Goodwill

Get the details right

Steve Collings, Partner, Leavitt Walmsley Associates Ltd examines the thorny issue of goodwill and how it must be reviewed to identify if there are indicators of impairment.

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 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 as the case may be in 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

Example: Impairment loss of goodwill with non-controlling interest

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.

£’000

Fair value of net assets and contingent liabilities 300 Goodwill (see below) 100 NCI (£300k x 20%) 60

Goodwill

Part of the £200,000 recoverable amount belongs to the non-controlling interest. FRS 102 para 27.26 requires the carrying value of Wolves to be notionally adjusted by the goodwill attributable to the non-controlling interest. Once this has been done, the notionally adjusted goodwill is included in the net assets of the subsidiary and compared to recoverable amount to determine the value of the impairment write down for goodwill as follows:

£’000 £’000

Goodwill (£100k x 4/5) 80

Cost of investment 340 Unrecognised NCI share of goodwill* 20

Net assets acquired (£300k x 80%)

Goodwill on acquisition (240)

100 Gross carrying value of net assets 300 Depreciation (30)

270

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 cash-generating unit 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. Notionally adjusted carrying value

Recoverable amount

Impairment loss 370

(200)

170

*Goodwill attributable to the parent’s interest of 80% was £100,000, so goodwill attributable to the NCI is 0.25 of 80%, hence £25,000. At the end of the year it is £20,000 (£25,000 x 4/5).

Carrying value of CGU £’000 Impairment £’000

Goodwill belonging to parent 80 (80)

Gross value of identifiable assets 300

Postimpairment £’000

Depreciation (30) 270 (70) 200 Carrying value 350 Recoverable amount (200)

Impairment loss in the parent 150 (150)

Proof:

Total impairment loss as notionally adjusted

Unrecognised NCI share of goodwill Impairment loss in the parent 170

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 there are 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 s 27 Impairment of Assets deals with the issue of asset impairment. Additional impairment requirements in respect of goodwill are in paras 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 to which the goodwill forms part.

For non-wholly owned subsidiaries, i.e. where there is a non-controlling interest, part of the recoverable amount of the cash-generating unit will belong to the non-controlling interest. 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 noncontrolling interest.

The notionally adjusted goodwill is then compared with the cash-generating unit’s recoverable amount to determine the value of any write down.

FRS 102 states that an impairment loss for a cash-generating unit 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.

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 s 18 Intangible assets other than goodwill (which deals with the amortisation aspects of goodwill) and s 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. ●

As with all other assets, goodwill must be reviewed at each reporting date to identify if there are indicators of impairment.

Author bio

Steve Collings is the audit and technical partner at Leavitt Walmsley AssociatesLtd.