Section 14 – Business Combinations and Goodwill

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Section 14 – Overview

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Section 14 – Business Combinations and Goodwill
Summary

Section 14 deals with business combinations which relate to the acquisition of trade assets of another business. It does not apply to the acquisition of shares as FRS 105 does not permit consolidated financial statements to be prepared.

A business combination is the bringing together of separate entities or businesses into one reporting entity. All business combinations are accounted using the purchase method of accounting.

What is new when compared to FRSSE/old GAAP?

The period for allowing adjustment to the fair values under Section 14 is the 12-month period after the date of acquisition. These adjustments are adjusted retrospectively (where the 12 months flows into the following year) and as a result a prior year adjustment is required. This contrasts with old GAAP/FRSSE (FRS 7) where the fair value could be adjusted prospectively up until the end of the first full financial year following acquisition.

Under Section 14, positive goodwill should be amortised on a systematic basis over the useful life, which cannot be indefinite. If there is no basis of estimation the default estimate of useful life is 10 years. This compares to old GAAP/FRSSE where the rebuttable presumption was 20 years and in some cases could be considered indefinite. Where under old GAAP a definite useful life was determined then it is likely there will be no change as this would still be applicable. So in practice it should only impact goodwill which was previously considered indefinite.

Section 14 requires an entity to test for impairment if impairment indicators exist. This contrasts with FRS 7 (old GAAP/FRSSE) whereby goodwill which had an indefinite useful life or a life of over 20 years had to be reviewed for impairment annually.

What is different when compared to FRSSE/old GAAP?

Section 14 defines a business whereas under old GAAP/FRSSE (FRS 6) this was not defined. This will mean more scrutiny will have to be applied to assess if a business or just assets are being transferred. However, it is unlikely to create any major differences.

Recognition of contingent assets is not permitted under Section 14 whereas under old GAAP/FRSSE (FRS 7) this was allowed.

Possible adjustment to inventory as under old GAAP/FRSSE the value to be placed on any inventory where the inventory is not traded in a market in which the acquirer participates as both a buyer and a seller at the date of acquisition is the lower of replacement cost or net realisable value.  Under FRS 105 fair value should be used regardless of whether the acquirer participates in an active market in which they are both buyers and sellers. This is unlikely to result in an adjustment as it is not likely to be applicate to many entities.

What is different when compared to previous GAAPs (applicable to all)- General?

Section 14 does not allow intangibles to be separately identified in a business combination instead they must be subsumed within goodwill (i.e. the difference between the fair value given for the fair value of net assets received must be goodwill). This compares with FRS 102 which states that an intangible should be recognised separately from goodwill if fair value can be measured reliably and it is separable or if it arises from contractual or legal rights. Old GAAP/FRSSE required an intangible to be recognised separately where fair value can be reliably measured, it is separable and it arises from contractual and legal rights but also subject to the constraint that, unless the asset had a readily ascertainable market value, the value was limited to an amount that did not create or increase any negative goodwill arising on acquisition. Assuming the exemption in Section 28.10 is claimed not to restate goodwill on prior business combinations this should not result in an adjustment required on transition however if acquisitions since transition an adjustment will be required if applicable.

Section 14 of FRS 105 only applies to business combinations which were effected by way of a trade asset/liability acquisition. It does not apply to the acquisition of shares as consolidated financial statements cannot be prepared under FRS 105. Under previous GAAP’s acquisition by shares was/is covered as consolidated financial statement was permitted to be prepared.

Not permitted to recognise deferred tax of any kind in a business combination and therefore in the determination of goodwill on the acquisition. This compares to FRS 102 where deferred tax was required to be recognised on differences between- the acquisition fair value and tax base (including revaluations and intangibles ‘created’ as a result of the combination but excluding goodwill) and the deferred tax was set against goodwill as well as any other deferred tax that was included in the entity that was acquired. Under old GAAP/FRSSE there was no requirement to take into account deferred tax on the fair value differences however there was a requirement to consider deferred tax generally where applicable. 

No requirement to measure share based payment transaction liabilities on the date of acquisition instead they should be valued based on the Section 23- Employee benefit rules. This share based payment rule was required under previous GAAP’s. This is unlikely to have an impact on entities that will be applying FRS 105 given the size of the entities involved.

Section 14 requires very little disclosures other than disclosures with regard to any financial commitment, contingencies or guarantees relating to this section. ROI entities require disclosure of the useful life of goodwill and the basis for the useful life as well as the accounting policy for business combinations/goodwill.

Other standards affecting Section 14 where differences arise:

Section 8 – Accounting policies, estimates and errors – Section 8 states that an adjustment to fair values require retrospective application which differs from old GAAP where they are adjusted prospectively.

Section 22 – Impairment of assets – This standard provides details of the impairment indicators and how an impairment review is to be carried out.

Section 28 – Transition to FRS 105 – Exemption not to restate business combinations to the requirements of Section 14 – Goodwill and Business Combinations, for business combinations entered in to prior to the date of transition. However, even where this exemption is availed of, on transition an entity will need to drecognise the deferred tax on any fair value adjustments (other than on goodwill) on prior business combinations, with the corresponding amount posted to profit and loss reserves as opposed to goodwill.

Section 24 -Income tax – Section 24 does not permit deferred tax to be recognised whereas old GAAP/FRSSE/FRS 102 did as discussed above. Where this exists the exemption in Section 28.10 to exempt business combinations from being restated will not apply as this only applies to goodwill not being adjusted, therefore the derecognition of deferred tax will be set against profit and loss reserves on transition (for FRSSE/GAAP all deferred tax would be set against P&L reverses)

What are the key points?
What do accountants need to do?

Be aware of the differences between Section 14 and old GAAP/FRSSE/FRS 102.

Review the client portfolio for client companies that engage in business (by way of acquisition of trade assets as opposed to shares)  combinations and advise them of the differences.

Inform clients that intangibles cannot be separately identified from goodwill in a business combination and assess if this has any tax disadvantages.

Advise clients of the potential for increased amortisation in the profit and loss if the reliable estimate of the life of goodwill cannot be measured (applicable for entities transitioning from FRSSE/old GAAP).

Advise clients of the need to retrospectively account for adjustments to contingent consideration and fair values.

Advise companies on the impact on distributable reserves as a result of the non-necessity  to recognise deferred tax on the fair value adjustments (applicable for FRS 102 entities transitioning). In particular, work with clients who have made acquisition since the date of transition so that transition adjustments can be determined e.g. any intangibles that will be subsumed within goodwill and any impact due to the change in amortisation as a result if goodwill amortisation rate differs to the intangible amortisation rate.

Inform clients who have goodwill which is being amortised over more than 20 years, the non-necessity to do an impairment review on a yearly basis under the new standard (applicable for entities transitioning from FRSSE/old GAAP).                                                                

Work with clients to ensure they review goodwill previously considered to have an indefinite life; and assess whether a life can be determined otherwise inform clients of the consequences of depreciating this over 10 years and the impact on profits and distributable reserves. Before any dividend is declared or paid ensure the distributable reserves as reported under FRS 105 are adequate to allow the distribution.

Advise clients of the transition exemption available not to restate business combinations entered into prior to the date of transition. Advise even where this exemption is availed of, that deferred tax on any fair value adjustments will need to be derecognised within profit and loss reserves on transition (applicable to FRS 102 entities transitioning).

What do companies need to do?

Determine whether Section 14 is applicable and if so, determine the difference between Section 14 and old GAAP/FRSSE/FRS 102.

For acquisitions since 1 January 2016 (assuming a 31 December year-end), review the acquisition accounting required under FRS 105 and assess the goodwill, intangibles and deferred tax adjustments required.

Consider whether work-loads can be reduced given the new requirement for impairment reviews to only be performed once impairment indicators exists.

Assess whether the exemption available in Section 28 not to restate goodwill previously recognised under previous GAAP should be claimed.

 

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