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  • 1. INTANGIBLE ASSETS: AN ASSESSMENT OF APPLICATION OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND ACCOUNTING STANDARDS FOR RECOGNITION AND MEASUREMENT OF INTANGIBLE ASSETS P.D.C. Udayashantha Department of Accounting, University of Sri Jayewardenepura, Gangodawila, Nugegoda, Sri Lanka udayamail@yahoo.com ABSTRACT Application of generally accepted accounting principles (GAAPs) and accounting standards for recognition and measurement of intangible assets increase the gap between book values and market values of firms and make the financial information less relevant. The main reason for the said gap is the conservative nature of financial reporting which discourages the recognition of many intangible assets. Through this study, the writer has assessed the application of GAAPs and accounting standards for recognition and measurement of intangible assets. The main objectives of the study are to identify the drawbacks in GAAPs and accounting standards, which discourage the recognition of intangible assets in financial statements, to justify the avenues for extended recognition of intangible assets and to elaborate the benefits that may accrue to the business firms and to users of financial information, due to extended recording and disclosures of intangible assets. This is a qualitative research paper. Hence, the writer has used secondary data for the study. The methodology adopted here is comparing and contrasting the features and methods of valuation of tangible assets with that of intangible assets. The writer has critically analyzed GAAPs and accounting standards to check whether those can be applied to encourage and to record more intangible assets in the financial reports of companies. The writer has analyzed the problem statement mentioned at the beginning based on the theme ‘preparation of Financial Statement Based on Generally Accepted Asset Recognition Criterions and Accounting Standards, Discourage Recognition of many Intangible Assets that Contributes Immensely to Create the Company Value’. The theme has been discussed based on three perspectives, namely: i.) valuation perspective – for financial reporting. ii.) value relevance perspective – for decision making and iii.) stock market perspective – for provisioning of information. The study revealed that it is possible to increase the recognition of more intangible assets with some degree of subjectivity, which is even common for tangible assets. It further revealed that non-financial disclosures play a prominent role in communicating the information in relation to intangible assets. The extended recording may reduce the gap between the book values and the market values of the 1
  • 2. firm and will help to minimize insider dealing. Reduce the cost of capital for firm and to the investors and cause to increase the efficiency of the organization. Keywords: Generally Accepted Accounting Practice , , Financial Reporting, Financial Statements, Assets, Intangible Assets, Tangible Assets INTRODUCTION The assets of a company fall into two major categories; Tangible Assets and Intangible Assets. Tangible Assets are tangible and visible. Items like property plant and equipment fall under this category. Intangible assets are the assets having no physical existence and whose values depend on the rights and benefits that the possession confers to the owner. Some authors use terms like intellectual capital (IC), intellectual properties (IP) and knowledge capital (KC) instead of the term intangible assets. Both of these assets categories contribute in generating economic benefits to the companies. ‘Most elements of a business’s intellectual capital don’t find their way on its balance sheet, but the lack of a standard evaluation method shouldn’t prevent companies from trying to gauge their worth (Tanny Wall, 2002/2003). The writer expects to critically evaluate the current accounting principles and standards and to identify weaknesses of present practices and to suggest new ways and means of recording them in financial statements through this study. PROBLEM STATEMENT ‘Financial accounting professionals have spent the past decade debating how companies should report their IC. The application of historical cost convention, accounting principles and rules laid down by the accounting standards discourage recognition of many intangible assets in corporate financial reports. The main argument against their inclusion is that no universally acceptable method of measuring them has yet been determined (Tanny Wall, 2002/2003). ‘The growing difference between firm’s market value on the stock exchanges and their book values… is said to reveal intellectual capital. After all, the argument goes, since the balance sheet accounts for all only physical capital…’[italics mine] (Bukh, Larsen , Mouritsen 2001). ‘The starting point of this problem is the accountancy profession’s preoccupation with the double-entry bookkeeping. The principle that for a every debit there must be a credit, has been an essential part of the process for centuries’ (Griffiths 1995). Therefore, balance sheet as at a given date does not show the fair value of a company. Due to this, values given in corporate financial statements become less relevant for users. Lev and Zarowin (1999) ‘have identified a major reason for the usefulness decline; the increasing rate and impact of business change and the inadequate accounting treatment of change and its consequences -- and linked empirically change to loss of informativeness of financial data. Of the various change drivers we have focused on intangible investments, thereby completing the linkage: intangibles-business change- loss of value-relevance of financial information’. In other words they attributes the declining value of information to the failure to record many intangible assets. Above literature confirms the role played by intangible assets in value creation. But many of those assets are not found in the financial statements as described in above sections. The writer expects to assess the generally accepted Accounting Principles and Accounting Standards to see whether some more intangible assets could be 2
  • 3. incorporated in to the financial statements. This has been summarized in the following problem statement. ‘Application of Generally Accepted Accounting Principles and Accounting Standards for Recognition and Measurement of Intangible Assets Increase the Gap between Book Values and Market Values of Firms and Make the Financial Information Less Relevant’. SIGNIFICANCE OF THE PROBLEM Any individual or corporation can purchase/ construct any kind of tangible assets if they are liquid enough to afford. But it is the intangible assets like goodwill, brands, human resources, research and developments activities etc., which give a strong competitive edge to a company. Knowledge is the most important asset of a company. Therefore, the importance of intangible assets is the distinguishing feature of the new economy. At a given time, if the market value of the company is compared with the book value of the company, there is a difference. This difference could take either positive figure or a negative figure depending on company’s performance. Same scenario is true for many companies irrespective of their geographical locations. Table 1 below shows the differences in value in a selected quoted public companies, quoted in Securities and Exchange Commission of Colombo, Sri Lanka . Table 1: Market value Vs book value of selected quoted public companies of Colombo, Sri Lanka Company Name (Note) Market Value Book Value Difference a b Rs. 000 Rs. 000 Rs. 000 Alliance Finance Company Ltd 388,000 116,484 272,316 Distilleries Company Lanka Ltd 4,156,246 1,125,000 3,031,246 Browns Beach Hotel Co. Ltd 480,000 185,542 299,458 Source: Hand Book on Listed Companies 2001, Colombo Stock Exchange, Sri Lanka Note- Three companies selected by the writer on random basis a- Market value is the share price as at 31.03.2001 X No of shares issued b- Addition of all the assets or addition of all the liabilities This difference between book values and market values is reflected by the value of intangible assets to a greater extent. This view is justified by Lev and Zarowin (1999). As per their view “ We extend our inquiry by considering the accounting for innovative activities of business enterprises - - the major initiator of change in developed economies. These activities, mostly in the form of investment in intangible assets, such as R&D (Research and Development), information technology, brands and human resources, constantly alter firms’ products, operations, economic conditions and market values. We argue that the accounting for intangibles is where the present system fails most seriously in reflecting enterprise value and performance, mainly due to the mismatching of costs with revenues”. 3
  • 4. By and large, existing financial statements recognize those assets only when they are acquired from others. The fact that homegrown intangible assets also contribute in creating value, has been forgotten by the accounting profession due to conservatism THE THEME OF THE STUDY AND THE PERSPECTIVES The writer expect to analyze the problem statement mentioned above based on the following theme. ‘Preparation of Financial Statements Based on Generally Accepted Asset Recognition Criteria and Accounting Standards, Discourage Recognition of many Intangible Assets that Contributes Immensely to Create the Company Value’. The theme will be discussed based on the following three perspectives. Perspective I: Valuation perspective- for financial reporting Under this perspective, the writer expects to discuss the issues that will arise when attempting to value intangible assets for reporting in financial statements. Perspective II: Value relevance perspective – for decision making The incorporation or non-incorporation of intangible assets will affect decision making of internal and external users of financial reports. Such implications will be discussed under this perspective. Perspective III: Stock market perspective The core of this perspective is incorporation of useful information in any manner is useful if the companies are not in a position to incorporate such information in financial terms. The importance and methods of presenting non-financial disclosures will be discussed under this perspective. SCOPE OF THE STUDY The problem has been discussed by giving special reference to Sri Lanka (generally applicable to all companies). Accounting principles and Generally Accepted Assets Recognition Criteria and Definitions and requirements of the accounting standards has been reviewed by the writer in the analysis. Therefore, the scope of the study has covered the generally accepted accounting principles, assets recognition criterions, accounting standards in relation to tangible and intangible assets. THE NUMBER OF INTANGIBLE ASSETS COVERED IN THE STUDY Various professional bodies and number of authors have identified many numbers of intangible assets. For this study, the writer intends to study the Brands, Human resources, Research and development & Software, by considering the importance of them for companies in the new economy. 4
  • 5. OBJECTIVES OF THE STUDY The objectives of the study are as follows. • Identify the drawbacks in generally applied accounting principles and accounting standards, which discourage the recognition of intangible assets in financial statements. • Identify the better / best practices among the different alternatives adopted by various countries. • Suggestion of new ways and means of identifying and recording intangible assets based on the knowledge accumulated by the writer. • To elaborate the advantages that may accrue to the business firms due to extended recording & disclosures of intangible assets. METHODOLOGY Comparing and contrasting the assets recognition criterion of intangible assets with that of tangible assets is the main methodology adopted by the writer for this study. The main methodology that has been used is as follows; i. Identification of definitions of tangible assets and compare them with the definitions given for the intangible assets and critically analyze the definitions. ii. Identify the features of the tangible assets and explore into the features of intangible assets in order to identify the similarities and differences between them. iii. Explore the treatments given by the accounting standards for intangibles and tangibles and critically evaluate them. In order to carry out the above analysis, the researcher has used the secondary data and information sources. The researcher intends to gather data and build the arguments around the theme mainly from the following sources. • Previous research papers both local and international • Journal articles available in International Journals on the subject • Internet websites on researches in Intangible Assets or in similar areas • International and Local Accounting Standards on Intangible and Tangible Assets • Companies Acts and Rules and regulations set out by Securities and exchange Commission of Sri Lanka • Textbooks in Accounting Theory and International Accounting • Annual reports of Sri Lankan companies in the banking sector Using this information, the writer expects to compare and contrast the intangible assets with tangible assets their features and characters etc to achieve the said objectives of the research. DEFINITIONS OF KEY TERMS USED IN THE STUDY The writer expects to use some key terms continuously throughout the research. Those terms are defined by referring to accounting literature and accounting standards. 5
  • 6. Financial Statements As per Sri Lanka Accounting Standard No. 3 (SLAS No 3) -Presentation and Disclosures in Financial Statements, the financial statements are: balance sheet, income statement, statement in changes in equity, cash flow statement, accounting policies and explanatory notes. Assets ‘The definition of asset is important because it establishes what types of economic factors will appear in the balance sheet. It identifies the elements to be recognized, measured, and reported in the balance sheet. A definition of assets should be solely concerned with the criteria for classifying accounting transaction as assets’ (Walk & Tearney 1997). Intangible Assets As per Sri Lanka Accounting Standards No. 37; Intangible Assets: An intangible Asset is an identifiable non-monetary asset without physical substance held for use in the in the production or supply of goods or services, for rental to others or for administrative purposes (SLAS 37). Tangible Assets As per Sri Lanka Accounting Standards No. 18- Property plant and equipments held for use in production/administration and are expected to be used during more than one accounting period. Financial Accounting Standards Board has defined the assets as ‘Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events’ (FASB, 1985). Generally Accepted Accounting Practice (GAAP)/ (Principle) GAAP is the term used to describe the basis on which financial reports are normally prepared. The term encompasses: specific rules, practices and procedures relating to particular circumstances and broad concepts and principles of general application (Mathews 1996). THE THEME IN DIFFERENT PERSPECTIVES Valuation Perspective for Financial Reporting The idea of putting a value on intangibles assets has become increasingly popular over the past couple of years. Others -users of financial statements including auditors cast the net wider to cover intellectual capital / intangible assets [italics mine] (David 2001). Under this perspective the writer expects to discuss the issues that may arise when attempting to record intangible assets in the financial reports. In this section, the writer expects to build the arguments by comparing the features of the tangible assets with that of intangible assets by outlining some pre- requisites to recognize items in financial statements. Next, the conservative nature of the accounting has been discussed. Thereafter, the nature and accounting issues relating to valuation of goodwill, brands, human resources and research and development, and software has been discussed in detail. Value Determination of Assets and Accounting Conservatism The tangible fixed assets can be constructed or can be acquired from others. Similarly, intangibles assets also could be self constructed or can be acquired from 6
  • 7. others. But the generally accepted accounting principles, like money measurement valuation, objectivity, prudence etc. do not allow the internally generated or self constructed intangible assets to be recognized in the balance sheets in many situations. Conservative recognition rules served to prevent the accounting existence of internally generated goodwill also for other internally generated intangible assets [italics mine] (Power M 2001). Those rules have been published as accounting standards. As per Sri Lanka Accounting Standards No. 37, ‘Internally generated goodwill should not be recognized as an asset (paragraph 37) and internally generated brands, mastheads, publishing titles, customer lists and items similar in substance should not be recognized as intangible assets (SLAS 37). There are some other accounting principles, which compel the recognition of intangible assets irrespective of whether those are self constructed or acquired from others. Accounting principles like going concern, accrual and matching, materiality and substance over form are some of those. But auditors’ objective evaluating criteria for certifications do not allow such compelling principles to dominate in the assets recognition. Value Determination of Intangible Fixed Assets The question in hand is not the value determination of tangible fixed assets, but the value determination of intangible fixed assets. The value determination of intangibles assets is not a critical question when those are acquired from others. Still there are some conditions to be satisfied. The question arises as to why accounting practice and accounting standards does not allow to incorporate such values when those are constructed or internally generated. If an asset is acquired, it gives some sort of assurance to the auditor for their verification procedures. But when it comes to value measurement of internally generated assets, valuation creates some issues. The issue is not the valuation but the subjectivity of the valuation. Even if there is a degree of subjectivity in the valuation, if the valuation of tangible fixed assets are perused, it will be obvious that there are subjective of values included in the assets. Those are elaborated in the following section. Subjective Nature of the Valuation of Tangible Assets and Intangible Assets Both categories of assets (tangible /intangible) are not free from the subjective nature of the valuation. The subjective natures of the valuation of tangible assets are also not trivial. Some of those instances are outlined below. i. Attribution of overheads and administrative expenses (SLAS No. 18). This may comprise a material value of the total cost of the assets in case where the assets are self-constructed. ii. An identical asset’s cost may differ depending on the period that may take for bringing the assets into its intended purpose. Efficiencies of the individual firm and firm’s inherent strengths and weaknesses may change the final value to be incorporated. iii. Fluctuation of purchase price when assets are acquired on lease basis. On the strength of the securities and the guarantees given and on the trust the parties have already built up, the rate of interest charged will differ and this will ultimately change the value of an identical asset capitalized between different companies. 7
  • 8. iv. When discounting future expected cash flows of an asset to work out the net present values, depending on the cost of capital, the net present value will change. (SLAS 19). v. When interest cost is capitalized ‘under allowed alternative’ (SLAS No. 20), the rate of interest will differ according to the bargaining power of the parties. There are many more examples like this in relation to the valuation of tangible fixed assets. One may be able to imagine the problems which may arises when attempting to value things which cannot be seen or touched i.e. intangibles. In case of intangibles the critical issue is not the valuation but the subjectivity of the valuation. But since there is a degree of subjectivity in the valuation of tangible fixed assets that is tolerated by the accounting profession and the users of the financial information, the subjective nature of the valuation of intangible assets, could be considered to tolerate. It will be very much useful incorporating these unrecorded assets even at a lesser objective value. There are issues raised by the profession in relation to existence of goodwill, mixing of value of it with the home-grown goodwill and information asymmetries, which question the value. Brands could be easily valued with a certain degree of subjectivity using either cost or market values. Training and development cost of human resources indicate many features comparable with tangible assets. Objective measurements & bringing future economic benefits are some of these features. Value relevance perspective for decision making The much-publicized gap between book value and market value increasingly posed the question about the relevance of accounting numbers to economic decision making (Power 2001). The writer has evaluated the impact of decision making on both internal and external users of the financial statements due to the alternative accounting treatments made on intangible assets by the accounting profession. Validity of decision is an issue due to presence of the alternative accounting treatments. The qualitative characteristics of financial information has also been discussed by the writer under this perspective, since the presence of such qualities are said to be increasing the decision usefulness of financial information. Further the writer has quoted a numerical example for highlighting the impacts on decision making. Some frequently used accounting ratios, which affect due to these alternative treatments have been discussed subsequently. The Accounting Treatments for Intangibles Assets General accounting treatment is to capitalize all the acquired or purchased intangible assets if those assets satisfy the assets recognition criteria given in the accounting standards and by the practices of accounting profession. (See figure 1). Instead of purchasing, if such assets are homegrown or internally generated, then the accounting treatment is to charge the expenses, against the revenue of the period. If the management is capable of proving to the auditors that some of those assets meet the exact asset recognition criteria (like measurements and control etc) those homegrown assets are allowed to be capitalized. Some intangible assets, which come under this category, are patent rights, some parts of the development costs and 8
  • 9. advertising etc. These intangible assets which pass the asset recognition tests will qualify to appear as assets in the balance sheets. Once an item is qualified to appear in the balance sheet, its value is amortized over a period. Some of the amortization periods are determined arbitrary while others are determined by reference to assets’ nature or constrains like legal restrictions. The other intangible asset categories which do not pass the test will not be qualified to appear as assets in the balance sheet. Hence, the cost of those items will either purposely or automatically be charged against the revenue of the company. An example for purposely-charged item is the training and development costs of the employees of the company. An example for a automatically charged item to the revenue is the cost incurred on development of brands. The cost incurred on these and on similar items may appear on several places of the revenue statement. For example, cost of advertising, quality and productivity controls and cost of maintaining databases etc. appear in several expense headings in revenue statement. Figure 1: General Accounting Treatment for Intangible Assets Intangible Assets Acquired Home Grown Capitalize & amortize Goodwill, brands Other objectively the value against etc * measurable assets revenue over a period ** Source: the writer Capitalize & amortize * List is not exhaustive Write off against the value against revenue ** The assets only meet the asset recognition criteria similar to tangibleaassets. revenue over period Figure 1 summarizes the accounting treatments for intangible assets in general. The capitalization or non-capitalizing of asset brings serious issues in to the decision making of the investors. Lev and Zarowin (1999) emphasize one of those problem as ‘the large investments that generally drive change, such as restructuring cost and R&D expenditures, are immediately expensed, while the benefits of change are recorded later and are not matched with the previously expensed investments. Consequently, the fundamental accounting measurement process of periodically matching costs with revenue is seriously distorted, adversely affecting the informativeness of the financial information (Lev & Zarowin 1999). In this quotation, they (authors) refer to the change. But giving a footnote they further explained that it is not the change that distorts the financial reporting, rather it is the increased uncertainty associated with the change. Any one will have to accept the fact that there is a probability of success in the programmes such as substantial restructuring, product developments and heavy advertising campaigns etc. If the outcomes of any of these programmes or similar activities can be predicted accurately, the accounting profession will not be reluctant to recognize the costs as assets and match the costs against revenue. But the uncertainty accompanied by such programmes force for expensing the cost of the said programmes (i.e. intangible assets) in the current year. 9
  • 10. Money measurements, objectivity and prudence like accounting concepts act as barriers for recognizing intangible assets in the financial statements in situations like this. Question of Value Relevance and Accounting for Intangible Assets Up to this stage accounting treatments for intangibles were explained. The writer has explained that there are different accounting treatments for intangibles depending on whether those are acquired or home grown. Due to various accounting treatments, the financial statements will lose the qualitative characteristics that they should have possessed. This is summarized in the figure 2 . The Alternative Accounting Treatments and their Impact on Decision Making As explained, due to alternative treatments of tangible and intangible assets, which contribute to company value, the financial statements may not show a fair picture. The writer intends to discuss the decision-making issues by referring to some numerical examples. The outcomes of those issues are common to many of the intangible assets. Figure 2: Alternative Accounting Treatments and Decision Usefulness Alternative treatments for intangible assets Affects relevance, reliability, consistence etc. eretccomparability etc Loose the quality and affects the decision making Source: the writer For example, ‘the capitalization of goodwill without amortization may allow the most advantageous financial reporting figures. A company gets to record an asset instead of a decrease in shareholders’ equity and net income is not periodically reduced. This allows higher assets, shareholders’ equity, and the net income amounts on the financial statements relative to any other method of accounting of goodwill (Fontanot 2003). The basic argument brought by this author is the distortion of the financial figures. Then it will affect to the decision making of users. So, the values given are less relevance for decision-making. Capitalization of Goodwill and Amortizations Following illustration shows how the amortization of goodwill impact on the earnings of the company and thereby the decisions taken by the users. Assume company A decided to buy all the shares of company B. Some of the relevant figures have been extracted in the table 2. Trading value of company B share is Rs. 30. Purchase consideration to be settled is Rs. 3,000,000 (100,000 shares x Rs. 30 per share). The difference between the book value and the payment made was Rs. 1,800,000. This figure will be shown as the 10
  • 11. goodwill in the books of company A. Also assume that the goodwill is to be amortized over 20 years. Table 2: Extracted figures of two hypothetical companies Company A Company B Earnings Rs. 1,000,000 Earnings Rs. 150,000 Shares outstanding 1 million Shares outstanding 100,000 Book value of the company Rs. 1,200,000 Book value per share. 12 Source: the writer (figures assumed for the explanation purposes) After the acquisition A & B, both become a one company. For the simplicity, assume the earnings are identical in the next year. Some of the important figures are given in the table 3, in the next financial year after the acquisition. Table 3: Performance of company A for the two financial years Item description Before the Acquisition After the Acquisition Earnings Rs 1,000,000 1,150,000 (1,000,000+150,000) Less- goodwill amortization --- 90,000 (1,800,000/20) Earnings 1,000,000 1,060,000 Earnings per share (EPS) Rs. 1 1.06 EPS- had the goodwill not Not applicable 1.15 been amortized Rs Source: the writer (based on the information given by the writer) The amortization of goodwill has reduced the earnings by cents 0.09 (1.15-1.06) per share in the above calculations. Depending on the regulations put by different countries the period of amortizations differ. The amount charged to earnings will also differ accordingly. If decisions were taken based on the figures as it is, the probability of failure is very much likely. The Affected Accounting Ratios due to Alternative Accounting Treatments Some of the accounting ratios are affected due to the alternative accounting treatments made on intangible assets. Some of those ratios are given in the table 4. Table4: Ratios that will affect due to various accounting treatments on intangibles Ratio Method of calculation Net profit Net profit / Turnover Return on equity Net profit / Equity Dividends payout Dividends / Earnings Price earning Share price / Earnings per share Market to book Share price / Book value per share Gearing ratio (Total liability – Current liability) / Capital employed Source: Brealey A R, et al, Fundamentals of Corporate Finance: 1999 2 nd Ed, The McGraw-Hill Companies, USA, p 474-475. 11
  • 12. The above list of ratio is not exhaustive. Any one can think of any other ratio as long as those are rationally designed. The selected ratios above are either related to earnings or assets. The treatments of intangible assets affect any of those two either directly or indirectly. Therefore, if a decision is taken without giving the due accounting consideration for intangible assets, the user may not be able to reach the optimal decision. For example, the gearing ratio measures the proportion of capital employed, which has been raised by fixed interest debt. Normally ‘high geared companies’ face difficulties in making further borrowings. But if they can prove that they have intangible assets, which has not been accounted for or fully amortized, they will be able to convince the lending parties regarding the strength of the company for borrowing further. Stock market perspective It is impossible to incorporate all the available intangible assets in the financial reports due to the controversies already explained. But this information could be presented in non – financial terms in the main body of financial reports or in the explanatory sections of the financial reports. The writer has examined, elaborated and emphasized the importance of such information in this section. Efficient Market Hypothesis (EMH) and the Share Market According to EMH an efficient market is one in which security prices incorporate new information so rapidly that it is not possible for investors to profit from the publicly available information (McMenamin 2001). Financial market efficiency has important implications for the investments and financial decisions, not only of individual investor but also of the firms. These findings show that accounting information does have economic significance in that share prices react to new accounting information (Glautier & Underdown 1994). ‘The research findings on this issue have tended to show that this is in fact the case. ‘The implication of theses findings is that it is not the accounting treatment of items such as intangible assets that really matters (Radebaugh & Gray 1993) ( i.e., whether they are capitalized or amortized, and so on). Irrespective of the accounting treatment, the economic substance of the information disclosed will be incorporated in share prices provided that there is a full disclosure. Therefore, it is important to ensure that sufficiently detailed information is disclosed about the nature and treatment of intangibles assets so that the users can make their own assessments of the treatments adopted and evaluate the likely effects of using alternative treatments. On the other end, all the stakeholders or especially the equity holders and potential investors of the share market may not fully aware of the market efficiency. There are some categories of investors who do not understand the very basics of financial information. Most of them operate in the market through intermediate parties such as brokering firms or financial analysts. There are research evidence, however, that reported corporate earnings are adjusted by analysts to exclude profits / losses on the sale of property and amortization / valuation adjustments, where these occur, with respect to goodwill and for other intangibles [italics mine] (Radebaugh 1993). When prices are analyzed by the analysts or the financial brokers they try to distinguish 12
  • 13. between recurring and non-recurring earnings for the prediction purposes. In addition, the market participants rely on and process wide range of information in making their recommendations to their clients. The share markets are also significantly affected by the economic and political climates of the country in addition to the accounting information disclosed by the companies. Non-Financial Information and Intangible Assets The financial analysts and consultants require information about the directors and managers ability in managing the operation of the organization both on long –tem and short-term basis. ‘Back in 1992, the Association of Investment Management Research (AIMR), comprising financial analyst over 100 countries, stated that non- financial information was a good way to communicate with shareholders about the company progress. Non-financial information provides evidence of ‘management operating know-how’ and non- financial information usually correlates with financial information (Zarzeski 2001). They have referred to the management’s operating know-how. What are these? These are not given directly in the article. But we can reasonably assume that they refer to the skills and competencies of the management, process efficiencies and the innovativeness of the organization etc. So all these have been referred as the intangible assets of the organization. Non-Financial Information and Shareholders Value An obvious question may arise to a reasonable prudent person whether there is a relationship between the non-financial indicators and the shareholders value. Through the literature this has already been substantiated. Sevby in his working paper gives an answer by raising a question as follows. ‘But can a non- monitory management information system guarantee financial success and shareholder value? Yes, as WM-data, one of Europe’s most successful computer companies, show, it is possible to create superior shareholder value by focussing on the intangible rather than tangible assets’ (Sveiby 1997). The writer has quoted only a one situation, which may not be reasonable to come into a conclusion. But most of the organization of the new economy relies heavily on computers and information technology, especially service related organizations. Therefore, there is a high probability that same scenario is true for almost all the business organization in the new economy. Subjectivity and Non-Financial Information The writer has already emphasized that there is a considerable amount of subjectivity when it come to the valuation of both tangible and intangible assets. All these valuations are based on the money measurement concept. Still the subjectivity rests with the valuations. Majority of the intangible assets recorded are acquired from other parties. This majority counts for a relatively small value when compared with the total value of the intangible assets possessed by a company at a given time. (Even though there are issues in calculating the total value of the intangible assets). But ‘intellectual capital (IC)[intangible assets] cannot be ignored (especially the internally generated or home- grown intangible assets) and, while financial accountants may have to wait for regulatory guidance before these assets can appear on the balance sheet, it doesn’t mean that the annual report can’t be sued as a medium 13
  • 14. for communicating how an organization’s IC adding value [italics mine] (Wall 2002/03). CONCLUSION The purpose of this section is to present the readers with the findings and conclusions arrived by the writer. These findings have been arrived at after discussing the theme of the study based on three perspectives already discussed in sections10.1, 10.2 & 10.3. The main problem of the valuation of intangible fixed assets is the subjective nature of the valuation. The subjectivity of the valuation has already been accepted by the accounting profession to a certain degree in case of tangible fixed assets. So, by considering the extreme importance of the intangibles, the intangibles should be valued even though the values are not objectively measurable 100% accurately. Brands, training and development costs of human resources, research and development are some of the example for these. Alternative accounting treatments for intangibles reduces the desired qualities of the financial information and make the information less relevant for decision making purposes. The empirical findings indicate that the availability of information regarding intangible assets in any manner (i.e. financial or non-financial term) is useful for information users. The method of recording intangibles when acquired from others are similar to a great extent even if there are differences in the periods of amortizations. These differences are critical when it comes to cross-broader listings. In Sri Lanka, non-financial information disclosed restricts to human resources. But, the literature revealed that, the annual reports of foreign countries (Sweden & India are some examples) disclose information relating to many intangibles assets using structures called Intangible Assets Monitor. These formats are similar to the presentation formats of Balanced Scorecard information. The retrospective capitalization of intangibles and restatements of financial statements can be considered as a best practice. The other best practices are to capitalize the training and development cost of employees as an asset and to create temporary assets account called ‘R & D in suspense’ till the uncertainties are cleared. The accounting profession should try to develop a format to present non- financial information similar to intangible assets monitors used by the accounting profession in foreign countries. There are empirical evidence which says that the cost of capital get reduced, insider dealings get minimized and efficiency of the organization get increased as a result of extended recognition and disclosures of information in relation to intangible assets. The prominent feature of the new economy is the creation of greater value through intangible assets. When information relating to the intangible assets get monitored, recorded and communicated to the decision makers and users, it will cause to take informed judgments, both internally and externally. This will allow keeping the intangibles under control and could be developed them for further enhancement of value. Therefore, conservative nature of the accounting should be converted to be 14
  • 15. matched with the requirements of the new economy, which will pave the avenues for extended recognition and disclosures of information in relation to intangibles. References Bukh, P. N. D., Larsen, H. T. & Mouritsen J. 2001. Intellectual capital and capable firm: narrating, visualizing and numbering for managing knowledge, Accounting Organization and Society, 26, 735-762. David, A. 2001. Hard Currency. CIMA Financial Management, 13. FASB (Financial Accounting Standards Board). 1985. Conceptual Framework for Financial Reporting, 25. Fontanot, P. 2003. How Good is Goodwill- You Decide. Accountancy SA (Journal of the Institute of Chartered Accountants of South Africa), 9. Glautier, M. W. E. & Underdown, B, 1994. Accounting Theory and Practice. 5th Ed, Singapore: ELBS with Pitman Publishing, 388. Griffiths, I. 1995. New Creative Accounting. 1st Ed, Great Britain: Mackays of Chatham plc, 161. Sveiby, K. 1998. Measuring Intangibles and Intellectual Capital - An Emerging First Standard. Internet version, 5, 1. Lev, B. & Zarowin, P. 1999. The Boundaries of Financial Reporting and How to Extend Them. Journal of Accounting Research, 37 (2), 353-384. Mathews, M. R. & Perera, M. H. B. 1996. Accounting Theory & Development, Australia: Nelson Australia Pty. Ltd, 107-151. McMenamin, J. 2000. Financial Management: An Introduction. 1st Ed, Oxford University Press, 130. Power, M. Imagining, measuring and managing intangibles. Accounting Organization and Society, 26. Radebaugh, L. H. Gray, S. J. 1993. International Accounting and Multinational Enterprise. 3rd Ed, New York : John Wiley & Sons, Inc., 233. Sri Lanka Accounting Standard 19-Accounting for leases, para 11. Sri Lanka Accounting Standard 20- Borrowing cost, para 9-11. Sri Lanka Accounting Standards 18- Property Plant and Equipment, para 2. Sri Lanka Accounting Standards 37- Intangible Assets, para 14. Sri Lanka Accounting Standards No. 3, Presentation & Disclosures in Financial Statements, 54. Sveiby, K. E. 1996. Intangible Assets Monitor. A working paper available in the web dated 15 May, updated December 1997, 4. Tony, W. 2002/03. Mental arithmetic. CIMA Financial Management, 28-29. Wolk, H. I. & Tearney, M. G. 1997. Accounting Theory- A conceptual and Institutional approach. USA: International Thomson Publishing Company. 4th ed. 332. Zarzeski, M. T. 2001. Counting more than numbers. Accountancy (The Institute of Charted Accountants of England & Wales), 114. 15