Adjusting for goodwill

Since changes were implemented at the beginning of the year by the Financial Services Authority, accounting for goodwill has been a hot topic in the insurance broking sector. Under UK GAAP, Financial Reporting Standard No. 10 states that goodwill and other intangible assets should be recognised as an asset on the balance sheet and amortised on a systematic basis over their useful economic life. There is a rebuttable assumption that 'useful economic life' is limited to 20 years or less; most firms included in this review operate under UK GAAP.

Under International Financial Reporting Standards, IFRS No. 3 and International Accounting Standard No. 38 state that goodwill and other intangible assets should be recognised as an asset on the balance sheet and reviewed annually for impairment, or more frequently if events or changes in circumstances indicate that it might be impaired. Only seven of the firms reviewed have adopted IFRS.

Our review demonstrates that, in the top 50 firms, there are significant intangible assets that are predominantly goodwill.

A balance-sheet analysis of the intangible-to-net asset ratio indicates that the market is highly sensitive to accounting policies adopted in respect of intangible asset recognition, amortisation and impairment. This is not surprising when 81% of the net assets of the 45 firms reviewed are goodwill. The market trend of consolidation, the increase in acquisition multiples and the fact that much consolidation activity is funded by debt are key factors in driving this ratio of intangible and net assets.

Worryingly, our sensitivity analysis shows that:

- Six firms have net liabilities if intangible assets are removed from the balance sheet.

- One firm would turn from profit to loss if the amortisation period were reduced from 20 to 10 years.

- Three firms would halve their profits if the amortisation period were reduced from 20 to 10 years.

This analysis raises the question of whether or not firms would benefit from a change to IFRS, where intangible assets are subject to annual impairment review rather than an annual amortisation, with such a change potentially improving future profits for some firms by a significant margin.

Jessica Wills, audit manager, financial services division, Littlejohn.