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ACCOUNTANCY

The ASB's new financial reporting standard on goodwill andintangibles will bring previously hidden assets to the balance sheet aswell as more information about how those figures were arrived at. Thisputs the issue high on the agenda for all FDs.

By this summer finance directors will be coming to grips with a new financial reporting standard on goodwill and intangible assets. The financial reporting exposure draft (FRED 12) received at least grudging admiration for devising a pragmatic solution to one of the most intractable problems in financial reporting. The International Accounting Standards Committee (IASC) is seemingly intent on hanging onto the Accounting Standard Board’s (ASB’s) coat tails on this particular issue in which case one of the most fraught debates of the last few years will either stop completely or, at least, change direction.

According to Financial Reporting 1995-96 – A Survey of UK Financial Reporting only 21% of companies carried intangibles on their balance sheet with by far the most popular intangible being goodwill. The “should they shouldn’t they be on the balance sheet” argument which has raged for years is now over. Intangible asset valuations, which have been dismissed by many respected accountants as highly subjective and volatile and not worth the paper they are written on, are about to become another year end task for the FD and the auditor. Indeed some experts reckon the publication of the new FRS will see a mini-boom in brand valuation.

David Haigh, a chartered accountant who has worked in the field of brand valuation for a number of years, believes brand accounting is a concept whose time has finally come. The ASB is changing a minority sport into something that every finance director is going to have to think about.

With the complicated nature of goodwill and intangibles coupled with the ASB’s sophisticated approach to the problem, it would be surprising if there were not one or two little wrinkles in the standard which the smart FD will be thinking of using to good effect.

The basic approach of FRED 12 is that purchased goodwill and intangible assets should be capitalised and subjected either to systematic amortisation over a limited period or an annual impairment review. And with acquisitions – takeovers, trade sales and various sorts of buyouts – in the UK last year reaching a modest #57bn, even if you prudently claim only 30% of that spent on goodwill and intangibles then the impact on the balance sheet begins to look somewhat hefty. But this figure is retrospective and cumulative.

Under the provisions of the FRED, companies can restate accounts to comply with the new rules. Now the option to restate past acquisitions should probably mean every FD is dusting down the records in order to cherry pick the organisation’s best deal of the last few years. Certain past acquisitions – namely the ones which have turned out well and the FD is reasonably confident won’t have to be written down too much too soon – can then be proudly placed on the balance sheet.

The standard is set to have some inbuilt safeguards against rogue finance directors sticking everything including the kitchen sink on the balance sheet and then pretending to forget about it if the market or the economy turns nasty. Under the proposed standard there is a maximum amortisation period of 20 years for all types of intangible assets.

Write-off should be on a straight-line basis. There is a “rebuttable presumption” that the useful life of an asset is 20 years. This provision will apply particularly to brands. Many famous brands will be assumed to have an indefinite life and will therefore avoid amortisation entirely.

Under the ASB’s proposals management has to carry out a limited annual impairment review of asset carrying values. Where it is assumed that the economic life of an intangible is greater than 20 years – which includes the assumption that its life is indefinite – there should be a detailed annual review based on a thorough discounted cash-flow analysis of the “income generating” unit in question.

The indefinite life assumption is expected to be unusual and will be subject to a “true and fair” test. Impairment tests are expected to be rigorous and independent. One question the FD must answer is who is going to be the independent expert. The natural choice would at first sight be the auditor. But just when many of the ethical storms which blew up in the 1980s have safely passed, both the FD and the audit partner may be wary of controversy. The sensible ones will want to avoid the charge that the valuation department of the company’s audit firm may lack independence and therefore credibility in helping management produce material valuations on assets which they, the auditors, will then review for reasonableness.

Even after the standard comes into force not all assets will be included whoever ends up as the valuer. The slightly odd situation is that internally generated brands will not be capitalised unless they can be shown to be part of a homogenous group of identical assets and to have “a readily ascertainable market value”. FDs will have to separately disclose in the accounts the basis of valuation together with certain key assumptions used in the valuation. After all the fuss to put brands on the balance sheet the ASB’s valiant efforts to ensure that every company has some decent rules to play by, it seems rather churlish to ask how much difference this will make to the valuations of companies, especially those that are quoted.

City and analysts community have often been contemptuous to the idea of “mere beancounters” being able to tell them anything about the worth of a company which they didn’t already know. One merchant banker summed up the opinions of a large proportion of his colleagues when he declared accounting for intangibles was just the last desperate throw to dress up the balance sheet of companies under threat of takeover. He believed the FD could make up any value they like but no-one in the Square Mile would take the resulting balance sheet seriously. The analysts would simply ignore the values they had no faith in and draw their own conclusions.

But stockmarket life isn’t quite as simple as that. The new standard will not only put previously hidden assets on to the balance sheet but it will also provide a great deal of information about how the numbers got there. It seems inconceivable that share prices will not go through a period of comparative readjustments when the smarter analysts have had a chance to go through the various calculations and see how the sums differ for different companies in the same sector.

Love it or hate it balance sheets are about to become a lot more relevant, and therefore a lot more controversial.

Peter Williams is a freelance journalist.

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