Findings of the Financial Reporting Review Panel in respect of the accounts of Equator Group Plc for the year ended 31 December 1999

FRRP PN 74 26 July 2002 The Financial Reporting Review Panel has had under consideration the report and accounts of Equator Group Plc for the year ended 31 December 1999 and has discussed them with the company’s directors. The matter at issue was the company’s accounting for its purchase, in June 1999, of Equator Films Limited and the subsequent accounting for the principal assets acquired. Film libraries with a book value of £1,090,000 were revalued individually, at open market value at the date of acquisition to a total of £13,158,000. This gave rise to negative goodwill of £1,830,000. Under the company’s accounting policy, the film libraries were not to be amortised but impairment reviews were to be carried out at least annually and any permanent decreases in value were to be charged to the profit and loss account. Financial Reporting Standard (FRS) 10 ‘Goodwill and Intangible Assets’, at paragraph 10, requires intangible assets acquired as part of the acquisition of a business to be capitalised separately from goodwill if their value can be measured reliably on initial recognition. They should initially be recorded at fair value, subject to the constraint that, unless the assets have readily ascertainable market values, the fair values should be limited to amounts that do not create or increase negative goodwill arising on the acquisition. ‘Readily ascertainable market value’ is defined in paragraph 2 of FRS 10 in the following terms: ‘The value of an intangible asset that is established by reference to a market where: the assets belong to a homogenous population of assets that are equivalent in all material respects; and an active market, evidenced by frequent transactions, exists for that population of assets’ In the Panel’s view, although the rights attaching to each film were similar, the films themselves were unique and could not, therefore, belong to a homogenous population of assets that was equivalent in all respects. It was also of the view that the market in which film libraries are bought and sold is not an ‘active market’. As the films acquired with the business of Equator Films Limited failed to meet either of the necessary tests the Panel concluded that they did not have a readily ascertainable market value, as defined in the standard. Hence, the revaluation of the films to fair value at the date of purchase of the business should have been limited to an amount that did not give rise to negative goodwill. FRS 10 also includes a rebuttable presumption (paragraph 19) that the useful economic lives of purchased intangible assets are limited to periods of twenty years or less. An indefinite life can be assigned only where the assets are capable of continued measurement, their durability can be demonstrated and can justify a longer period. In its financial statements for the year ended 31 December 2000, the company changed its accounting policy and commenced amortisation of film libraries over a twenty year period to their residual values. Having regard to the factors on which durability depends, as noted in paragraph 20 of FRS 10, the Panel welcomed the directors’ decision to amortise the film libraries. Under FRS 10, in amortising an intangible asset, a residual value can be assigned only if it can be measured reliably (paragraph 29). This is likely only when there is a legal or contractual right to receive a certain sum at the end of the asset’s period of use or where there is a readily ascertainable market. There is no legal right to receive an amount at the end of a film’s useful life. Nor, for the reasons given above, was the Panel of the view that the films have readily ascertainable market values. Therefore they should be amortised without regard to any estimate of residual value. The directors have accepted the Panel’s views in respect of both the accounting for the original acquisition and the determination of the libraries’ useful economic lives. In their preliminary announcement published today, they have corrected both matters by way of prior year adjustment. The effect of this is a cumulative adjustment of £181,000. The Panel welcomes the action taken by the directors and regards its enquiry into the company’s December 1999 accounts, which it initiated on 9 February 2001, as complete. Notes to Editors The remit of the Financial Reporting Review Panel is to examine the annual accounts of public and large private companies to see whether they comply with the requirements of the Companies Act 1985. Within this framework a main focus is material departures from accounting standards where such a departure results in the accounts in question not giving a true and fair view as required by the Act. Where a company’s accounts are defective the Panel will wherever possible endeavour to secure their revision by voluntary means, but if this approach fails it is empowered to make an application to the court under section 245B of the Companies Act 1985 for a order compelling their revision. To date no court applications have been made, though in some instances, the necessary steps have been at an advanced stage. The Panel does not itself monitor or actively initiate scrutinies of company accounts for possible defects, but acts on matters drawn to its attention, either directly or indirectly. The Panel’s responsibilities do not extend to the directors’ report, summary financial statements or interim statements. The Chairman of the Panel is Richard Sykes QC and the Deputy Chairman Ian Brindle FCA. There are currently 19 other Panel members drawn from a broad spectrum of commerce and the professions. Individual cases are normally dealt with by specially constituted Groups of 5 or more members. END Press Enquiries: Ann Wilks, Secretary to the Panel, on 020 7611 9750.