FRS 102 Business Combinations, Goodwill, Intangible Assets

The key changes to UK GAAP with the introduction of FRS 102. We review the changes to accounting for business combinations, goodwill and other intangible assets under the new standard.

With the publication of FRS 102, all existing accounting standards for UK GAAP will be replaced by a single standard. As well as simplification, this new standard will result in a number of significant changes to financial reporting in the UK. Adoption will only be compulsory for accounting periods commencing on or after 1 January 2015, but early adoption is permitted for year ends on or after 31 December 2012.

Business combinations

Financial reporting for business combinations under FRS 102 remains largely unchanged. However, there are some key differences.

A business combination remains the acquisition of an identifiable business. This is accounted for by the purchase method (which is essentially the same as the acquisition method).

The fair values of the costs incurred to acquire the business are measured. There are two areas in this that remain unchanged from current UK GAAP, but are different from the treatment under IFRS.

  • If part of the consideration is variable (such as contingent consideration), any adjustments to the actual consideration paid are taken as amendments to the purchase consideration.

On acquisition, the fair value of the assets and liabilities acquired are then measured. There are two key differences in how this will apply under FRS 102.

  • Deferred tax will be recognised on fair value adjustments made to assets or liabilities.
  • Goodwill remains the difference between the fair value of the consideration and the assets and liabilities acquired.

Goodwill is always considered to have a finite useful life and is amortised over the useful life. One key change here is that if the expected useful life cannot be reliably measured, the useful life shall not exceed five years, a substantially shorter period than previously permitted.

If the original business combination is not restated, it is not necessary to change the amortisation period on first time adoption. However, care will be needed with impairment testing going forward. The option to carry goodwill forward indefinitely, subject to an annual impairment review is no longer available under UK GAAP.

If the fair value of assets acquired exceeds the fair value of the consideration paid, negative goodwill is recognised on the balance sheet and amortised alongside the assets acquired. Deferred tax should be considered.

The use of merger accounting is still permitted, but only when there is a group reconstruction with no change to the ultimate ownership of an entity.

Intangible assets

The section in FRS 102 on intangible assets, other than goodwill, replaces FRS 10 and SSAP 13. There are no fundamental changes to the recognition of intangibles, but the definitions for recognition and measurement have been revised.

In particular, it will be easier to recognise internally generated intangible assets. Previously, an asset could only be recognised if there was an active market in that asset. Under FRS 102 internally generated intangible assets can be recognised if their cost can be measured reliably and it is probable that economic benefits will flow to the entity.

Economic benefits may be cost and efficiency savings (as long as they can be demonstrated) as well as external income streams.

As before, internally generated goodwill cannot be capitalised.

Intangible assets may be carried at fair value, but as under FRS 10 this can only occur if there is an active market to establish that value. Intangible assets will continue to be amortised over their expected useful life. However, if the expected useful life cannot be reliably estimated, the expected useful life shall not exceed five years.

Research and development

The accounting treatment for research and development costs is largely unchanged.

Research costs are expensed as incurred.

Development costs can be capitalised if the following can be demonstrated:

  • the project is technically feasible
  • the intention is to sell or use the intangible asset
  • the asset is expected to generate future economic benefits
  • the costs of development can be reliably measured.