Business combinations and intangibles

Section 18 of FRS 102 sets out the accounting treatment and disclosure for all intangible assets other than goodwill. Section 19 does the same for business combinations and goodwill.

What is meant by ‘intangible assets’?

[[[An intangible asset is an identifiable non-monetary asset without physical substance.]]]

An intangible asset is an identifiable non-monetary asset without physical substance. To count as identifiable an intangible asset must be separable or must arise from contractual or other legal rights. To be separable it must be capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged.

Section 18 does not apply to:

• financial assets;
• heritage assets; or
• mineral rights and mineral reserves.

When are intangibles recognised?

An intangible asset is only recognised if it is probable that its expected future economic benefits will flow to the owner and if its cost of value can be measured reliably.

Entities should assess the probability of expected future economic benefits using reasonable and supportable assumptions that represent management’s best estimate of the economic conditions that will exist over the useful life of the asset.

How are intangibles measured?

Intangible assets are initially measured at cost. The cost of a separately acquired intangible asset consists of its purchase price and any directly attributable cost of preparing the asset for its intended use.

• The cost of an intangible asset acquired in a business combination is its fair value at the acquisition date.
• The cost of an internally generated intangible asset is the sum of expenditure from the point when it first meets the recognition criteria. Internally generated goodwill is not recognised as an asset.
• The cost of an intangible asset acquired by way of a grant is its fair value at the date the grant is received or receivable.

Where an intangible asset is acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets the entity should measure the cost of such an intangible asset at fair value. This applies unless the exchange transaction lacks commercial substance; or the fair value of neither the asset received nor the asset given up is reliably measurable. In these instances, the cost of the asset is measured at the carrying amount of the asset given up.

What about research and development costs?

The process of internally generating an intangible asset is split into a research phase and a development phase. Research costs are always expenses to profit or loss. Where an entity cannot distinguish the research phase from the development phase, it treats the expenditure on that project as if it were incurred in the research phase only.

FRS 102 contains a list of items (such as internally generated goodwill) which should be treated as an expense and not be recognised as intangible assets.

If the conditions set out in FRS 102 for development costs are satisfied, an entity has the choice of capitalising the expenditure (with subsequent amortisation) or writing the expenditure off as incurred.

FRS 102 does not specify how software and website development costs should be treated.  Entities will need to determine and apply a suitable accounting policy to classify such costs as tangible or intangible fixed assets. It is possible that having considered the nature of the asset that it is recognised as an intangible asset (Note: UITF 29 required all such costs to be capitalised as tangible fixed assets).

How are intangibles subsequently measured?

After initial recognition, assets are measured using the cost model or the valuation model.

Whichever model is chosen, assets are systematically amortised. Additionally, appropriate provision should be made for impairment losses.

If the fair value of a revalued intangible asset can no longer be determined by reference to an active market, the carrying amount of the asset shall be its revalued amount at the date of the last revaluation by reference to the active market, less any subsequent accumulated amortisation and any subsequent accumulated impairment losses.

Amortisation over useful life

All intangible assets shall be considered to have a finite useful life. If in exceptional cases an entity is unable to make a reliable estimate of the useful life of an intangible asset, the life shall not exceed ten years.

How are business combinations accounted for?

Section 19 applies to accounting for business combinations. It provides guidance on identifying the acquirer, measuring the cost of the business combination, and allocating that cost to the assets acquired and liabilities and provisions for contingent liabilities assumed. It also addresses accounting for goodwill both at the time of a business combination and subsequently.

[[[Merger accounting is not permitted except for group reconstructions and certain combinations involving public benefit entity combinations.]]]

All business combinations shall be accounted for by applying the purchase method. Merger accounting is not permitted except for group reconstructions and certain combinations involving public benefit entity combinations. Currently under UK and Irish GAAP, FRS 6 permits the use of merger accounting for business combinations when certain conditions are satisfied. In other respects, the approach to combinations is similar to old GAAP.

Intangibles acquired as part of a business combination

An intangible asset acquired in a business combination is normally recognised as an asset if its fair value can be measured with sufficient reliability. However, an intangible asset acquired in a business combination is not recognised when it arises from legal or other contractual rights and there is no history or evidence of exchange transactions for the same or similar assets, and otherwise estimating fair value would be dependent on immeasurable variables.

[[[An intangible asset acquired in a business combination is normally recognised as an asset if its fair value can be measured with sufficient reliability]]]

Under old GAAP (FRS 7), assets (including intangible assets) are only recognised separately from goodwill if they are “capable of being disposed of or settled separately”. In many acquisitions this limits the number of assets which are separately recognised.

Goodwill acquired as part of a business combination

Positive goodwill acquired in a business combination is initially measured 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. After initial recognition, the acquirer shall measure goodwill acquired in a business combination at cost less accumulated amortisation and accumulated impairment losses.

Goodwill shall be considered to have a finite useful life, and shall be amortised on a systematic basis over its life. As with other intangibles, if in exceptional cases an entity is unable to make a reliable estimate of the useful life of goodwill, the life shall not exceed ten years. Under old UK and Irish GAAP, there is a rebuttable presumption that positive goodwill has a finite life of twenty years or less.

Are there any exemptions on transition?

Yes – business combinations that occurred prior to the transition date can remain as originally accounted for. So combinations effected using merger accounting, where this would now be prohibited, can remain unchanged. In addition, any intangibles that would be separately identified and recognised under FRS 102 can remain subsumed within the amount recognised as goodwill in connection with such combinations.