In the accounting world, goodwill is treated differently under UK Generally Accepted Accounting Principles (UK GAAP) compared to International Financial Reporting Standards (IFRS).
Under UK GAAP, goodwill is viewed as an intangible asset, subject to amortisation over its estimated useful life. The approach contrasts with that of IFRS, where goodwill is not amortised but tested annually for impairment. These differences in treatment underscore the importance of comprehending the nuances of accounting standards and their potential impact on business valuation and financial analysis.
What is goodwill in accounting?
Before diving into the specifics of UK GAAP, let's briefly define what goodwill represents in accounting. Goodwill represents assets that enhance a company’s value, such as strong brand recognition, a loyal customer base, or an exceptional management team.
It typically comes into play during an acquisition when the purchase price exceeds the fair market value of the target company's net assets. It's an asset that can generate value indefinitely and is subject to annual impairment tests rather than amortisation.
How goodwill works under UK GAAP
Under the UK GAAP, goodwill encapsulates future economic benefits from assets that cannot be individually identified or separately recognised. Unlike regular assets, purchased goodwill is not written off as an immediate expense but is gradually amortised over its useful economic life.
This approach differs significantly from the IFRS. Under IFRS, goodwill is not subject to amortisation. Instead, it undergoes an annual impairment review. This reflects the belief that goodwill possesses an indefinite useful life, continuing to generate value for the business for as long as the business exists.
Positive and negative goodwill under UK GAAP
Under UK GAAP, positive and negative goodwill are handled slightly differently.
Positive goodwill and UK GAAP
Positive goodwill emerges when the purchase price of a business combination surpasses the fair value of the net identifiable assets acquired. Under UK GAAP positive goodwill is treated as an intangible asset, including the future benefits from assets that cannot be individually identified or separately recognised.
Negative goodwill and UK GAAP
Negative goodwill, on the contrary, arises when the acquisition cost for a business is less than the fair value of its net tangible assets. According to Financial Reporting Standard (FRS) 102 under UK GAAP, negative goodwill is deferred and presented on the statement of financial position. This treatment differs from IFRS rules which mandates immediate recognition in profit or loss.
Negative goodwill, up to the fair values of the non-monetary assets acquired, should be recognised in the profit and loss account when these assets are recovered, either through depreciation, sale, or otherwise.
UK GAAP and amortisation of goodwill
The process of amortisation involves gradually writing off the value of the good will over its estimated useful economic life. This period cannot exceed a presumptive maximum of five years unless a longer period can be justified.
The amortisation expense is recognised in the profit and loss account. If there's an indication that the value of goodwill has diminished or become impaired before the end of its useful economic life, an impairment review is carried out. Any impairment losses are also recognised in the profit/loss account.
This treatment provides a systematic and logical approach to accounting for goodwill, reflecting the consumption of the asset over time and providing a clearer picture of how good a company's financial management is.
UK GAAP and impairment of goodwill
The FRS 102 offers further guidance on the impairment of assets, including goodwill. According to FRS 102, goodwill should be subject to impairment reviews. These reviews are particularly necessary if the useful economic life is less than 20 years or if there's an indication the value of goodwill has diminished or become impaired before the end of its useful economic life.
An impairment loss is recognised as a reduction in the goodwill account on the balance sheet and as a loss on the income statement. If the fair value of assets drops below their carrying amount, an impairment loss is triggered. In such scenarios the role of technology in finance is very important as when impairment loss is triggered it can compare and identify such impairment.
It's also worth noting that the option to carry goodwill forward indefinitely, subject to an annual impairment review, is no longer available under UK GAAP.
These provisions ensure the reported value of goodwill remains an accurate reflection of its economic benefit to the company, providing a more transparent picture of a company's financial health.
Examples of goodwill under UK GAAP
A notable real-world example of goodwill under UK GAAP can be drawn from the acquisition of ARM Holdings by SoftBank in 2016. ARM Holdings is a British semiconductor and software design company, while SoftBank is a Japanese multinational conglomerate.
SoftBank acquired ARM Holdings for £24.3 billion, which was a significant premium over the net value of ARM's identifiable assets. The excess amount paid over the net assets was recorded as goodwill in SoftBank's financial statements, as per the requirements of UK GAAP.
Under FRS 10 of the UK GAAP, this goodwill is considered an intangible asset with a finite useful life, and it must be amortised systematically over its useful life. This approach differs from the International Financial Reporting Standards (IFRS), which allows goodwill to have an indefinite useful life.
Key differences in UK GAAP and IFRS for goodwill summarised
Here’s a quick recap of some of the key differences in how goodwill is treated under UK GAAP and IFRS:
Amortisation of goodwill:
● In IFRS Goodwill is not amortised but is subject to annual impairment review.
● Goodwill is amortised in UK GAAP over its estimated useful life. It must not exceed a presumptive maximum of five years unless a longer period can be justified.
Intangible assets – development costs:
● If any development expenses satisfy the recognition criteria under IFRS, they must be capitalised; however, under UK GAAP FRS 102, this is an option once the requirements are satisfied.
Purchases:
● All acquisitions that are additional expenses incurred to secure a contract are declared to be assets under the IFRS standard and are subject to amortisation.
● In contrast, the UK GAAP FRS 120 standard states that acquisitions are recorded in accordance with the relevant period. Thus, for instance, if an employee received commission, this ought to be acknowledged in the month that the commission was received.
Investment property:
● The company may opt to hold the investment property at fair value with adjustments reported in profit or loss, or at depreciated cost under IFRS.
● In contrast, investment property under FRS 102 must be valued fairly if it can be ascertained with reasonable accuracy.
Using technology to keep track of goodwill under UK GAAP
In the digital age, keeping track of goodwill can be made more efficient and accurate with the help of technology. OneAdvanced Cloud-based accounting software, Financials, enables businesses to track and measure goodwill effortlessly. By leveraging this innovative technology, companies can ensure compliance with UK GAAP requirements and streamline their accounting processes.
The tool can help your organisation with measurement and tracking of impairments. It can monitor the carrying value of goodwill and compare it to the recoverable amount to identify any impairments. Such implementing such cloud technology it offers automated calculations, helps manage amortization and impairments, and provides comprehensive financial management tools. As a result, businesses can ensure accuracy, save time, and make more informed financial decisions.