Intangible Assets: Measurement and Accounting Practices

Transcription

1 Contents Overview Intangible Assets: Measurement and Accounting Practices Section I Creative Value and Perspectives 1. Intangible Asset: An Introduction 3 Archana Dinesh Mehta and Pankaj M Madhani 2. Management of Intangible Assets: A Value Enhancing Strategy in Knowledge Economy 20 Pankaj M Madhani 3. Creating Shareholder Value by Exploiting Internal and External Intangibles 37 Jan Doppegieter and Martin Zoller 4. Intangible Asset and Intellectual Property Valuation: A Multidisciplinary Perspective 63 Paul Flignor and David Orozco 5. Intellectual Property and Intangible Assets: A Legal Perspective 87 Andrew F Christie and Sally Pryor Section II Identification and Valuation 6. Identification and Measurement of Intangible Assets: A Must for Corporate Governance 111 Dipesh Kumar Dipu 7. Valuing Intangible Assets What are they Really Worth? Measuring and Managing Intangible Value Drivers 132 Bernard Marr 9. Intangible Value: Delineating Between Shades of Gray How do You Quantify Things You can t Feel, See or Weigh? 144 Marc G Olsen and Michael Halliwell 10. Specific Intangible Assets in the Air Transportation Sector: A Theoretical Construct for their Identification and Valuation 154 Ilídio Tomás Lopes and Ana Maria Gomes Rodrigues Section III Accounting and Reporting 11. Accounting for Intangibles: Challenge to Corporate 175 Ashok Kumar Panigrahi Electronic copy available at:

2 12. Accounting Standards for Intangibles Reporting 180 Pankaj M Madhani 13. Intellectual Capital Reporting: Concepts and Key Methodologies 191 Madan Bhasin Index 221 Electronic copy available at:

3 Overview Intangible assets are a little abstract in nature, with their characteristics varying from firm to firm and sector to sector. Not long ago, physical, tangible assets were major drivers of wealth; today, it s intangible assets that are creating wealth. They are the assets that don t have physical existence. Examples of which are knowledge, skills, brands, patents, copyrights and human resources or intellectual property. Intangible assets are becoming more and more vital to firms as they create value for long term competitive advantages. They have become increasingly important mainly because of the transition of economy from industrial to knowledge-based. This book is on the perspectives and practices of intangible assets. In the 21st century much emphasis is being laid on intangible assets as they are major contributors to the market values of firms. They are vital strategic resources and are the critical sources of competitive differentiation. Wealth and growth of firms in today s market place are governed mainly by them. This book highlights the importance, valuation practices and major challenges for intangible assets. In the current era of knowledge economy, they are occupying dominant proportions of firms overall assets. The book focuses on intangible assets as major competitive differentiators in knowledge economy. It underlines their evaluation and measurement issues and signifies the relevance and importance of intangible assets in the new economy. The book also covers accounting standards for them. This book is presented in three sections and contains thirteen articles. The first section Creating Value and Perspectives contains articles on the introduction of intangible assets, their management as a strategy for enhancing value, creating shareholder value by exploiting internal and external intangibles, intangible asset and intellectual property valuation from multidisciplinary and legal perspectives. The second, Identification and Valuation contains articles on the identification and measurement of intangible assets for sound corporate governance, valuing intangible assets, measuring and managing intangible values drivers, quantifying intangible value and valuation of intangible assets in airline companies. The third, Accounting and Reporting contains articles on accounting for intangibles and emerging challenges, accounting standards for intangibles reporting, intellectual capital reporting concepts and key methodologies. Section I: Creating Value and Perspectives The opening article of the book titled Intangible Asset: An Introduction by Archana Dinesh Mehta and Pankaj M Madhani provides basic information on intangible assets that includes the definition, importance, management and measurement issues. It differentiates intangible and tangible assets in terms of public appearance, depreciation, transfer costs, ease of recognition of trading opportunities, disclosure of attributes and enforcement of property rights and provides broad categories of intangible assets under International Accounting Standard Board (IASB). This article highlights the emerging importance of intangible assets in the present world economy and discusses several valuation methods, viz, cost approach, market approach and income approach. Evaluation of several intangible assets is done by means of objective and subjective indicators. The article summarizes the objective and subjective indicators along with non-financial indicators for intangible assets in a firm.

4 The second article Management of Intangible Assets: A Value Enhancing Strategy in Knowledge Economy by Pankaj M Madhani explains the key components of intangible assets, viz, human capital, structural capital and relational capital. The terms intangible assets, knowledge assets and intellectual capital can be used interchangeably based on the fact that they differ only in their discipline of origin. The article discusses major factors driving the growth of intangible assets across organizations. It highlights their role as drivers of competitive differentiation and explains how they enhance corporate valuation with the help of intangible resources like human skills, stakeholder relationships, culture, routines and intellectual property. As they are critical for the success and sustainable performance of a business, there is need to discuss this with stakeholders in order for them to be able to better understand and value the organization. With comprehensive disclosure of intangible assets, capital costs and the volatility of firms share prices should decline as investors gain greater certainty about the values of the companies. The next article Creating Shareholder Value by Exploiting Internal and External Intangibles by Jan Doppegieter and Martin Zoller provides approaches to manage a firm s intangibles in order to leverage shareholder value creation. The article highlights internal and external management actions required to maximize shareholder value. It is essential for the management to understand the alternative pathways to leverage a firm s intangibles. Two different types of actions are available to the management when viewed from a financial and reporting perspective. The internal actions focus on measurement that can be controlled essentially within the firm. On the other hand, external actions focus on measures targeted to external stakeholders, where the results are beyond the management s influence. The article describes a variety of measuring tools, viz, balanced scorecard, Skandia Navigator, performance prism and strategy map. These tools make intangible assets more visible to firm managers and investors. External intangibles management implies the voluntary disclosure and reporting of a firm s intangible assets as well as the actions of optimizing and leveraging intangible assets to capital market participants including fund managers, equity and credit analysts and other investment parties to provide a better idea of what is driving the business. Intangible asset rich firms tend to be subject to information asymmetry and volatility of stock prices, resulting in higher capital costs. Better disclosure policy on intangibles as a part of comprehensive framework of managing intangibles can counter these effects. The subsequent article Intangible Asset and Intellectual Property Valuation: A Multidisciplinary Perspective by Paul Flignor and David Orozco provides an overview of some of the critical elements of intellectual property (IP) and intangible assets (IA) valuation and combines both academic perspective on IP management issues and a practitioner sexperience in valuing these assets for a number of different business perspectives. IP and IA issues abound throughout the business world, touching nearly all aspects of a company. This wide diversity of IP application is a leading contributor to the complexity of managing IP. The article presents the valuation pyramid as a device to structure the valuation process. Any valuation exercise can be viewed as a pyramid where each level supports the analysis generated on the level above. The article describes the legal attributes of each type of asset under consideration. It explains four basic valuation methodologies, viz, transaction, cost, income and binomial option. Proper understanding of the legal, business and financial attributes of the assets help ensure the proper selection and computation of the valuation methodology.

5 The last article Intellectual Property and Intangible Assets: A Legal Perspective written by Andrew F Christie and Sally Pryor explains the legal understanding of that special class of intangible assets, called intellectual property (IP). A sound knowledge of the fundamentals of IP law is critical for those who need to manage this most important of intangible assets. The article describes different meanings of the term intellectual property. As a general rule, lawyers use the term intellectual property to mean three different but related things, viz, the subject matter that is known as IP, it s about the rights granted in relation to that subject matter and lastly it s about the legal regimes that grant and regulate rights in relation to that subject matter. The article discusses common characteristics of IP rights like specific subject matters, innovation/creation thresholds, limitations on exclusivity of rights, limitations on duration of rights, transferability of rights and statutory basis of rights. It highlights intellectual property laws related to copyrights, designs, patents and trademarks. Despite its growing importance, intellectual property remains a challenging area of law. This is because, unlike the laws of real property, its laws create rights between individuals that are vested in abstract objects being objects that inherently are difficult to define. Section II: Identification and Valuation The first article of this section Identification and Measurement of Intangible Assets: A Must for Corporate Governance written by Dipesh Kumar Dipu highlights the prominence of intangible assets in the cotemporary business scenario. Recent studies show that the market values of firms comprise about 50 to 90% intangibles. However, financial accounting in the present format does not give that much significance to their identification, measurement and reporting. The article discusses the various accounting principles being followed in the European Union, the US and those countries following the international accounting standard. In the US, introduction of Statement of Financial Accounting Standards (SFAS) 141 and 142 brought a new paradigm. The article signifies the consequences of inadequate accounting for intangibles. Without the inclusion of intangible assets the financial statement falls short of being complete. For universal acceptance, standards need to be developed that can present reliable information. The article discusses a hypothetical case study to emphasize how financial analysis is impacted by corporate disclosure and better accounting treatment of intangible assets. It describes identification and measurement challenges posed by intangible assets. It states that traditional accounting concepts need to be overhauled to include relevant information and may need to develop new mechanisms to account for intangible assets and intellectual capital. The next article Valuing Intangible Assets What are they Really Worth? by Deloitte & Touché discusses different valuation methodologies used for determining the fair value of intangible assets. The main valuation methodologies used are: market methods, income methods and cost methods. It talks about valuation issues, viz, identification of intangible assets, choosing an appropriate valuation methodology, avoiding double counting of intangible value, long term implication of identifying certain intangibles and taxation implications. The value derived from intangible assets has increased significantly in today s knowledge based economy. The valuation is important both from an accounting and commercial perspective. The article highlights the implications of IFRS (International Financial Reporting Standard) for intangible assets. The subsequent article Measuring and Managing Intangible Value Drivers by Bernard Marr outlines how managers can develop meaningful indicators that will yield real management

6 insights. Organization s intangible assets are value drivers for its superior performance. Measuring and managing these elusive drivers of performance is critical for all organizations. The large and growing discrepancy between the importance of intangible assets to economic growth and the ability to clearly identify, measure and account for these assets is a serious problem for business managers and investors. The management of intangible assets poses significant challenges if it is approached from an accounting or objective reporting perspective. Instead of trying to quantify the unquantifiable, indicators can be used to assess the performance of intangible elements in order to guide management decision making and strategic learning. The succeeding article Intangible Value: Delineating Between Shades of Gray How do You Quantify Things You can t Feel, See or Weigh? by Marc G Olsen and Michael Halliwell emphasizes the business need of a systematic method for analyzing the value of intangible assets for reasons that include the role of intangibles in financial reporting, litigation, licensing, the sale of business, bankruptcy, taxation and financial and strategic planning. Intangible assets are a big part of contemporary business and represent the principal basis for growth. The article discusses that guidance related to the recognition and valuation of intangible assets comes from accounting and tax regulation. The congress and FASB have pushed for greater disclosure and clarity in recent legislation such as Sarbanes Oxley act, FASB statement no. 141 and 142. Statement no. 141 and 142 give specific guidance on defining and measuring intangible assets. The article highlights various criteria for their identification. Most of them fall into one of five categories: marketing related and customer related, artistic related, contract related or technology related. The authors describe the most commonly used methodologies to value an identified intangible asset. Discounted cash flow is a popular methodology used to value intangible assets such as technology, software, customer relationship, strategic agreements and franchises. The subsequent article Specific Intangible Assets in the Air Transportation Sector: A Theoretical Construct for their Identification and Valuation by Ilídio Tomás Lopes and Ana Maria Gomes Rodrigues is about the identification and valuation of specific intangible assets in the air transportation sector. The authors have defined a theoretical approach for the identification and measurement of the capital assets of the Portuguese airline companies. The article discusses the importance of intangible assets in the entire value creation process. Section III: Accounting and Reporting The first article of this section Accounting for Intangibles: Challenge to Corporate by Ashok Kumar Panigrahi emphasizes the importance of intangible assets in the current era of globalization. Though the importance of intangibles is widely acknowledged, identifying, measuring and reporting them have raised questions. The accounting for intangible assets must be considered in the context of the objectives of the financial statements as a whole. The author identifies criteria for their evaluation, viz, identity, control and future economic benefits. He discusses the accounting standard AS 26 on intangible assets. The AS has included expenditures on advertising, startup, research and development activities as intangibles. All the internally generated intangibles are not recognized as assets because they do not meet the recognition criteria. The article highlights the difficulties in measuring intangible assets such as firms have less control over intangibles which causes higher risk, intangible assets cannot be sold off easily like tangible assets, no markets for intangibles and the management has no incentive to share the

7 information about intangibles. Following article Accounting Standards for Intangibles Reporting by Pankaj M Madhani discusses IASB (International Accounting Standard Board) issued IAS 38 for regulating intangible assets, although while in India it s governed by AS 26 issued by the Council of the Institute of Chartered Accountants of India (ICAI). The main reason for increased emphasis on intangible assets is transition of economy from being industrial to knowledge based. Their valuation is very crucial from both accounting and business perspectives. As intangible assets are non physical in nature, it is not easy to get proof for their existence, hence making it complicated to recognize them in accounting practices. IAS 38 describes criteria for intangibles to be recognized as assets in the balance sheet of a firm. According to it, an intangible asset can be acquired by a firm in four different ways: by separate acquisition, by internal generation or self creation, by acquisition as part of a business combination and by an exchange of assets. IAS 38 prescribes the accounting treatment for intangibles that are not dealt by another IAS. The article explains the Indian scenario by explaining AS 26 for intangible assets which is very similar to IAS 38, and its requirements are explained in detail. The last article Intellectual Capital Reporting: Concepts and Key Methodologies by Madan Bhasin explains the term intellectual capital and its various components. The existing accounting system may not completely recognize the intangible resources of the company despite their growing importance. Intellectual Capital (IC) is an important value driver in today s organizations. The article describes various approaches for internal reporting of intellectual capital, viz, Skandia s Navigator and balanced scorecard. Skandia Navigator as a measurement tool has five main components: financial, customer, process, human and renewal and development. Balanced scorecard is a tool used for managing, measuring and communicating a firm s financial and non-financial information. The author explains various approaches for external reporting of IC, viz, value chain scorecard, IA score sheet and Danish IC statements. The article highlights arguments for and against voluntary disclosure of IC information and talks about three favorable factors with regard to it, viz, lower borrowing cost, higher value relevance and decreased information asymmetry. It also discusses three factors opposing its disclosure, viz, the transparency drawback, regulatory barriers and auditor conservatism.

8 Intangible Assets: Measurement and Accounting Practices Editor: Pankaj M Madhani 2008 The Icfai University Press. All rights reserved. Although every care has been taken to avoid errors and omissions, this publication is being sold on the condition and understanding that the information given in this book is merely for reference and must not be taken as having authority of or binding in any way on the author(s), editor(s), publisher or sellers. Neither this book nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, microfilming and recording or by any information storage or retrieval system, without prior permission in writing from the copyright holder. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Only the publishers can export this book from India. Infringement of this condition of sale will lead to civil and criminal prosecution. First Edition: 2008 Printed in India Published by The Icfai University Press 52, Nagarjuna Hills, Punjagutta Hyderabad, India Phone: (+91) (040) , 369, 370, 372, 373, 374 Fax: (+91) (040) , info@icfaibooks.com, icfaibooks@icfai.org, ssd@icfai.org Website: ISBN: