Showing goodwill

The Accounting Standards Board has sent goodwill rocketing to the top of the agenda as the hot issue of the moment with the publication in June of its new draft standard FRED12.

Entitled Goodwill and intangible assets, it proposes a number of radical changes from an immediate write-off to reserves to capitalisation and amortisation with at least one compulsory impairment review in period two. Fortunately, for many, the transition arrangements will leave existing goodwill in place. Nevertheless, this is an issue which will be exercising the minds of finance directors and analysts alike.

In Company Reporting this month, we examine the proposal and speculate about its impact particularly on interest and dividend cover, with the added possibility of consequential impact on debt covenants. According to our database, 98% of companies do not currently amortise so the changes will be even more far-reaching than those of FRS3, Reporting financial performance, in relation to extraordinary items.

Separate disclosure

Electronics manufacturer Racal adds itself to the ever-growing list of companies establishing and disclosing separately a goodwill reserve. The company tells us that this arises from both the desire for greater transparency in the presentation of its accounts and the perception that the future treatment of goodwill may change.

Our database also shows 19% of companies now maintain a separate goodwill reserve. Three of them – European Colour, Misys and Philip Harris – implement a form of reserve to reserve amortisation.

There was a great uproar in December 1991 at the time of the publication of UITF3, Treatment of goodwill on disposal of a business, which specified that calculation of the profit or loss on disposal of a business take into account the related element of goodwill not already written off against profits. This requirement is now embodied in FRED12 for the transitional treatment of goodwill previously written off to reserves.

Some controversy arose as companies tried to mitigate the effects of this requirement by separately disclosing the goodwill element and matching it against an equal and opposite transfer from reserves. The ASB objected and effectively banned the practice by publishing a UITF information sheet in December 1992.

Engineering group Hampson Industries has found another way to mitigate the effect of writing off the goodwill at the time of disposal. At the foot of the profit and loss account, there is a ‘net effect on shareholders’ funds’ line, somewhat helpfully showing the net impact for the benefit of analysts and anyone else who finds the standard treatment less than clear.

Cashflow support

The operating and financial review, originating in the ASB’s July 1993 statement of the same name, is being used increasingly as a platform for expressing views on developments in regulation (see, for example, Argyll in Company Reporting issue no. 73). This month another cash-based business, Marks & Spencer chooses to use the OFR to support the ASB in its review of cashflow statements. M&S goes further, to argue in support of partial provisions for deferred tax.

We have noted recently that responses to the CA 1985 (Miscellaneous Accounting Amendments) Regulations 1996 have been fairly bland. Marks & Spencer seems always to be prepared to offer good value in its accounts and this year is no different. By specifically stating the detailed bases on which payments are made, M&S stands head and shoulders above the crowd. (See, for example, Fine Art Developments in Company Reporting issue no. 74).

The first report of the remuneration committee of furniture retailer Courts discloses an interesting item. Not only do the directors join those of the 3% of companies which disagree with the Greenbury stricture that directors’ bonuses should not be pensionable, but they have also chosen to include benefits in kind which, together with bonuses, add 29% on top of basic pay.

In our May issue, we noted that household products manufacturer Reckitt & Colman (see Company Reporting issue no. 71) was able to dispense with a share premium account on a share issue by first issuing convertible loan stock at a premium and then converting the nominal value of the loan into shares of the same nominal value. Essentially, the premium arose on the issue of the debt not the shares.

We now note that brewer and leisure operator Scottish & Newcastle chooses not to adopt this path and so ends up with # 345m, some 96% of the issue proceeds, locked up in share premium account. The company tells us that it considers the substance of the transaction to be that of a share issue regardless of the scheme adopted and so the accounting would be through a share premium anyway.

Two-edged sword

Increased disclosure is a two-edged sword, as drinks company Matthew Clark found recently. In response to Greenbury, the remuneration committee fully disclosed the amount of relocation assistance provided to the CEO at the time of a head office move. For those analysts who argue that the annual report and accounts contains no price sensitive information, there is another view of the world. At least one fund manager was reported to have told the CEO that he sold out his holding of Matthew Clark on reading the note to the accounts, and the price dropped 15p within days of publication.

The resulting fiasco left the company’s PR agency squirming, trying to find excuses suggesting there was no evidence the sale took place.

The requirement of FRS3 that restructuring costs be treated as exceptional operating costs is generating a new phenomenon: advance notice of exceptional items. Racal, in each of the chairman’s statements, the review of operations and a post-balance sheet note, discloses that a current review has determined the need for a future restructuring. As a result, Racal gives notice that a future charge of # 20m is expected to be treated as exceptional under FRS3.

Clearly, Racal is responding positively to the City’s pathological dislike of surprises, be they good news or bad news. In this sense, it is only for the good that advance notice of exceptional items is given, and it would be a welcome move if others followed suit.

This feature is an edited version of the Review published in Company Reporting, a monthly publication that monitors the financial reporting practices of companies in the UK. Company Reporting is available on subscription at # 385 per annum. This includes an optional half-price offer of a second subscription for a colleague. ‘Goodwill and other intangible assets’ is a brief summary of current policies in relation to intangibles and the proposals of FRED12, ‘Goodwill and intangible assets’. The 15-page report, priced at # 25, is available free of charge to subscribers. ‘Corporate environmental reporting in the UK’ is a comprehensive survey of environmental reporting by UK listed companies, covering both annual accounts and separate environmental reports. The 150 page-report, priced at # 150 is available to subscribers to ‘Company Reporting’. Details from Andrew Anderson at Company Reporting on 0131-558 1400.