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How the new accounting rules for UK SMEs can boost innovation capability

We know that much of the investment that firms make in innovation are into ‘intangible’ assets – the capability of staff, brands, designs, research, and intellectual property. And that these types of assets are increasingly important for UK businesses. But these investments and their returns are, for the most part, poorly captured both by companies' internal management accounting systems and in their publicly-reported accounts. This is particularly the case for small and medium-sized enterprises (SMEs). 

This is a win-win opportunity for UK SMEs: by getting a better grip on their intangible investments and asset profile they can focus their innovation efforts, but it will also allow them to comply more easily with the new financial reporting rules.

Inngot is working with Nesta and international accounting body the ACCA to run a UK pilot of the National Corporate Innovation Index methodology, which looks at the value created by intangible asset investment across a range of categories. Full participants in the pilot receive a tailored feedback report on their company’s intangible asset profile.  We are looking for UK-based SMEs who  are not sole traders to take part in the pilot in August and September this year. If you are interested in your firm taking part, do get in touch with Ben at Nesta: [email protected].

New rules to raise the profile of intangibles

The new Financial Reporting Standard 102 (‘FRS 102’) comes into effect from the end of 2015 (where a company’s accounting year is the calendar year) and April 2016 (where it is the fiscal year). It changes the treatment of intangible assets for small and medium-sized enterprises (SMEs), who will now follow substantially the same rules as multinationals.

It’s therefore a good time to brush up on the identification and valuation of this category of assets, which is responsible for driving the majority of value in most companies. The main changes fall under two headings.

Buying or ‘merging’ companies

Currently, when two companies are combined, either merger accounting (adding the two existing balance sheets together) or acquisition accounting (placing a fair value on all an acquired company’s assets) might be permissible. FRS 102 states acquisition accounting must be used in nearly all cases (bar group reorganisations).

Also, acquisition accounting rules are being updated. Any excess paid over and above the fair value of the fixed assets and liabilities can no longer simply be characterised as ‘goodwill’. Instead, it needs to be broken down into goodwill and identifiable intangible assets, in a very similar manner to IFRS 3 (with some minor wording differences).

This means that the sources of intangible value that have never previously appeared on an acquired company’s balance sheet will need to be identified and quantified.

The useful life of intangible assets and goodwill

FRS 102 preserves the option, previously available under SSAP 13 (which it replaces), of either amortising qualifying development costs of new products and services over a suitable period, or expensing these costs during the year in which they are incurred.

However, UK GAAP currently permits ‘goodwill’ to have an indefinite life, as long as the value is tested annually for impairment. Under FRS 102, the concept of an indefinite life falls away and a lifespan has to be specified for amortisation purposes.

If an asset’s lifespan cannot be determined reliably, a ‘default’ figure of five years must be used. This is much shorter than existing UK GAAP, under which it would have been customary to amortise some assets over a much longer period (up to 20 years).

Combine these changes with the reduced role of ‘hard’ assets, which are increasingly outstripped by spending on intangibles, and the number of businesses looking to reflect their real investment profile on their balance sheet looks set to rise.

Author

Martin Brassell

Martin Brassell is the CEO of IP valuation consultancy Inngot. Nesta and Inngot are working with international accounting body the ACCA to run a UK pilot of the National Corporate I...

Benjamin Reid

Benjamin Reid

Benjamin Reid

Head of International Innovation - Development Programmes

Benjamin is head of the International Innovation team within Nesta's Policy and Research division, examining new global trends and practices in innovation, with an emphasis on emergi...

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