Dr.Kretov Kirill (Master of Arts in Human Resource Management, and Doctor of Business Administration) explains various types of intangible assets (non-physical resources) recognized (and not) by current accounting practices. This paper is an extract from the Doctorate Thesis written by Dr.Kretov Kirill in December 2009, Geneva / Montreaux, Switzerland. The author invites everyone to participate in his ongoing survey on the site http://www.kretov.ch

1. Dr. Kretov Kirill - Basic classification of corporate assets.
Introduction to Various types of Intangibles.
“Making the invisible visible is the CEO’s job” (John Hagel, The McKinsey Quarterly)
1.0 Introduction
Amid the many complicated and creative models encountered over the last decade, it has become
evident for most companies that the valuation of Intangible Assets and Intellectual Capital has proven to be
more theoretical than practical. Although a number of studies have been carried out on the valuation of
Intellectual Capital, most of the findings seem more theoretical than practical.
The concept of intellectual capital has already been researched by many elite scholars, who have created
many interesting theories. However, most of their work is purely theoretical, and their concepts and theories are
not widely accepted. Very few of them have been actually applied. For example, many papers have been written
about intellectual capital and its importance to a company’s performance; quantitative analyses and reports
show that intellectual capital is an emerging competitive advantage that results in long-term profits and greatly
increases the value of the company. However, current accounting practices recognize only a very limited
number of intangible asset types (in terms of intellectual capital). From the accounting perspective, the choice is
very limited: there are R&D and Goodwill (the second being inapplicable to most companies). Only if the
company is aware of the existence of some particular type of asset may it decide to estimate its value using a
given valuation method (if one is applicable). The problem is that the final value is not a guarantee of the real
value of an asset. Another practitioner may not agree with the valuation principle applied and may propose
another that he finds more appropriate, or someone might apply a number of theories to the Intellectual Capital
of a company and come up with a list of indicators that might not be accepted or understood by others who
prefer other concepts. Thus, it seems that the root of the problem is not the lack of evaluation methods but the
lack of widely accepted standards for these methods and for the reporting of the results.
Moreover, there are issues involving patents, trademarks, copyrights, and other forms of “know-how”:
exclusive rights, the most profitable kind, are given only to patent holders. An accountant recognizes only those
assets recognized by current accounting practices (as regulated by the IFRS). Since reporting unrecognized
assets is only optional, an accountant may decide not to spend time reporting them, especially if his motivation
is not very high, and he wants to spare himself the work. Knowledge management scholars know that it is
possible to identify where knowledge comes from and classify it using various theories and taxonomies. This
can be helpful for companies that apply KM principles to create value through the continuous identification of
the pieces of intellectual capital they create. The foregoing has described only a few of the perspectives from
which the field of intangibles can be considered.
1.1 Historical Overview
Intangible assets are not a modern invention or a phenomenon of the 21st century. Indeed, contrary to
popular misconceptions, this type of asset has existed for a long time. Throughout human history, knowledge
and information have remained two of the most precious commodities. The caveman who discovered the
secret of manufacturing and used a spear to kill a mammoth faster and with less risk to himself possessed an
intangible asset that meant the difference between life and death not only for the hunter-gatherer but also for
his community. Similarly, the inventors of the alphabet, calendar, and mathematics possessed equally
important intangible knowledge assets.

2. In contemporary society, knowledge has become far more complicated, specialized, and technical.
Mistakes made in the operation of a nuclear plant, space shuttle, or biological weapons research facility can
mean the deaths of millions. Much like in prehistoric times, knowledge, and expertise have remained assets
that can mean the difference between the life and death of the tribe.
Now, particularly in the developed world, businesses are increasingly reinventing themselves as
service-oriented operations. Manufacturing tangible commodities that consumers can touch, smell, or taste is
rapidly becoming a thing of the past. These transformations have become increasingly frequent across a wide
spectrum of organizations. Many companies rely almost entirely on intangible assets and consider them one
of their core competitive advantages. This was accurately described in the Harvard Business Review:
Employees skills, IT systems, and organizational cultures are worth far more to many companies than their
tangible assets. Unlike financial and physical ones, intangible assets are hard for competitors to imitate, which
makes them a powerful source of sustainable competitive advantage.( Robert S. Kaplan and David P. Norton,
“Measuring the Strategic Readiness of Intangible Assets”).
It is well known that most of the business resources in developed countries are intangible: in 1982, the
material assets of American companies constituted 62% of their marketable value (Stewart T.A. Intellectual
Capital. The New Wealth of Organizations.); after 10 years, that share fell to 38%, and current research (R.S.,
and Norton D.P. Die strategiefokussierte Organisation: Fuhren mit der Balanced Scorecard.) estimates it at
only between 10% and 15%. By the end of 1999, the value of the property reflected in the balance sheet
constituted only 6.2% of Microsoft’s market price, 4.6% of SAP’s, and 6.6% of Coca-Cola’s (Daum J.H.
Intangible Assets). In 1982, the share of the non-material resources in added value creation for the 500
largest American companies was 38%, and by 1998 it was 85% (Du Voitel, R.D., Roventa, P. Mit Wissen
wachsen–Strategisches Management von intellektuellem Kapital, in.: Perspektiven der Strategischen
Unternehmensfuehrung.).
The current investments structure strengthens the prevalence of non-material resources: in the early
80s, 62% of investments in the American industry were acquisitions of material assets; by 1992, that share
dropped to 38% and was only 16% in 1999 . Since 1991, US enterprises have been spending more money on
information processing equipment than on other equipment; information is replacing material merchandise
stock, and knowledge is pushing out tangible fixed assets.
Prominent economist Leonard Nakamura estimates that the United States invests at least $1 trillion
per year in intangibles (Leonard Nakamura, “A Trillion Dollars a Year in Intangible Investment and the New
Economy,” in John Hand and Baruch Lev, eds., Intangible Assets: Values, Measures, and Risks.), a figure
derived from the fact that about 6 to 10 percent of the US GDP is spent on intangible assets. Investments in
R&D and software have increased significantly over the last 40 years. Simultaneously, the average cost of
goods sold has fallen by more than 10 percent since 1980. Services, which are counted as intangibles, rose
from 22% of GDP in 1950 to 39% in 1999.
These dramatic changes (Margaret Blair, and Steven Wallman, “The Growing Intangibles Reporting
Discrepancy,” Unseen Wealth: Report of the Brookings Task Force and Intangibles.) not only document a clear
increase in investments in intangible assets but also underscore the growing value of intangibles as an
important element of contemporary business.

3. 2.0 Basic classification of corporate assets
Every organization possesses multiple types of assets, which it combines to produce goods and
services. The objective of this section is to classify these assets based on their common attributes.
All assets can be divided into two major types. The first type incorporates conventional assets that can
be touched, sensed, and felt: these are known as tangible assets. Any asset that does not fit the above
description can be categorized as intangible. According to IFRS (IAS-38 Intangible Assets, Issued in September
1998, revised in January 2008.), an Intangible Asset is an identifiable non-monetary asset that does not have
physical substance. An intangible asset must be identifiable, a requirement that distinguishes it from goodwill.
Tangible assets are usually associated with intangible assets, as represented in the diagram by the overlap
between the two major categories. For instance, when an organization produces physical commodities, it will
usually have some form of intellectual property (IP) associated with and involved in the manufacturing
process.
Most physical products, however, cannot be patented in their entirety. For example, a notebook computer
manufactured by Sony may include not only a patented CPU cooling technology, the Sony brand name, and
the VAIO trademark but also a Blue-ray player, which relies on technology developed and patented by the
Blue-Ray Disk Association (BDA). Similarly, automobile industry giants like BMW incorporate components,
such as GPS systems and MP3 players, that are patented by other organizations.
On the other hand, an organization can also possess intellectual property that has not yet been employed in
any manufacturing or production process. For example, General Motors maintains an extensive portfolio of
inventions and licensed intellectual property in addition to its vast array of trademarks and patents used in
current product offerings. Thus, an overlap between tangible and intangible assets does exist but is only
partial.
Furthermore, the diagram also includes financial assets, which are intangible by definition. Cash and its
equivalents are not real property, because cash needs no valuation; however, it can still be secured by physical
assets. For this reason, the diagram illustrates a partial overlap between financial and tangible assets.
J. Cohen proposes that Intangible assets can be categorized into two distinct groups, identifiable and
unidentifiable. In addition, intangibles (or proto-assets) share some of the attributes of identifiable and
unidentifiable assets but do not fit neatly into either of these two categories. Here we see the difference in
opinion about the essence of Intangible Assets. From an accounting standpoint (i.e., for the IFRS), an IA is an
identifiable non-monetary asset, but J. Cohen states that the IA may be further split into identifiable,
unidentifiable, and proto categories. Those who begin to explore this field farther will see more serious
disagreements among researchers regarding terminology and concepts. In my opinion, an asset should be
called by a name recognized by accounting practices: if it is not recognized but is clearly identified and
valuated, then it is an asset.

4. 2.1 Identifiable Intangible Assets (Recognized in Accounting)
Intellectual property is most commonly associated with the concept of identifiable intangible assets and
includes patents, copyrights, trademarks and trade secrets. These elements all share one salient commonality –
they are accorded special legal protection or recognition and are deemed property as a matter of law.
Recognition and protection of intellectual property is not a development of modern times. The
Copyright Act was enacted in the United States in 1790, while President Jefferson’s Patent Act of 1793 codified
the concept of patents. Legislation, however, has occasionally proven to be inadequate, raising the possibility of
benefits derived from the ownership of intellectual property being removed. For example, in 2003 alone, 308
out 526 patent infringement suits filed in the United States were deemed invalid or unenforceable.
Aside from temporary monopolies, the major benefit of intellectual property ownership is its potential
marketability. Patents are routinely sold, licensed and bought. IP assets are identifiable, separable and are often
purchased or assigned to someone other than the inventor or creator.
Research and Development
It is probably a good idea to begin the discussion about types of Identifiable intangibles with Research
and Development (R&D). Historically there were only two intangible items reported in public company
financial statements: R&D and Goodwill. For this reason R&D expense records of public firms have been the
topic of widespread academic research.
R&D is defined as an identifiable intangible asset because it may result in the creation of intellectual
property. For example a company’s research may lead to patents that can be bought and sold separately.
Marketable patents, however, are not the only purpose of R&D investments - they often lead to improved
manufacturing techniques, trade secrets and other types of intellectual property that will never be patented, but
will nonetheless improve the company’s competitiveness. Consequently R&D has the potential for the creation
of other assets, some of which are discussed below.
Patents
There are three basic types of patents, which include utility, design, and plant patents. (See U.S. Code
Title 35 – Patents1, for a full description of patents and patent laws.) For the patent to become enforceable it
should be listed in at least one registry of intellectual property, some of which can include The United States
Patent and Trademark Office (USPTO), the European Patent Office, the Japanese Patent Office, and World
Intellectual Property Organization (WIPO).
The core purpose of all of these offices is to act as the registry of patent information. These
organizations check whether a patent application meets various criteria (must be “novel, non-obvious, and
useful”) and if so, records the invention as having been created and owned by patentee. The application process
is not rapid and the cost to obtain a patent is not nominal. The author of this paper (Dr.Kretov Kirill) resides in
Switzerland and has recently sent a patent application for “a method of password protection against various
types of key-logging techniques” to the European Patent Office (EPO). Besides attorney costs to help draft the
application, simply starting the process costs CHF 3,600 and the first results are expected to arrive no earlier
than six months after the date of application. Normally it takes two to three years to win patent approval. After a
successful application, the patent holder has the right to exclude others from making, using, or selling its
invention for a period of 20 years (which is why patents are often described as temporarily granted monopolies).
Perhaps most interesting is a subset of utility patents knows as process or method patents. During the
internet boom of the late 1990s, many start-up technological firms have filed for process patents that described
1
U.S. Code Title 35, http://www.law.cornell.edu/uscode/html/uscode35/.

5. methods that could be useful to everyone. For instance, there is a patent filed on the “process” of using modem
to connect to the Internet. Most famous are probably Amazon’s “1-Click” buying feature and Microsoft’s
double-click patent. Some critics of the USPTO allege that during 1990s, patent reviews have failed to take into
account the test of “non-obviousness”. Many suggested that the life of Internet-related process patents should be
reduced to under 20 years.
However, in spite of the fact that many Internet-related process patents were approved only a few
resulted in economic benefit to their inventors. It is probably logical to ask: “Why grant patents at all?” There is
a simple economic rationale: if inventors cannot protect their work and make some money of it, they have little
motivation to create the invention in the first place. The right to exclude others from using the invention is a
kind of reward for investing the efforts to develop a patentable idea or technology. Patent law generally
supports the notion of monopolies being oftentimes good for customers. The enforced expiration of patents
supposedly creates the right balance: enough protection to encourage innovation, but not so much as to
encourage abuse.
Copyright
U.S. copyright law was established in 1790, during the Second Session of Congress, convened on
January 4th and the bill was signed into law on May 31st by George Washington. However the initial idea of
copyright goes back to the late fifteenth-century England when the printing press was introduced. Copyright is
usually made for written material or creative works, such as books, photographs, music, video records, and
software code. The process of applying for copyright is relatively straight forward – the creator of work owns
the copyright as soon as the work is created. Unlike patents, filing for copyright registration simply gives notice
that the creator is claiming copyright to the work, but it does not conclusively establish ownership. Furthermore,
the copyright office does not screen submission for possible conflicts with existing copyrighted materials.
Up until 1980s, owners of copyrighted materials, such as books or audio and video records were not
faced with mass copying of their works. But lately, due to the rapid development of technology (especially the
Internet) enormous quantities of copyrighted material were digitalized.
At this point it might be interesting to note copyright issues related to digital media and to mention the
concept of “fair use”. Fair use is “… any use of copyrighted material that does not infringe copyright even
though it is done without the authorization of the copyright holder and without an explicit exemption from
infringement under copyright law.2” However, fair use is widely misinterpreted. For example if someone buys a
computer game for about EUR 100, it is logical to expect that the buyer will not be happy to lose it due to
accidental scratching or other physical damage caused to the disk. DVD copying software can be used to make
a backup copy, so that if the original disc stops working, the buyer does not lose their money.
However, there is no guarantee that the buyer will not decide to share this backup with other people.
Uploading the image file (exact copy of the disc) to a file-swapping peer-to-peer network may expose it to
millions of people, potential buyers who will not pay for game, but use its pirated copy instead. Some
companies are integrating anti-copying techniques that complicate the copying process, but at the cost of the
buyer’s ability to create a backup copy.
In other words DVD-ripping and peer-to-peer networking software itself can be very helpful, and may
have socially valuable legal uses, even if it often is used for illegal ones. Copyright holders struggle to find a
solution that will help to prevent unauthorized use of their work, but with minimal success so far.
2
Congressional Budget Office, Copyright Issues in Digital Media, http://www.cbo.gov/ftpdocs/57xx/doc5738/08-09-Copyright.pdf
(August 2004) p.X.

6. Trademarks
Webster’s dictionary3 defines trademark as “a distinctive name, phrase, symbol, design, picture, or style
used by a business to identify itself to consumers”. Just like copyright, trademarks can be established through
common-law usage. The registration process is somewhere between copyrighting and patenting in terms of the
amount of review conducted and legal assistance required. There are legal advantages to registration, but
trademark search is not necessary. An attorney normally conducts one search only to determine what other
trademarks exist that could be confused with the one under consideration. It is even possible for two very
similar trademarks to coexist, provided that they are not likely to be confused. For example it is possible that
some plastic-window manufacturer will apply for the trademark called “Windows”, even if a very similar
trademark is registered by Microsoft. However if a start-up software developer company will create its web
browser and apply for the “Internet Explorer” trademark they most likely will not obtain it, simply because the
product classes are very similar and likely to cause confusion.
Trade Secrets
Trade secrets are types of assets that result from a certain way of doing business or proprietary
technology that provides competitive advantage to its holder. It is something that is used in ongoing business,
like a unique compilation process or data mining system. According to the Uniform Trade Secret Act (UTSA):
"Trade secret" means information, including a formula, pattern, compilation, program device, method,
technique, or process, that: (1) derives independent economic value, actual or potential, from not being
generally known to, and not being readily ascertainable by proper means by, other persons who can
obtain economic value from its disclosure or use, and (2) is the subject of efforts that are reasonable
under the circumstances to maintain its secrecy.” 4
Simply speaking, trade secrets are something that provides economic value because they remain
unknown to the competition. For example one company may abandon e-mail protocol as the communication
channel between workers and switch to an instant messaging service. Derived economic value could be the lack
of spam, instant message delivery, and improved security. In the meantime, its competitors will still using slow
and unsecure e-mails, waste 90% of their traffic on spam, and wonder why messages have been sent, but not
received.
Unlike patents, owning a trade secret does not prevent others from using it. Two firms can
independently and simultaneously hold the same information as the trade secret, but they cannot hold two
separate patents on exactly the same invention. There is no way someone can prevent another company from
using instant messaging service as the internal channel of communication, except if the company is unaware of
this possibility.
Brands
Brands are often confused with trademarks – in fact, the author (Dr. Kirill Kretov) of this paper was
surprised to find that Webster’s Merriam dictionary defines brand as synonym to trademark. It is not - brands
are much more than simply names or trademarks. A brand is an economic asset, because it adds value by
3
Merriam-Webster’s Collegiate Dictionary, 11th ed. (Springfield, MA: Merriam- Webster, 2003).
4
National Conference of Commissioners on Uniform State Laws, Uniform Trade Secrets Act,
http://nsi.org/Library/Espionage/usta.htm (Minneapolis, MN: NCCUSL, August 2-9, 1985), $1.4.

7. conveying information about a product. According to Tom Blackett 5, brands that keep their promise are
business assets. They attract loyal buyers who regularly return to them, making it possible for the brand owner
to forecast cash flows and to plan and manage the development of the business with greater confidence.
Because of the brand’s ability to secure income it can be classified as a productive asset in the same way as any
other, more traditional business assets like equipment, cash, investments, and so on. At the same time brand
owners have the incentive to “keep their promise”. If eventually the market discovers fraud the company risks
to lose a significant number of its clients.
The author of this paper is a great fan of all Sony products - he believes that this company produces
beautiful, innovative and durable products and, as a result, he is willing to pay more for their quality. But there
are many other Japanese brands available on the market and if suddenly Sony decides to cut corners and trade
low quality products under its good name, the author will simply switch to available alternatives.
Software Code
Software code is said to be one of the most complicated intellectual properties to codify. It is possible to
obtain a patent for the business process that the code enables or trademark certain features of the software. In
fact, even some part of the code can be kept as a trade secret while the code itself can be simply copyrighted.
However, this is complicated by different accounting treatments which largely depend on whether the
software regarded as an input to the organization’s manufacturing process, or whether the software is the firm’s
product is and of itself. In other words the firm may use and/or sell software code. For example Microsoft
Office is a very useful application that organizations might use for word processing or spreadsheet calculation.
However the cost of license for a given number of workplaces may not be treated as valuable intangible
property. At the same time MS Office is an extremely valuable intangible property to its creator Microsoft. Note
that only Microsoft holds the source code, while those who buy licenses are only given its compiled version.
5
Tom Blackett, “What is Brand?” in Brands and Branding, Rita Clifton and John Simmons, eds. (Princeton, NJ: Bloomberg Press,
2003) 18-9.

8. 2.2 Questionable Recognition
Accounting standards normally have high requirements regarding disclosure of information about non-
material (intangible) assets. For example, IFRS-38 requires that financial reports should include the following
information for each type (class) of assets: methods of amortization, results of re-evaluations, estimated life
periods (asset remains useful), and other explanations of significant changes in total value of non-material
assets. Reporting should also include the total cost of R&D, which is considered as spending for the current
period. However, it is the specific company that develops a classification of non-material assets, normally based
on some principle of their homogeneity.
In other words, IFRS recommends disclosure of information about valuable intangible (non-material)
assets that are owned by a company but not recognized by current accounting practices (CAP). At the same
time, the report format can be defined by a company. As a result, we have a lack of standardization and a
nightmare for investors, who have to compare parameters that are very often of different natures and
incomparable. Some reports with information about particular “assets” may be not incomparable just with other
companies but even with reports from the same company for different time periods. Some researchers 6 have
already identified this negative side of flexibility and freedom in reporting and classification allowed by IFRS. 7
As can be seen, then, current accounting practices only recognize R&D (primarily replacement cost). It
is possible to calculate the total cost of Human Resources. But there are no practical and widely accepted tools
or techniques for evaluation of intangible assets separately, at least from the accounting perspective. In the table
below (table 2.1) there is a list of intangible assets classified as recognized and not recognized by CAP
(recommendations from IFRS).
Recognized in accounting (mainly in IAS-38) Not recognized in accounting
Trade marks Expenses on training and education
Software Advertizing Expenses
Licenses and Franchises Reorganizational Expenses
Patents Research expenses
Copyrights Stuff (Personnel) skills and abilities
Service and exploitation rights Technical knowledge
Recipes, formulas, models, projects and concepts
Market share
Source Codes and documented algorithms List of clients
Acquired Goodwill (IAS-3) Brand names
Other intangible assets, regulated by various Internal Goodwill
standards8
Classification of assets by their recognition in IFRS.
Also, from an accounting standpoint there are “unidentifiable intangible assets”. These assets are special
in the sense that they remain hidden (at least in the accounting sense) until a transaction like a merger or
acquisition gives rise to their identification. Goodwill is such a type of an asset that is only valuated under
certain circumstances and may have significantly different value depending on those circumstances.
6
Wayne, S.U., Challenges from the New Economy. Business and Financial Reporting, SPECIAL REPORT/Financial Accounting
Standards Board, April 2001. www.fasb.com
7
At this point the idea of need of universal taxonomy model and superior reporting standard came to the author’s mind.
8
Discussed in IAS 12, 17, 19, 27, 28, 31, 32, 39, etc.

9. There are other unidentifiable intangibles (that may not be present in the above lists), but conventional
accounting rules do not provide much insight into valuating them. Between two very similar (in terms of
identifiable assets) companies, one might be more profitable than another. Various unidentified factors account
for one company being more efficient than another. Consider two very similar high-tech companies, both doing
business by developing software and selling it on the Internet. All visible characteristics of both companies are
very similar but one, let’s call it Company A, generates 10% more sales each month than Company B. If a
bigger holding company decides to acquire a high-tech firm, it might be willing to pay more for company A
than for company B, simply because A is more profitable. This difference may appear as Goodwill on the
financial statement. But why is A more efficient? It could be because company B was focused on designing
their portal by using nice graphics and animated menus to make their site look more attractive than that of
company A. At the same time, company A paid more attention to cross-browser compatibility, so that the page
correctly displays in all browsers. Thus some potential buyers with very specific web browsers are simply
unable to execute the shopping cart script on the company’s B portal, while everything runs smoothly on their
competitor’s (company A) portal. It is possible that those users of specific browsers account for the percent
difference in the amount of sales generated by both companies.
If company A identifies that it is more efficient because of its portal’s compatibility, it may wish to keep this
fact secret, thus the reason for its efficiency will become a trade secret. In other words, when the source of
efficiency is identified, the subject asset becomes an identifiable one. The cross-compatibility module will
become a trade secret or know-how. However, often that efficiency remains unidentified and in many cases the
management is unable to pinpoint the reason for it.
Goodwill
Goodwill is probably the most commonly discussed unidentifiable asset. It has already been mentioned
that goodwill is one of two intangible items that were routinely reported in public company financial statements
(another one is R&D). Goodwill shows up on a company's books when it acquires another company, and the
buyer naturally has to pay more for it than the fair value of the net identifiable assets, both tangible and
intangible.
Numerous goodwill definitions can be found in various documents and standards regulating the business
accounting and estimate activities (IFRS, USA GAAP). Note that given definitions are paraphrased and not
exact citations from sources.
IFRS 3 "Companies merger" (International Financial Reporting Standards)
By IASB (International Accounting Standards Board)
Goodwill arising from merger of the companies is the sum paid by the buyer over the purchase marketable value in
expectation of future economic gains. The future economic gains can result from the synergy effect of the acquired
identified non-material assets or assets which separately are not subject to acknowledgement in the financial reporting but
which are a part of the purchase cost. Goodwill is the excess of a purchase cost over the acquired share in fair value of the
identified acquired assets, which are inseparable from the target company. Actual goodwill cost is the purchase cost minus
the difference of fair value of identified assets, obligations and contingent obligations.
SFAS 142 "Goodwill and other intangible assets"(Financial Accounting Standards)
By USGAAP (US Generally Accepted Accounting Principles)
Goodwill is the cost excess of an acquired company over the cost of its identified assets minus obligations. Goodwill
reflects such factors as customer demand satisfaction, good management, production efficiency, successful location, etc.

10. EVS 2000 (European Valuation Standards) (latest 2009)
By TEGOVA (The European Group of Valuers’ Associations)
There are three categories of non-material assets subject to evaluation: business goodwill (unallotted non-material assets),
personal goodwill, and identified non-material assets. Business goodwill is inseparable from the company and can be
considered in the balance sheet after company sale, according to IFRS. Personal goodwill is not transferred under sale and
is not considered at company cost calculation.
As can be seen from the given definitions, in various business accounting standards, there are practically
no discrepancies concerning the essence of goodwill. Thus, most of the time, goodwill value appears if
company acquisition takes place, and the difference between the purchase cost and the fair value of identified
assets is calculated.
In other words, the traditional understanding of goodwill origins lies in the following: Goodwill arises
when a business is acquired at a price exceeding its assets’ marketable values sum. In turn, this excess can be
explained this way: The business market price as a whole is comprised of the cost of all assets, including the
ones not reflected in the balance sheet. As it is known that in the balance sheet un-identifiable9 assets cannot
(should not) be reflected, their cost is embodied in goodwill. The residual method of goodwill calculation is
based on it.
However goodwill takes place not only when the company possesses unrecorded intangible assets. We can
give examples of some factors irrelevant to the value of intangible company assets that influence goodwill value
and are subject to be reflected in the company-buyer balance sheet:
 Cost of the identified assets (the more non-material assets are capitalized, the less remain for goodwill);10
 Sales price of an acquired enterprise depending on a seller's ability to prove the high price or on the buyer's ability
to beat down the price, on commission intermediaries, etc.;
 Identifiable assets evaluation errors (cost calculation is based on taken balance, not marketable value of net
assets);
 Award paid at acquisition (excess of purchasing price over market capitalization at the moment of purchasing);
 A value of all company obligations (more obligations lower the value of goodwill);
 Goodwill allowances methods (in different national accounting standards, allowance during the permitted by
accounting standards period; immediate allowance of this value at the expense of equity capital or absence of the
allowance in general is accepted);
 External environment influence: favorable location, favorable conjuncture, new preferences of consumers, special
taxation rates, etc.;
 Identified assets depreciation methods;
The marketable value of both assets and the business as a whole is determined for cases of probable
most effective utilization.11 It is obvious that the most effective methods of use for separate assets and business
as a whole cannot coincide: The asset markets develop under the influence of different factors than the business
9
In this context we also assume all identifiable intangible assets that are not recognized by current accounting practices (see
previous section).
10
Ideally, if all assets are identified and properly valued, goodwill should be equal to zero. But that is impossible, since many assets
just cannot be fairly valued, and some of them are even hard to identify.
11
IVS 2007 (International Valuation Standards), published by International Valuation Standards Council.

11. markets. In other words, a business cost is determined by money flows from sale of the goods or services
produced by the business and the cost of separate assets necessary for production – by money flows from sale of
these assets.
Thus, efficient use of the business as a whole and of separate assets are non-comparable, which means
that the business as a whole and separate assets marketable values are also non-comparable. Completeness of
company asset representation in the balance sheet does not matter: If the cost of all assets is entered into the
balance sheet, even those not identified by standards of the business accounting, the sum of the assets
marketable values basically will not coincide with business cost as a whole. If cost in these assets’ use within
this business is higher than cost at average market alternative method of use, the goodwill will be positive, if not
– negative. Still, negative goodwill does not testify to inefficient activities within the business if we understand
an effective business as the one which has assets return at an average branch level. Incomparability valuations
of business as a whole and of separate assets is caused by the fact that the business valuation as a whole is made
with a view of business continuation, and evaluation of each asset is made proceeding from the assumption of
its independent sale (separately from the property complex included in the business).
To confirm the above we will present the following provisions. Goodwill evaluation is always attached
to the value assessment of a business as a whole, which non-material assets and intellectual property valuation
specialists specify. Business cost calculation methods are based on revealing forecast data concerning company
activities, on assets creation costs measurement or on comparison of activity indicators with the comparable
companies from an objective database. From the market point of view a business cost shall not depend on the
cost of its elements, as business is an "ongoing concern", and its partition into elements shall happen only with a
view of real or fictitious liquidation. Acting business is always considered as a single complex which will
continue to act in the foreseeable future (IFRS, Principles).12
Most material and non-material assets, at their merge in business, lose their liquidity because of their
greater specificity and sometimes complete inseparability from the business. These are assets which are created
specifically for this business and have no other application, as owing to technological specificity and to
attachment to a business site. (Tangible examples are various constructions like bridges and pipelines; an
intangible example could be a value associated with personal ties of ex-owners with clients and suppliers.)
Besides, sometimes there are restrictions in their use: long-term obligations, contracts, government
requirements (for example, ecological regulations), or social responsibility of the business. It is also impossible
to dismiss management and personnel errors. Under these conditions, market evaluations of assets are difficult
and can be replaced with substitution costs. Thus, assets often lose their independent marketable value; it
remains only as a historic fact of investments realization into these assets in the past. This cost is also necessary
to investors as a reference point for risk identification of present and future investments.
Bringing it all together, we can conclude that the goodwill concept can be used in a narrow and a wide
sense. In a narrow sense, goodwill is understood as the accounting assets meeting the financial reporting
standards criteria. Only acquired goodwill is acknowledged; internally created goodwill is forbidden to reflect
in the balance sheet. The goodwill size is determined as a difference between the acquisition value of the
company and the book value of its material, non-material and cash assets and obligations. In a wide sense,
goodwill is a complex of all intangible company assets. Hence, we can speak of the goodwill of an operating
company only in the meaning different from accounting sense. The approximate sense of this meaning is
expressed by the terms reputation, business standing, or/and company brand. But such goodwill (in a wide
sense) is not shown in the balance sheet. Some authors, speaking about goodwill, prefer to call it "the company
price" or "business reputation", keeping the same sense.
12
Roslender R. and R. Fincham, Thinking critically about intellectual capital accounting, Accounting, Auditing & Accountability
Journal, 2001, vol. 14, no. 4, pp.383-99.

12. When investor makes a decision to invest money (or buy some company) he normally wants to know
exactly what he is buying (or simply speaking, what he gets in exchange for his money). If it is a service
company (an IT company that operates in the field of software development or web applications), then most
likely the sum total of all of its intangible assets is much smaller than the overall company value. This value
will most likely appear in some form of goodwill, but what makes these numbers? With current accounting
practices, in many cases we deal with an “expensive black box”. This is a reason why a prospective buyer will
perform a due-diligence of the company. It will help to evaluate the intangible assets owned by this company.
Human Capital
The term human capital came into the business lexicon after Gary Becker (University of Chicago
economist and Nobel Prize-winner) published a book titled “Human Capital” in 1964. Becker (along with Jacob
Mincer, Milton Friedman, Sherwin Rosen, and Ted Schultz) created the economic concept of human capital as
distinct from typical financial or physical assets, because of its difference from them in the sense that human
capital cannot be separated from the humans who possess it. “It is fully in keeping with the capital concept as
traditionally defined to say that expenditures on education, training, medical care, etc., are all investments in
capital.”13 Soon after Becker developed the concept of human capital, economists and consultants began to
subdivide and classify it. Simply speaking, it means both physical and intellectual ability.
Many researchers state that human resources are the most valuable assets of an organization. But how
can the capital value of human resources be found using current accounting practices?
For the intellectual organization that focuses on creation of various types of intellectual capital (not
speculation, but real innovative development) and that has the biggest portion of its value allocated to intangible
assets, people are everything. The company can be evaluated by calculating the amount of all the HR spending
(salaries, payments to outsourced workers, training programs, various incentives, etc.). Someone may say that
this is precisely what is done to calculate the cost, but cost is not a value the capital represents. It is more of a
cost as capital value concept. It may sound nonsensical, but it basically means that if someone incurs cost it
assumes that something was bought (money was changed to something). No matter whether that something was
tangible or intangible in nature, it has a value and a price. More important is whenever that something is, it is
useful to others (how many people would love to have it). If there were many of them, what would be their
price, and how would this price be determined? Also, if that something was bought on the market, for many
buyers the cost would be similar (this product or service has a fixed price). Thus it can be said that it is a sort of
valuation using the market approach. However, the value really depends on the type of asset you hold and the
supply/demand curves for it. If the new owner obtained it for a lower price than others, it means he has good
contacts (refers to relational capital in IC concept).
In relation to HR, if you have a project where you need professionals to do work for you, you don’t
simply spend money, but you get some quality work and even if it doesn’t have a material form it still has
value. For example, it could be consultation with a lawyer in Switzerland; project duration is 4-6 hours and an
hourly rate would be between 300 and 1000 Swiss francs. Depending on your contacts (RC) the cost of project
(outsource) will be between 1500 and 5000Chf. But after the project’s completion and payment, you begin to
own something - it could be answers to questions asked during consultation hours or some other piece of
knowledge from the lawyer consulting with you. In other words, you become the owner of some piece of
intellectual capital. If it is not very specific to your needs, probably there are many others who are willing to pay
13
Becker, Gary, Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education (Chicago: University of
Chicago Press, 1993) 15-6.

13. a similar price for that kind of information. Thus it is really an intangible asset, which can be valued using at
least the cost and market approaches (more about evaluation will be discussed in later sections of this thesis).
However, the salary is a very average reflection of the real creativity of a given person and value
generated (profit associated) from it. Also, there are industry leaders and lagers – industry leaders are those who
pay above the average salary set by industry in order to acquire the best people. Industry lagers normally pay
below average, but it is not that their human resources are worse in terms of creativity, skills, knowledge or
experience than those in big companies. Consider all the possible areas of expertise that are available to the
modern IT companies: There are big companies that are best in providing their particular products and services
on the market, but they can’t be best in all possible market niches. It makes possible the situation when a little
group of experts in particular field are a lot more productive in a certain task (Activity) than a research center of
some big company.
Also, worth mentioning is that it seems like in today’s economy companies no longer compete in terms
of best technology; it is the competition of patented technologies and various licenses. Research and
development, including creativity, are tied by various legal barriers (patent sharks), so that many professionals
are not allowed to enter a particular field of technology.

14. 2.3 Intellectual Capital
Modern lines of world economy development, strengthening of a role of intellectual and information
resources for production of competitive products have led to occurrence of one of the most scaled financial
problems.
Its essence can be described as follows: as methods of a product creation have changed, and knowledge
has turned to one of major factors of new cost creation, it is necessary to reconstruct in appropriate way the
content of the public reporting of the companies before their proprietors and other investors. The reporting shall
contain the information on cost major factors: company strategy, future monetary flows, non-financial activities,
intangible company assets, including business standing.
Of course, the public reporting is not limited to only the financial statements. As it was mentioned
before, IFRS recommends publication of information about intangible assets not-recognizable by CAP. For
instance, there are various notes and discussions reported in annual reports (like K-10). However, this field
requires farther standardization otherwise it has little practical value. In this paper, Kretov Kirill applies some
concepts of intellectual capital in order to develop a reporting model for the complete capital structure.
Initially the problem of evaluation of intangible factors has arisen in information-saturated companies
where the amount of material assets is insignificant, and the mental potential is high. Investors were not inclined
to invest to such companies, and in front of the managers there was a task of calculation of their intangible
assets value and of informing investors to create more adequate picture about the company activities of the and
its prospects.
Modern idea about intangible factors of new cost production are embodied in concept "intellectual
capital". The managers managing companies cost are almost single in the opinion concerning the name of this
phenomenon, its content, and also that modern accounting can’t consider these new assets (employees
competence, customers relations, computer and administrative systems, databases, etc.) 14. Some researchers
even state that for intellectual capital accounting it is required new financial and administrative concept15 .
Financiers discuss whether it is necessary to change traditional accounting terms (non-material assets, business
standing), and also about possibility of cost evaluation of a new indicator, its accounting and showing in the
reporting.
Three Major Elements of Intellectual Capital
Various models and theories of intellectual capital represent generalization of value factors management
practice in the specific companies, and now it is admitted by both researchers and experts. For this reason each
model is unique and reflects specificity of the company. At the same time, accumulating of experience and
knowledge of an intellectual capital by the beginning of current decade has allowed to determine general
approaches, to develop more or less single structure of companies’ knowledge assets. Almost all this problem
researchers and managers allocate three components of intellectual capital:
1) human capital (HC);
2) structural, or organizational, capital (SC);
3) customer capital (CC).
14
Richard Petty, James Guthrie. Intellectual Capital Literature Review. Measurement, reporting and management. Journal of
Intellectual Capital. Vol. 1, Number 2, 2000, pp. 155—76.
15
Dzinkowski, R. The measurement and management of intellectual capital. Management Accounting (UK), Vol. 78, Number 2, p. 32-
6.

15. In some models16, the client capital is called the capital of relations, or connections (relational capital),
but it is understood also as loyalty and customer satisfaction.
Generally speaking, it is possible to estimate the human capital volume through the number of
intellectual workers and the amount of information, knowledge and skills which they own, through the quantity
of leaders, idea men, "revolutionaries". The value of personnel knowledge and abilities is characterized by
specialists' capability to solve difficult, non-standard, unexpected problems; employees' independence and
trainability; the capability of managers to deal with transformations; creative activity; tendency to partner
interaction; etc. We can estimate development of the human capital through proportion of the types of activity
"inspiring" on search of new solutions forcing company's employees to learn something new. At last, degree of
human capital binding is estimated through personnel adherence to company's insight and values, employees'
satisfaction by work and industrial relations, personnel loyalty to the company and retention of leading workers,
company's reputation on the labor market, etc. (Later in the work, the Human Resources will be discussed more
into details.)
Organization structural capital is reflected by the number and quality of business partners; degree of
business partner retention to the enterprise; integration of the value chain and an company's role in it;
availability of a flexible and effective business network (on a global scale, as well); information system quality;
early detection system quality; involving of pressure groups into decision making; procedures of transformation
of implicit knowledge into explicit one; partnership level in the organization; quality of network interaction;
completeness and quality of databases; trademarks and patents; codified knowledge of technical processes (the
degree of completeness and clearness of documentation reflecting consumer value creation in the organization);
collection of prototypes for economic problem solution; intellectual property; backlogs on new products;
corporate culture market orientation; territorial arrangement advantages; unique technical libraries and
databases, customer databases; logistic, sales, advertising, cartel contracts; overcome starting difficulties;
licenses.
The organization customer capital is reflected, by the following characteristics: expected discounted
income from available consumers; number of regular company's customers, their share in sales amounts,
average cooperation experience; customer growth quality and prospects; customers' satisfaction; company's
"ownership" of the industry standard; competitive advantage with new production launch; the volume of the
concluded contracts; the degree of customer retention to the organization.
So, it is possible to tell that in the provided models there is more common than distinctions. The
overwhelming majority of authors recognize presence of intellectual capital independent elements – human,
organizational, client, however they are called. At the same time, now there are a lot of terms anyhow connected
with intangible assets: brand, business standing (goodwill), intellectual property, non-material assets, expenses
on researches and developments. What is relation of these terms with concept of an intellectual capital? It is not
quite obvious why the general name "intellectual capital" is used to combine such essentially different and
frequently not having the direct relation to the intelligence phenomenon as employees' value system, enterprise
image, brands, customers' loyalty. In our opinion, the uniting basis here can be the idea of intellectual capital
circulation: employees' knowledge and capabilities are embodied in organizational processes and relationship
with business partners that, in turn, create the base for steady relations with customers; cooperation with
customers and partners leads to experience accumulating, development of enterprise employees' knowledge and
capabilities.
16
Sanchez P., Chaminade C., Olea M.. Management of intangibles - An attempt to build a theory. Journal of Intellectual Capital, Vol.
1, Number 4, pp. 312—327.

16. Ordering and systematization of existing terminology becomes pressing question on which, in particular,
the method of intangible assets reporting, accepted and recognized by the accounting organizations will depend.

17. About the author
Present article is a part of Doctorate Thesis written by Dr. Kretov
Kirill (Master of Arts in Human Resource Management and Doctor
of Business Administration) December 2009, Geneva, Switzerland.
The author invites everyone to participate in his ongoing survey
on the site http://www.kretov.ch