Taking goodwill back to basics
FRS 10 Goodwill and intangible assets previously defined purchased goodwill as:
‘The difference between the cost of an acquired entity and the aggregate of the fair values of that entity’s identifiable assets and liabilities. Positive goodwill arises when the acquisition cost exceeds the aggregate fair values of the identifiable assets and liabilities. Negative goodwill arises when the aggregate fair values of the identifiable assets and liabilities of the entity exceed the acquisition cost.’
In a 1901 stamp duty case, Lord MacNaughton defined goodwill as being ‘the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old-established business from a new business at its first start.’ This definition has been cited in a number of subsequent tax cases.
FRS 10 required that positive purchased goodwill should be capitalised and classified as an asset on the balance sheet. Internally generated goodwill should not be capitalised. IAS 38 also states that internally generated goodwill shall not be recognised as an asset.
When goodwill is regarded as having a limited useful economic life, it should be amortised on a systemic basis over that life, and the only time goodwill should not be amortised is when it is regarded as having an indefinite useful life. There is a rebuttable presumption that the useful economic lives of purchased goodwill (and intangible assets) are limited to periods of 20 years or less.
The standard sets out the circumstances when that presumption can be rebutted, which is only when the durability of the acquired goodwill can be demonstrated and justifies estimating the useful economic life to exceed 20 years; and the goodwill is capable of continued measurement.
FRS102 will have a slightly different approach to useful economic life and states that if an entity is unable to make a reliable estimate of the useful life of goodwill, the life shall not exceed ﬁve years.
If an acquisition appears to give rise to negative goodwill, the fair values of the acquired assets and liabilities should be carefully checked to ensure that there is no impairment of assets, or omission or understatement of liabilities. Any remaining negative goodwill should be recognised on the balance sheet. Negative and positive goodwill should not be netted off.
The other area in relation to goodwill that can sometimes cause confusion is relating to whether or not the amortisation is tax deductible. The amortisation would not be allowable if the entity involved were a sole trader or partnership. However, companies can claim a deduction for the goodwill amortisation, as long as the goodwill was created after April 2002. This deduction will even be allowed if the goodwill arose on the incorporation of a sole trader’s business, as long as the sole trader commenced to trade after April 2002.