Presentation on theme: "Accounting of Intellectual Property Assets: an Overview"— Presentation transcript:
1 Accounting of Intellectual Property Assets: an Overview Guriqbal Singh JaiyaDirector. SMEs Division
2 The Main Take AwayWhile discussions continue on how to adequately account for IP assets, businesses are best advised to develop a voluntary annual IP report, so as to: (1) enhance their market position,(2) facilitate access to funding, and(3) improves overall decision-making and effectiveness of management!
3 Fixed AssetsFixed assets (non-current assets) represent future economic benefits which are expected to be consumed at a slow pace (generaly over more than one financial year)Every fixed asset can be considered an unexpired expense, and at balance sheet date a company must review to what extent the individual asset has been consumed during the accounting period
4 Fixed Assets (cont.) Two central accounting issues: How do we determine tha appropriate value of an asset at the point of acquisition?How do we systematically recognise the expensing of the asset over time?
5 IAS 38 - IntangiblesAn intangible is an identifiable non-monetary asset without physical substanceMain characteristics:They meet the definition of an assetThey lack physical substanceThey are identifiable
6 IAS 38 – Intangibles (cont.) Definition refers to “identifiability”Separability, orArising from contractual or other legal rightsRecognition criteria challenge - Degree of uncertainty with respect to the future economic benefitsMagnitude and timing of future economic benefits?Control over economic benefitsThe useful life of an intangible asset can be finite or indefiniteDefinition of Intangibles: sharpened by the identifiability criterium, which is essential to distinguish intangibles from the more general concept of goodwill.Separable:capable of being separated from the company and sold, licensed, rented, etc.Specific recognition criteria apply – there should be future economic benefits, but one has to be sufficiently certain that they will accrue to the company in the future !Matching principle: additionally, it should be possible to arrive at a good / reliable estimate of the magnitude and timing of the future benefits (estimate of useful life?) to allow matching.Some companies show a large R&D effort in order to detect and develop new or improved products which will improve future economic benefits. But R&D is a risky process – with no guarantee that the efforts will lead to profitable products.General principle: if uncertainty regarding magnitude and timing is too large => no matching of costs feasible and costs are to be taken immediately in the IS.
7 Intangible Fixed Assets These are intangible resources such as scientific and technical knowledge, development of new processes or systems, intellectual property, privileged customer relationships, etc.Typical examples:R&D, patents, brands, copyrights, computer software, licences
8 Definitions Accountants – intangible assets Economists – knowledge assetsManagers and lawyers – intellectual capitalAll are the same except for:Legal – intellectual property, which is intangible assets legally secured for patents, trademarks, designs, copyrights, etc.
9 Classified Balance Sheet... Generally contains the following standard classifications:Current AssetsLong-Term InvestmentsProperty, Plant, and EquipmentIntangible AssetsCurrent LiabilitiesLong-Term LiabilitiesStockholders' Equity21
10 Cost Principle An asset must be carried on the balance sheet at the amount paid for it.The cost of an asset equals the sum ofall of the costs incurred to bring the assetto its intended purpose, net of discounts
11 Traditional Distinction Between Capital and Revenue Expenditures Does the expenditure increase capacity or efficiency or extend useful life?YESNOCapital ExpenditureRevenue Expenditure
12 Accounting of Intangible Assets IntangiblesPurchasedInternally-CreatedSpecificallyIdentifiableGoodwill-type assetsSpecificallyIdentifiableGoodwill-type assetsCapitalizeExpense,except directcostsExpense
13 How Accounting meets IP Copyright/Related Rightsprotects reproduction &performance in arts/softwareOnly IP thatgeneratesdirect cash flowsin a commercialtransactionis consideredIndustrial Designprotectslook of products,packaging, aestheticsPatentsprotectproducts, businessprocessesTrade Secretsprotect business plans,know how,client portfolio,tacit knowledge,processesMark/Geographical Indicationprotects, logo,slogans, symbolsProtection against Unfair Competition
14 IP is an intangible asset, ... Knowledge ContentBackground of users &context determine relevanceof IP to businessTransferabilityIP is transferable to a newor similar business contextNon Rivalry inConsumptionIP can be usedsimultaneouslyby different peoplewithout diminishingin its worthPerishabilityOver time IP maybecome outdated,e.g. technology cyclesNatureof IPSpontaneitySuccessful IP creation is risky since there is a creative & a business element to itPartial ExcludabilityIP guarantees a firm exclusivity and freedom to operate in the market
15 Why Measure Intangible Assets? (Purpose in order of popularity) Monitor Performance (Control) Six Sigma, Balanced Scorecard,Acquire/Sell Business (Valuation) Industry rules-of-thumb ($ per click, $ per client, brand valuation)Report to Stakeholders (Justification, PR) IC supplements, EVA, Triple-bottom line,Guide Investment (Decision) None! (Discounted Cash Flow still best)Uncover Hidden Value (Learning) None! (Scorecards and Direct IC methods probably best)
16 … which Accounting finds difficult to grasp Rationale behind AccountingImpact on Type of Language developed for IPHistorically evolved to report tangible assets/liabilitiesQuantitative stock of performanceDocumentation of past financial positionFactual, precise, objective,comparable informationDetermines perception of a firm’s management and other market participantsSilence about a lot of a firm’s IP due to inherent definitions and assumptions in accountingInternally and externallygenerated IP is treateddifferentlyGoodwill
17 How Accounting Concepts Impact Business Concept ImpactThe same IP may beperceived to beworth nothing or100 Mn $Internally Generated IPis immediately expensed,Acquired IP is valued at its acquisition cost, amortized or subject to an impairment testFair value: “Amount at which an asset couldbe bought or sold in a current transactionbetween 2 willing parties, other than aliquidation.”Intangible Asset: “… identifiable, controlled byan enterprise as result of past events & shouldgenerate future economic benefits for the firm.”Goodwill: “price a market participant is ready topay in excess of the value of a firm’s tangible assets.”Implies a benchmark,yet worth of IPdepends also on context& backgroundMuch IP won’t qualify since it hasan indirect impacton cash flowsDifficult to makeworth of IP explicit &compare Goodwillof different firms
18 Accountants Recognize the Challenge FASB & SEC recommend Voluntary IP Reports“Companies are encouraged to continue improving theirbusiness reporting & to experiment with types of informationdisclosed & the manner by which it is disclosed.”US GAAP allows to account IP explicitly in M&AFAS 141 & 142 require to identify each single asset& determine its fair valueThe amortization of Goodwill is replaced by an annual impairment testsBasel Committee on Banking Supervision recognizesthe inadequacy of “fair value” for financial assets“In the absence of active markets it will be difficult to obtainor calculate a reliable fair value for certainnon-marketable financial instruments held at cost.”
19 Explicit IP accounting gains momentum — Comparison of different Accounting Standards —German HGBIAS/IFRSUS-GAAPRecognition of IPForbidden: § 248/2 HGBException: acquired IPRecognition of IP if IAS criteria are met: IAS 38Recognition of IP:Novel approach underFAS 141 &142Recognition of acquired IP:§ 255/4 HGBAcquired IPRecognition of acquired IP if IAS criteria are met:IAS 38Purchase Price distributed across all items: FAS 141Impairment Test of Goodwill: FAS 142InternallyGeneratedIPImmediately expensedTrend towards the explicit recognition of IP increases
20 Advantages of Reporting IP MANA G E R SCommunicates the value of IP to investorsShows what IP the company ownsPuts a value to the IPExplains how the IP relates to business segmentsIN V E S T O R SFORGet information on how IP drives growthReceive adequate inputs for earnings/sales forecastsCan better estimate risks/revenues of an investmentCan better understand the nature of a businessIncreases predictability while decreasing volatility
21 The IP Reporting Process Create IPownershipBuild IPBusinessCultureCreateIPOwnershipUnderstandIPOwnershipGenerateSuperiorResultsReportIPAlign IP portfolio to overall business strategyExplain to all in the firm why IP mattersEnsure market position through IP ownershipEstablish an enabling IP policy and environmentAudit IPSet ownership in correlation to expected resultsUnderstand legal scope of IPUsea reporting system demonstratingthe value of IP to your business$$$or¥¥¥£££
22 Elements of an IP Report Executive SummaryHow does IP relate to the bottom line of your business?How do you make money and what role does the IP play in it?Relate your income streams to IPWhat were the returns from IP protected business segments?Does the IP help you to gain market share or profits?Relate IP to your position in the MarketHow did IP give you an advantage over competitors?Do you have freedom to operate & exclusivity in the market?Demonstrate your managerial skillsHow determined are you to extract revenue from IP?What experience do you have in managing IP?Understand the legal scope of the IP rightsWhat level of protection does your IP guarantee you?Is there a risk that you infringe the IP of competitors or that competitors (legally) steal your IP?
23 The Agenda A) The today’s rise of intangibles B) Consequences of the Non-treatmentof intangiblesC) Initiatives and actions undertaken(by companies/academics, and institutions)D) Policy indicationsE) Some open problems and conclusions
24 “The substantial foundation of the industrial corporation is its immaterial assets” “There may be peculiar difficulties in the way of reducing this goodwill to the form of a fund, expressing it in terms of a standard unit”Thorstein Veblen, 1904
25 Why did market values diverge from book values? What information does the market use that is not included in the financial statements?Reprinted from Baruch Lev’s Intangibles Management Measurement and Reporting, The Brookings Institution 2001
26 A) The Rise of an Interest in Intangibles Change in the bases of creation of firm value- from industrial to post-(post-)industrialeconomy (e.g. advanced service firms)- post-fordist, interactive mode of production- decentralization/diffusion of knowledgeFrom unidimensional to multidimensional performance of an organisationObsolescence of traditional accounting systems (2004: Market-to-Book ratio 3)Scarcity of data on intangibles in National Accounts
27 Goodwill and Intangibles The Stock Market PerspectiveIf the market is efficientThe nature and treatment of intangible assets should be sufficiently disclosed to help users assess the treatment usedIf the market is inefficientSkepticism exists concerning analysts adjustmentsMarkets are affected by international and national political and economic factorsMore disclosure means fairer stock prices
28 Goodwill Only an issue when purchase method is used Controversies Should goodwill be included as an asset?Should goodwill be amortized?Accounting MethodsAsset without AmortizationAsset with Annual Impairment TestingAsset with Systematic AmortizationImmediate Write-Off
29 Purchased GoodwillGoodwill - the excess of the cost of an acquired company over the sum of the fair market value of its identifiable individual assets less the liabilitiesGoodwill often results from such factors as:brand recognitionreputationmarket shareearnings potentiallocationcustomer list or base
30 Goodwill and Abnormal Earnings The final price that a company will pay for another is the culmination of a bargaining process.The amount of goodwill is subject to the negotiating process.Goodwill is essentially the price paid for “excess” or “abnormal” earning power.
31 Amortization of Goodwill Goodwill does not have a perpetual life, but it may be maintained by continuous efforts.GAAP requires that goodwill be amortized and charged as an expense against net income for a period not to exceed 40 years.Many companies use a much shorter amortization period.Most companies use straight-line amortization.
32 Goodwill Comparative National Practices Conclusions Conflict existed between U.S. and U.K. over benefits derived from immediate write-offProblem magnified by increased merger activityConclusionsGoodwill is not an asset under “separability”Goodwill meets the “reliability” criterionGoodwill meets the “relevance” criterionAccounting for goodwill should be flexible, but fully disclosed within competitive limits
33 Brands, Trademarks, Patents, and Related Intangibles Should brands be capitalized?Brand capitalization wouldRestore equityEnhance borrowing capacityFacilitate takeovers without consultation with shareholders (U.K.)Avoid undervaluation of firms
34 Brands, Trademarks, Patents, and Related Intangibles Methods of AccountingAsset without AmortizationAsset with Systematic AmortizationImmediate write-off“Current Cost” approach – U.K.Capitalization without amortization if no limit to useful life – FranceBrands are identified as intangible assets in Australia, France, and the U.K.
35 Brands, Trademarks, Patents, and Related Intangibles U.S. – combination of asset-without-amortization method and asset-with-systematic-amortization method depending on estimate of useful lifeIFRS requires recognition of intangible assets for consolidated statementsU.S. and Canada must write off internally developed intangibles immediately
36 Brands, Trademarks, Patents, and Related Intangibles International Accounting StandardsIAS 38Intangible assets only recognized if future benefits will flow to the enterprise and cost of asset can be measured reliablySystematic amortization required for finite livesImpairment testing for assets with infinite lives
37 Brands, Trademarks, Patents, and Related Intangibles ConclusionsProblems are linked with the goodwill issueBrand names qualify as assets under “separability”Measurement of intangibles may not be “reliable”Value-oriented approach to brands and intangibles should be used
38 A) The New Value Creation Process and Its Implications Change in production processes: strategic phases are research, marketing and know-how, and not so much manufacturing phases where intangible assets are keyToday main determinants of growth at firm (micro) and country (macro) levels are, therefore, intangible assets
39 A) Benefits of Intangible Investments Scalability, non-rivalry, non-scarcityLarge sunk costs, negligible marginal costsNot subject to diminishing returnsUse by one user does not preclude the use by another userScalability only limited by the size of the marketi.e. A computer operating system, a drugIncreasing returns to scale
40 A) Benefits (continued) Network EffectMetcalf’s law – the value of the network increases geometrically with each new useri.e., software:Window Office suite – the more users that can share documents the more valuable the software isInstant messenger – the more people on your buddy list the more valuable it is to you.The more travel agents and airlines that use Sabre the more valuable it becamePositive feedback loop – Napster, AOL, Win 95/98/2000 XP
41 A) Costs Unique to Intangible Investments Partial Excludability and SpilloverDifficult to exclude non-ownersEmployee training benefits the employee and if the employee quits, the new employer gets the benefitsNon-patented employee know howElectronic devices can be reverse engineeredNew software functionality can be incorporated in rival products
42 A) Costs (continued) Partial Excludability and Spillover (continued) Intellectual property laws for patents, trademarks, copyrights etc. vary from country to countryNot recognizing the value of an innovation and giving it awayAT&T – cellular telephonyIBM – PC architecture, cpu, DOSXerox PARC – Laser printing, Ethernet, GUI and the mouse
43 A) Costs (Continued) Inherent Risk Intangibles are inputs into innovation and innovation is risky10% of patents account for 81-93% of total patent valueMost new products failEarnings volatility (risk) is three times greater for R&D than physical investmentsRisk mitigationPortfolio of patentsMany R&D projectsResearch alliances
44 A) Costs (Continued)Non-tradability (except for intellectual property)No organized and competitive marketsMeasurement and valuation difficult without market pricesNone or little value if projects abandonedResult – most innovation in corporations and research centersBut, companies cannot use all of their innovations and there is no market for selling them(except patent licensing and royalties)
45 A) Problems encountered by firms capturing benefits from intangible investment… Economic attributes of intangible assets make it:Difficult to exclude other users (public good problem) so firms cannot appropriate the full benefits from the investment (Geroski 1995)Difficult to estimate ex ante the precise use of intangible inputs, potential products, and timing and magnitude of benefitsDifficult to write contracts for transfer or exchange of intangibles that are not embodied in a physical asset
46 A) Effect of uncertainty Investment in intangibles is also associated with high levels of uncertainty/riskWhile there is evidence that investment in intangibles leads to tangible investment, there is a lag between intangible investments and economic benefits (intangible investment occurs early in the life cycle)To overcome problem associated with this risk, most accounting standards require expenditure on (particularly internally generated) intangible assets to be expensed considered more reliable
47 A) Measuring Intangibles Accounting and economic models relate inputs to outputFor tangible assets you know costs (input), risk, and return (output)For intangibles:you don’t know the cost, risk, and returnsThere may be no relationship between cost of input and value of output, but, you do know the risk is enormous.Without knowing how to measure intangibles you cannot understand them, and, therefore cannot manage them !
48 A) The Logic of Traditional Accounting ECONOMIC TRANSACTION AS THE “ENGINE”OF TRADITIONAL ACCOUNTINGECONOMIC TRANSACTION SETS ACCOUNTINGVALUE PRICE HISTORIC COST/FAIR VALUEMEASUREMENT CATEGORIES LINKEDMAINLY TO “FORDIST” INDUSTRIAL ACTIVITYMEASUREMENT OF PERFORMANCE &SURPLUS IN A SHAREHOLDER PERSPECTIVE
49 B) Traditional Accounting for Intangibles (e. g B) Traditional Accounting for Intangibles (e.g. International Accounting Standard 38)General suspicionRecognition issues (R&D, Brands, Training)Conservative measurement criteria:- General principle: Immediately expensed asa period cost- If recognised as an asset, then valued at Costor Revalued Cost (not value)- Amortisation over a short period of timeNo attention to the intangible drivers of value
50 B) Accounting for Goodwill Most countries treat goodwill as an asset subject to systematic amortizationMaximum amortization periods of 5 to 40 years apply in some countriesU.S. and IASB treatment is an annual impairment test of goodwillSome countries use immediate write-off method against reservesNot permitted in U.S., Australia, JapanSome countries retain goodwill as a permanent asset
51 General Guide for Financial Accounting (GAAP) GenerallyAcceptedAccountingPrinciples
52 What is financial accounting supposed to accomplish? Provide the the most useful financial information for…Decision Making4
53 Primary Accounting Setting Body in the USA FinancialAccountingStandardsBoard4
54 U.S. Government Agency That Oversees Financial Markets SecuritiesExchangeCommission4
55 Remember… GAAP Are the Rules The FASB makes the rules.The SEC enforces the rules.
56 Statement 141: Business Combinations All business combinations initiated after June 30, 2001 must use the PURCHASE METHODPooling-of-Interests method is no longer permitted
57 Statement 141: Business Combinations Requires disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption.
58 Statement 141: Business Combinations Application of the purchase method requires identification of all assets of the acquiring enterprise, both tangible and intangible.Any excess of the cost of an acquired entity over the net amounts assigned to the tangible and intangible assets acquired and liabilities assumed will be classified as goodwill.
59 Statement 141: Business Combinations Fair Value is defined in SFAS No. 141 & 142 as“The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.”It is more of an “Investment Value” concept as the benefits of synergies and attributes of the specific buyer and specific seller are included.The ability of a controlling shareholder to benefit from synergies and other intangible assets that arise from control might cause the fair value of a reporting unit as a whole to exceed its market capitalization.
60 Intangible Asset Recognition An intangible asset shall be recognized as an asset apart from goodwill:If it arises from contractual or other legal rightsIf it is separable; that is, it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged.
61 Intangible Asset Recognition An acquired intangible asset (other than goodwill) with an indefinite useful economic life should not be amortized (regardless of whether it has an observable market) until its life is determined to be no longer indefiniteIf no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an asset, the useful life of that asset should be considered indefinite.
62 Intangible Asset Recognition “The accounting for a recognized intangible asset is based on its useful life to the reporting entity. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized. The useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.”
63 Intangible Asset Recognition A number of pertinent factors that should be considered in deciding the useful life of an asset:Expected use of the asset by the entityLegal, regulatory, contractual limits to useful lifeAbility to renew/extend contractual or legal lifeEffects of obsolescence, demand, competition and other economic factorsLevel of maintenance expenditures required to realize expected future cash flowsUseful life of another asset (or asset group) to which useful life of intangible relates
64 Intangible Asset Recognition Separable intangible assets that have finite lives will continue to be amortized over their useful lives.A recognized intangible asset that is not amortized must be tested for impairment annually, and on an interim basis if an event or circumstance occurring between annual tests indicates that the asset might be impaired.
65 Intangible Asset Recognition The FASB has classified intangible assets into five categories:1. Marketing-related intangible assets2. Customer-related intangible assets3. Artistic-related intangible assets4. Contract-based intangible assets5. Technology-based intangible assets
67 Customer-Related Intangible Assets Customer ListsOrder or Production BacklogCustomer Contracts and Related CustomerRelationshipsNon-Contractual Customer Relationships
68 Artistic-Related Intangible Assets Plays, operas, balletsBooks, magazines, newspapers, otherliterary worksMusical works such as compositions, songlyrics, advertising jinglesPictures, photographsVideo and audiovisual material, includingmotion pictures, music videos, televisionprograms
69 Contract-Based Intangible Assets Licensing, royalty, standstill agreementsAdvertising, construction, management, service orsupply contractsLease agreementsConstruction agreementsFranchise agreementsOperating and broadcast rightsUse rights such as drilling, water, mineral, timbercutting and route authoritiesServicing contracts such as mortgage servicingcontractsEmployment contracts
70 Technology-Based Intangible Assets Patented technologyComputer software and mask worksUnpatented technologyDatabases, including title plantsTrade secrets, such as secret formulas,processes, recipes
71 GAAPFASB Statement No. 142 Goodwill and Other Intangible Assets (June 2001)This statement carries forward without reconsideration the provisions of Opinion 17 related to the accounting for internally developed intangible assets. This statement also does not change the requirement to expense certain acquired research and development assets at the date of acquisition as required by FASB Statement No. 2.AICPA APB Opinion 17 (August 1970)A company should record as expenses the costs to develop intangible assets which are not specifically identifiable.
72 Statement 142: Goodwill and Other Intangible Assets This Statement addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition.This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements.
73 Statement 142: Goodwill and Other Intangible Assets Goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment.Intangible assets that have finite lives will continue to be amortized over their useful lives, but without the constraint of an arbitrary ceiling.
74 Statement 142: Goodwill and Other Intangible Assets Goodwill will be tested for impairment at least annually using a two-step process that begins with an estimation of the fair value of a reporting unit.The first step is a screen for potential impairment, andThe second step measures the amount of impairment, if any.
75 Statement 142: Goodwill and Other Intangible Assets This statement requires disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisition. Information to be disclosed:The changes in the carrying amount of goodwill from period to period,The carrying amount of intangible assets by major intangible asset class for those assets subject of amortization and for those not subject to amortization, andThe estimated intangible asset amortization expense for the next five years.
76 Statement 142: Goodwill and Other Intangible Assets The provisions of this Statement are required to be applied starting with fiscal year beginning after December 15,2001.This Statement is required to be applied at the beginning of an entity’s fiscal year and to be applied to all goodwill and other intangible assets recognized in its financial statements at that date.
77 Impairment of Goodwill and Other Intangible Assets SFAS No. 142 mandates that goodwill and intangible assets without a defined live shall not be amortized over the defined period; rather they must be tested for impairment at least annually at the “reporting unit” level.
78 Impairment of Goodwill and Other Intangible Assets All acquired goodwill should be assigned to reporting units. This will critically depend on the assignment of other acquired assets and assumed liabilities.The amount of goodwill allocated to a reporting unit is contingent upon the expected benefits from the synergies of the combination. This goodwill allocation is required even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit.
79 Impairment of Goodwill and Other Intangible Assets The measurement of the fair value of intangibles and goodwill can be performed at any time during the fiscal year as long as the timing is consistent from year to year.
80 Impairment of Goodwill and Other Intangible Assets The annual impairment test is to be accelerated and goodwill of a reporting unit should be tested for impairment on an interim basis if an event occurs that would more likely reduce the fair value of a reporting unit below its carrying value.
81 Impairment of Goodwill and Other Intangible Assets Impairment Test Triggering Events:A significant adverse change in legal factors or in the business climateAn adverse action or assessment by a regulatorUnanticipated competitionA loss of key personnelA more-likely-than-not expectation that a reporting unit will be sold or otherwise disposed ofThe testing for recoverability under SFSA No. 144 of a significant asset group within a reporting unitRecognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of re reporting unit
82 Goodwill Impairment Test The Two-Step Impairment Test:Compare estimated fair value of each reporting unit to the carrying amount of the unit.If FV > Carrying Amount, no need to perform Step 2If FV < Carrying amount, then Step 2.
83 Goodwill Impairment Test If the carrying amount of a reporting unit goodwill exceed the implied fair value of that goodwill, then an impairment loss must be recognized for an amount equal to that excess.In order to determine the implies fair value of the goodwill, all assets must be valued.The impairment loss cannot exceed the carrying amount of the goodwill. Only the value of goodwill is adjusted through this process.The adjusted carrying amount of goodwill will be its new accounting basis.Goodwill cannot be increased to its original carrying amount in the future. Once written down, it stays down.
84 Goodwill Impairment Test Ex: Assume a company has a reporting unit with a fair value of $10,000,000 including goodwill of $3,000,000. further assume that the relative fair values of the assets have been valued and recorded on the books of the acquirer as:______________________________________________Recognized tangible assets $5,000,000Recognized identifiable intangible ,000,000assets (with definite life)Goodwill ,000,000==========$10,000,000
85 Goodwill Impairment Test After one year assume the carrying amount of certain assets after amortization are:______________________________________________Recognized tangible assets $3,500,000Recognized identifiable intangible ,500,000assets (with definite life)
86 Goodwill Impairment Test Assume that an impairment test is performed at this time one year later and the fair value of the reporting unit is $9,000,000. A new asset allocation must be performed to determine the new goodwill amount:______________________________________________Recognized tangible assets $3,800,000Unrecognized tangible assets ,000,000Recognized identifiable intangible assets ,400,000Unrecognized identifiable intangible assets ,000Goodwill ,000,000___________Fair Value of the reporting unit $9,000,000
87 Goodwill Impairment Test Net Carrying amountFair ValueImpairment AmountSFSA Citation(Taiwan)Recognized tangible assets$4,000,000$3,800,000200,000142Unrecognized tangible assets1,000,000Recognized identifiable intangible assets (with a defined life)1,800,0001,400,000400,000144Unrecognized identifiable intangible assets800,000Goodwill3,000,0002,000,000Total$10,000,000$9,000,000$1,600,000
88 B) Consequences of Accounting Standards Current GAAPExcept for R&D almost no reporting and disclosures on intangiblesRequired capitalization of software development costs is often ignoredResultInvestors and some levels of management are kept in the dark about investment and return on intangiblesAsymmetry of informationAbnormal gains to those that know the potential return on intangibles – insidersAs investment in intangibles increases, volatility and risk increases, asymmetry of information increases, and insider gains increase
89 B) In company reporting, once upon a time there was Goodwill... Purchase price – Fair value of net assets = Goodwill- Poor (synthetic) representation in cognitive terms of the intangibles possessed by an organisation- Residual value used to represent all the “unidentifiable”/“unseparable” intangibles of the acquiree- Managerial and users’ need for a more analytical knowledge, control, and representation of intangible elements of a firm’s wealth (brands, organisational capabilities, IPR, etc.) and of its drivers
90 B) Unmeasured intangible inputs and outputs in the economy Problem: Changing composition of investment is not reflected in financial reportingProblem: Accountability of management for actions/decisions in managing the firm’s resourcesProblem: Lack of data for analysis and rational resource allocation info. asymmetry
91 B) Micro-Economic consequences Serious economic consequences for the firm fromthe poor accounting treatment of intangiblesThe non-measurement of intangibles at thecompany level has adverse economiceffects in terms of:- Investment decisions- Level of information asymmetry concerninga firm (volatility of share prices & insidertrading)- Internal/management information systems
92 B) Intangibles at a macro level Intangibles as connecting tissue, the “glue” thatallows the homeostasis of the economic systemWe need to better understand how tangibles andintangibles combine to create collective valueIntangibles are not measured or quantified –more often under-measured – at a macro levelPotentially serious consequences at a policy level wrong indicators wrong diagnosis of acountry performance and policy recipe
93 Current US GAAP Criteria to be considered an asset Defined and distinctEffective controlPossible to predict future economic benefitsPossible to determine impairmentAsset Examples:Property, plant, equipmentFinancial assetsPurchased identifiable intangibles such as patents, trademarks, copyright and mailing listsPurchased goodwill
94 GAAP (continued) Internally developed intangibles Expense when incurred (Except for software when certain conditions are met)Examples:R&DTrainingAdvertisingInequity in accounting treatment – intangible assets have future economic benefits—the matching principle is violated.
95 Characteristics of Useful Information Relevance1. Provides a basis for forecasts2.Confirms/corrects prior expectations3. Is timelyReliability1. Is verifiable2. Is a faithful representation3. Is neutralComparabilityDifferent companies use similar accounting PRINCIPLESConsistencyCompany uses same accounting METHODS from year to yearCharacteristics of Useful Information95
96 Basic Terms Relevance - information makes a difference in decisions Reliability - information must be free of error and biasComparability - ability to compare information of different companies because they use the same accounting principlesConsistency - use of same accounting principles and methods from year to year within the same company
97 GAAP (continued) Inequity between: acquired intangibles—capitalized andinternally developed intangibles – expensedCannot compare a company that acquired intangibles with another company that internally developed intangibles even though cost and benefits between the two companies are identical
98 Constraints in Accounting Permits companies to apply GAAP without hurting the usefulness of informationMateriality - The constraint of determining whether an item is large enough to likely influence a decision.Conservatism - The approach of choosing an accounting method, when in doubt, that will be least likely to overstate assets and net income.10
99 B) The IssueImproving information used by decision makers for the optimal investment in intangibles:Investors and creditors – which companies to invest in or liquidate?Business managers – which projects to invest in or drop?Government policy makers, Regulators, and Standard Setters– what research needs to be funded and should increased information reporting and disclosure on intangibles be mandated?
100 B) Costs of Non-measurement - Firm level: risk of poor or wrong strategies- Industry level: misallocation of resources within and between industries; skill bias- Capital market level: under- or over-valuation of companies; misallocation of resources; volatility- Country level: policy making based on imperfect set of indicators may result in inappropriate policies
101 C) A series of initiatives: company and academic reactions In 1992 Kaplan and Norton propose the Balanced Scorecard non-financial measures break inIn 1994 Skandia starts the production of an Intellectual Capital StatementMany measurement and reporting models are put forward by practioners, academics, companies
107 C) A series of initiatives at an institutional level Half ’90s: OECD Studies1999: International Conference in Amsterdam (OECD + Dutch and Danish Governments)2000: European Commission’s High Level Expert Group on the Intangible Economy: Research projects Prism and Meritum/E*Know-net funded by the Commission Meritum Guidelines on ICR
108 C) A series of initiatives at an institutional level (cont’d) 2002: International Conference in Madrid (Autonomous University Madrid + Spanish Government + OECD + European Commission): Official Study for the European Commission on the measurement of intangible assets (Ferrara+New York+Melbourne)2004: International Conference in Helsinki (Sept.) + OECD Forum in Paris (Oct.)
109 C) A series of initiatives at an institutional level (cont’d) : Danish Guidelines on IC Reporting as a result of a Government-driven project: Various documents on intangibles by the UK Department of Trade and Industry2003: Letter on Intangible Economy signed by the UK, German and French Governments2004: German Guidelines on IC Reporting by the Ministry of Labor
110 C) A series of initiatives at an institutional level (cont’d) June 2004: The Japanese Government issues a White Paper about making economic policy in the knowledge era strong emphasis on intangibles and intellectual capital reportingApril 2005: A new policy by the city's Pudong New Area recognition of human resources as capital contribution up to a maximum of 35% of the enterprise's registered capital, and a report and filing system for enterprise annual reviews (for both domestic and foreign companies)
111 C) A series of initiatives at an institutional level (cont’d) : High Level Expert Group set up by the DG Research of the European Commission with the task of producing an official report on Intellectual Capital Reporting especially for research-based SMEs2005: Action Plan of the European Commission on business-related services strong recommendation to these co’s to prepare an intangibles-based report
112 C) A series of initiatives at an institutional level (cont’d) June 2005: World Bank has organized a Conference on “Intellectual Capital for Communities in the Knowledge Economy: Nations, Regions and Cities” held in Paris20-22 Oct. 2005: OECD will hold an International Policy Conference on Intellectual Assets in conjunction with the University of Ferrara (
113 C) Official Study for the European Commission A 2003 STUDY ON “THE MEASUREMENT OF INTANGIBLES” MADE BY THE UNIVERSITIES OF FERRARA, NEW YORK AND MELBOURNE FOR THE DG ENTERPRISE. Available at:business_services/index.htm
114 C) Definitions of Intangibles Far too many definitions & different classificationsand taxonomies of intangibles (micro & macro)• Need for reducing them through consensusIn the Study intangible assets defined as a source offuture benefits that is without a physical embodiment:• Intellectual property is an intangible asset with legal rights• Includes innovation-related intangibles (patents), but alsomarket-related (brands), human resource (compensationsystems, training policies), and organizational intangibles(internal structures, systems and processes)• “Hard” intangibles (tradable) vs. “Soft” intangibles
115 Objectives of Financial Reporting FASB Concepts No. 1Financial reporting should provide information:That is useful to potential investors and creditors and other users in making rational investment, credit and similar decisions.To help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts and net cash inflows to the enterprise.About the economic resources of an enterprise, the claims to those resources, and the effect of transactions, events, and circumstances that change its resources and claims to those resources.
116 C) New measurement & reporting models for Intangibles Various innovative methods for the recognition, measurement, and disclosure of intangibles and intellectual capital (IC) have been analysedA taxonomy of the different new methodologies (holistic vs. atomistic; monetary vs. non-monetary)The rise in company practice of IC statementsAnalysis and comparison of the four main Guidelines on IC statements proposed so far (Meritum, Nordika, IFAC, and DATI)Exploration of the relations between IC statements& Corporate Social Responsibility (CSR)(e.g. GRI)
117 C) A working definition of IC Intellectual Capital – IC – is the internal (competencies, skills, capabilities, etc.) and external (image, brands, customer satisfaction, etc.) stock of intangibles of an organisation, which allows the latter to transform a bundle of material, financial and human resources in a system capable of creating stakeholder value through the pursuit of sustainable competitive advantages (Zambon, 2000)Organisational knowledge becomes IC only when it is durably and effectively internalised or appropriated by an organisation
118 Representing & Managing Intangibles IC as New Concept forRepresenting & Managing IntangiblesA concept that encompasses the various types of intangibles, including social and environmental intangibles- a “new” notion of the wealth of an organisation- thrust towards information relevance instead of reliability in reporting- a concept in evolution different accents- a concept on whose basis company reporting might be reformed?
119 C) Towards a New Reporting Tool Intellectual Capital (IC) Statements or Report onIntangiblesBased on indicators many without a financial natureThe partitioning of IC into three interrelated sections is quite widely accepted: Human Capital, Organizational Capital (including Innovation Capital), Relational Capital visualized/measured through indicators and parameters
120 C) Guidelines on IC statements: some emerging convergences and differences - International Federation of Accountants (IFAC) –Study no. 7 (1998)- Danish Agency for Trade and Industry (DATI)Guidelines (2000, but new edition 2003)- Nordika Project Guidelines (2001)- Meritum Project Guidelines (2002)- “Intellectus Model” (Spain) (2003)- German Guidelines (2004)- Japanese Guidelines (2005)Other documents deal with some aspects of IC reports, but without focussing on them (e.g., GRI, EFQM, ISO)
121 C) INTANGIBLES AND INFO. USERS: THE CASE OF FINANCIAL ANALYSTS In 2001, the Italian Association of Financial Analysts (AIAF) set up a study group on IntangiblesIn January 2002, a model has been developed – in collaboration with the University of Ferrara – to measure the level of disclosure on intangibles by companies in their external reportsThis model has now been refined/extended in order to represent/rank European companies on the basis of their level of disclosure on intangibles
122 C) The Basic Framework for Ranking the Level of Disclosure on Intangibles (AIAF 2002) LEVELS OF COMMUNICATIONON INTANGIBLESLevel 3Extended informationFIVE DIMENSIONS OF COMMUNICATIONLevel 2“Reasoned” informationOrganisationInnovation & IPRHuman resourcesLevel 1“Minimum” informationCustomers & MarketStrategyNATURE OF INFORMATIONActualForecast
123 IC Statements and Environmental and Social Reports: The case of GRI The Global Reporting Initiative (2002) is:- a reporting framework for non-financial aspects- based on the three-dimensional concept of “sustainability” (economic, environmental and social) so called triple bottom line- evidence of an overlapping between IC statements and social & environmental reports (e.g., indicators on employees’ training and education, supply chain management, quality of management, investment in R&D, stakeholder engagement)
124 An Intangible Perspective on CSR and Stakeholder Value THE BASIC IDEA SOCIAL CAPITAL & ENVIRONMENTAL CAPITAL AS PARTICULAR INTANGIBLES TO BE MANAGED BY COMPANIES (AND PUBLIC SECTOR ENTITIES)
125 The Integrated Reporting System Intangibles / Intellectual Capital ReportingENVIRON-MENTALREPORTINGSOCIALREPORTINGCollectivitySocietyTRADITIONAL FINANCIALREPORTINGInvestors/Auditors/Financial Analysts
126 D) Main Policy Implication Urgent to better measure intangibles both at micro and macro levelPriority: better measurement at firm level because good indicators at micro level allow also to build better indicators at macro level
127 D) Intangibles Reporting: policy recommendations Policy aim: Develop and promote a new, integrated, reliable and verifiable company disclosure system which is based on intangiblesWhat is needed is CONVERGENCE between existing methods and reports
128 D) Intangibles Reporting: policy recommendations (cont’d) Identify a standardised set of intangibles indicators serving as minimum common information denominatorConsistent data at micro level as foundation for more aggregated analyses in this respect we need rather detailed categories in the prospective intangibles taxonomy
129 D) Intangibles Reporting: policy recommendations Provide incentives to firms to adopt a new reporting system based on intangibles, as well as to use and reveal that informationFavor the emergence of a generally agreed taxonomy and definition of intangiblesEncourage voluntary experimentations & exchange of best practices good IC reporting guidelines are already in place
130 D) Intangibles Reporting: policy recommendations (cont’d) Induce information system/software providers to develop the collection of data on intangibles e.g. XBRLPromote the gathering of the reported information on intangibles in a systematic and coherent way (cf. US Edgar)Support ad hoc research
131 D) Intangibles reporting: policy recommendations (cont’d) Convergence to be searched for with statistical offices, but starting point of intangibles information should be corporate reporting a delta, not a substituteDrawing on other forms of voluntary/ supplementary reporting (such as social, environmental, sustainability reports etc.) for inducing companies to produce information on intangiblesLooking for synergies in the efforts e.g. OECD + European Commission + US Institutions + Japanese Institutions
132 E) Some questions on IC Reports Despite their value and innovativeness, IC reports face some criticisms concerning their:- consistency- reliability/subjectivity- thoroughness- meaningfulness:a) high subjectivity in the choice of the useful indicatorsb) indicators do not possess additive propertiesc) high specificity of indicators
133 E) Some questions… (cont’d) However, some open problems:- Value in absence of a market price (value in use vs inexchange) (i.e., credibility and meaningfulness)- Specificity vs Generalisability (i.e., consistency &comprehensiveness problems)- Regulation vs Voluntary Compliance- Atomistic vs Holistic measurement approach- Common vs Different Measurement Units- Relevance vs Reliability- Users stakeholders?
134 Final consideration We face a major PARADOX: - The more the system is based on intangible assets, the stronger it is (because intangibles are major determinants of growth and value creation).- However, at the same time:the more the system is based on intangibles, the more vulnerable it becomes.The challenge we all face is to learn how to measure and report in this intangibles environment