With a witch-hunt having been waged on accounting irregularities since the Enron/Andersen affair came to light, it was perhaps only a matter of time before the UK’s largest accounting software company should have its time in the spotlight.
The attention, viewed as unwanted by Sage, has duly arrived on the Newcastle-based company, and has centred on its accounting mechanism, labelled ‘contentious’ by one industry analyst recently. This attention has been partially brought because Sage appears to be the only IT company in Europe not to amortise goodwill. It was warned its profit figures would be hit ‘by a significant amount’ if it moved away from its mechanism towards a standard industry type.
In response to these allegations, Sage has issued the ostrich approach, and refused to talk about the issue, or put anyone in front of the media, claiming: ‘this is no issue for us’.
But, the fact remains that the company could face millions of pounds of write-offs in the unlikely event the Financial Reporting Review Panel ordered it to move to standard industry practice in the way it treats the numerous acquisitions it has made lately.
After a number of deals in recent years, Sage has £836m of goodwill sitting on its balance sheet. If say, it was to amortise this over 20 years, it would have to wipe off more than £40m a year off its paper value – though it would not affect cashflow.
Its acquisition strategy includes the buyout of customer bases and local brands (eg. PeachTree, Best, Saleslogix) followed by active spending on maintaining customer relationships (55% of revenues are recurring in nature from the installed base) and the various software brands.
According to its latest annual report, The Sage Group profits were up £10m to £84m. Instead of amortising goodwill, Sage completes an annual impairment review, examining the performance of each business it has acquired to see if the value has fallen. Of course, its policy is fully disclosed and highly visible, and enables readers to evaluate it and apply amortisation charge if they want.
A Sage statement on the issue reads: ‘Our accounting principles comply with UK and US GAAP. Sage has a track record of significantly enhancing the value of goodwill. Our approach involves subjecting goodwill to rigorous annual impairment review rather than arbitrary amortisation.’
However, what is for sure, is that its policy on goodwill complies with UK and US GAAP. It also has a track record of significantly enhancing the value of goodwill on its purchases.
A lot of its goodwill is represented by customer bases, channels to market and Sage’s track record is to grow the value of these assets.
Its approach also involves subjecting goodwill to rigorous annual impairment review rather than arbitrary goodwill amortisation. Auditors place significant emphasis on this area.
In any event, analysts use EBITDA and cash flow as critical measures of performance. And if the company did change its policy, its headline earnings and estimates would not alter.
Earnings for technology businesses are generally considered before goodwill amortisation and exceptional items (the rest of the UK and US software universe presents their headline earnings this way).
Therefore, if Sage were to begin amortising goodwill, it would not lead to a change in analyst estimates around the City, since the change would be ‘below the line’.
Sage’s policy is unusual, but nothing more. Current policy is to carry goodwill on its balance sheet and perform an impairment test annually.
This is allowable under FRS 12, although a more usual approach in the UK would be to amortise over five or 10 years with impairment tests only if business conditions suggest the goodwill had materially fallen in value.
Sage’s approach would require its management to justify to the auditors the carrying value of the balance sheet goodwill (£836m) in terms of the value of the Sage customer base and brand to the business. Goodwill amortisation is intended to write off through the P&L the value of acquired customer relationships and brand value. Sage’s argument is that, through its marketing and high-service model it maintains the value of the acquired goodwill asset.
But, post Enron, everyone is worried about cash and for as long as Sage continues to undertake its accounting in a different manner to everyone else, the issue may continue to hog the headlines.
How long this policy will be allowed to remain is debatable, as the government is in the process of consulting on the issue of goodwill. Changes to legislation should be expected. Soon.
REVENUE’S INTANGIBLE REFORM
The Inland Revenue is expected to announce at the end of November the outcome of consultation into the taxation of intellectual property, goodwill and other intangible assets.
Comments were invited on the draft clauses and the partial regulatory impact assessment before the end of January.
The government published proposals for a comprehensive new regime for intangible assets at the time of the Budget last year. These proposals were developed after consultation with business and were designed to:
- provide relief for the cost of acquiring intangible assets where none had previously been available;
- give relief on a consistent basis, following the rate of amortisation used in companies’ accounts;
- treat sales of intangibles consistently, with profits taxed as income but subject to a new roll-over relief for reinvestment in new intangibles; and
- provide transitional arrangements that preserve expectations for companies’ existing intangible assets.
The new approach has been welcomed by business and subject to consultation, the government will introduce it from 1 April.
The intangibles reform will mark a further step in the government’s programme of corporate tax reform, set out in a consultation document on large business taxation. The government sees the key principles for reform as:
- business competitiveness – to create the best possible location for investment by removing tax distortions and promoting productivity; and
- fairness – ensuring that individual businesses pay their fair share of tax in relation to their commercial profits and compete on a level playing field.
In addition to the intangibles reform, the government is:
- introducing an exemption for capital gains and losses on disposals of companies’ substantial shareholdings;
- introducing a modernised regime for the taxation of corporate debt, financial instruments and foreign exchange gains and losses;
- consulting further on the design of an R&D tax credit for larger companies; and
- consulting on proposals to reduce the compliance burden associated with the requirement to deduct tax at source on cross-border royalty payments.
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