurdle for compulsory recognition of intangible assets in a business combination.
However, while the legal or contractual rights attaching to an intangible asset should in most cases be reasonably evident (for example the patent attaching to a unique piece of technology), there are a surprising amount of intangible assets which have been demonstrated to be separable with reference to market transactions, and so this aspect of the new rules should not be dismissed too quickly. In fact, for many intangible assets (including order backlogs and customer contracts, as well as artistic, contract and certain technology-based assets) it should typically be presumed that these must be recognised, unless it can be proved that they do not fulfil the recognition criteria.
Example: customer contracts
To take the example of customer contracts, there is plenty of market evidence of such contracts being sold at arm’s length on the open market. We would only envisage such assets not being recognised (assuming they are material) if there exist specific provisions that prevent their transfer, e.g. for Government contracts of a highly sensitive nature in which business owners may have been vetted in advance.
It is worth bearing in mind that the recognition of intangible assets is often a good thing, and the option to recognise assets that don’t necessarily need recognition should be given consideration. Among other things, it can improve overall perception of the balance sheet if the various intangible items that drive value are assessed and understood by various stakeholders, in place of a much larger (and otherwise uninformative) single asset identified simply as goodwill.
Our position as to which intangible assets must be recognised, and for which recognition is optional, under the revised FRS 102 are summarised in the following table. It should be noted that the choice to recognise these assets must be applied consistently to the relevant class of intangible assets
When does it come into effect?
The changes come into effect for accounting periods beginning on or after 1 January 2019 (although early adoption is permissible, so long as all of the amendments in FRED 67 are adopted as well).