Under existing UK GAAP, both FRS 10 and the FRSSE require that goodwill and other intangibles are amortised over their useful economic life – but this should be no more than 20 years.

FRS 10 includes a rebuttable presumption which states that the useful life of purchased goodwill may be assessed to be more than 20 years only if the durability of the acquired business or intangible asset can be demonstrated and that the entity justifies estimating the useful economic life to exceed 20 years. Where an entity determines the useful economic life of goodwill to be more than 20 years, FRS 10 requires impairment reviews to be carried out at the end of each reporting period. Some entities have taken this caveat to the limit by not amortising at all.

There has been no such caveat in the FRSSE. However, small entities not wanting to amortise at all; or wanting to amortise over more than 20 years could discard the FRSSE and follow full UK GAAP – provided, of course, that they did the necessary impairment review required by FRS 10.

In practice, for most entities, goodwill will have been amortised over a period of no more than 20 years and the entity will have established reliable evidence to support the amortisation period. That said, the impact of changes to tax relief for goodwill in 2002 might have encouraged some entities to determine a much shorter useful economic life! The tax relief was introduced on a prospective rather than retrospective basis, but thereafter some entities would have justified a period significantly less than 20 years.

Under FRS 102, “goodwill shall be considered to have a finite useful life, and shall be amortised on a systematic basis over its life. If an entity is unable to make a reliable estimate of the useful life of goodwill, the life shall not exceed 5 years”.

So, goodwill continues to be amortised over its useful economic life, though this is to be a finite life. It will be no longer possible to have an infinite life, though this is not common in practice.

Entities will need to assess the useful economic life of goodwill and amortise it over that life.  If the entity is not able to make a reliable estimate of the useful life, the default period is not to exceed 5 years. FRS 102 does not state that all goodwill will have useful economic life of 5 years.  Many entities will be amortising goodwill over more than 5 years. This can, and should, continue under FRS 102 – provided this is a reliable estimate of the useful economic life. The 5-year cap only applies when a reliable estimate cannot be made. It could be that a reliable estimate can be made and that is less than 5 years. This may very well have been the case for entities, where eligible, that were claiming tax relief. If the circumstances are such that a reliable estimate for the useful economic life cannot be made at the date of transition to FRS 102, then the 5-year cap starts ticking from the date of transition (i.e. the date for the opening, comparative balance sheet).

It should be noted that changes to the EU Accounting Directive will mean that the stipulated 5 years will increase to 10 years. However, whether the threshold is set at 5 or 10 years appears to be a red herring. The fundamental principle is that goodwill is amortised over it useful economic life – whether that be less than 5; more than 10 or somewhere in between.

Entities will need to justify the useful economic life. Considerations will vary dependent upon the circumstances. Goodwill could arise on the acquisition of a business – where the acquirer might consider whether the vendor will remain with the newly acquired business as part of an earn-out; and whether the vendor’s business name will continue to be used. Goodwill could also arise on the incorporation of a business where the entity might consider the age profile of the owner-managers and the expected longevity of clients.

At the date of transition to FRS 102, an entity will need to consider the basis for their previous estimate of goodwill and determine whether it is reliable.  The guidance within FRS 102 states that information is reliable when it is “free from material error and bias and represents faithfully that which it either purports to represent or could reasonably be expected to represent”.

It is highly likely that most entities will not need to change the amortisation period for goodwill.  It is a matter of judgement what the useful economic life of goodwill should be. If the reliability of the useful economic life of goodwill has been considered to be appropriate under current GAAP and there is nothing which affects this estimate at the date of transition to FRS 102, there would appear to be no need to change the period of amortisation under FRS 102.

It’s life – and probably still as we know it.

Phil Frost