There can be no doubt that business models are evolving and becoming ever more dependent on intangible assets as technology and know-how increasingly become drivers for commercial success. The magnitude and speed with which this change has taken place is reflected in the market value components of the S&P 500 companies across the last 40 years – intangible assets representing only 17% of market value in 1975 and rising to 87% by 2015. (Source: 2015 Annual Study of Intangible Asset Market Value , Ocean Tomo).
The gapWith the rise of intangible assets we also find the gap between an organisation’s book value and market value widening, with many of these –often internally generated- intangible assets failing to meet criteria for recognition in the balance sheet. To put this into perspective, the market value of Facebook currently stands at over 7 times the book value of its assets. For some this is a clear indication that financial statements have lost their relevance. For others, the solution to this information gap lies not in the financial statements but in better disclosure of how organisations create value over time.
What is clear is that action on intangibles is required, a message that came across loud and clear in discussions held between ICAEW and key stakeholder groups to develop the Financial Reporting Faculty’s latest thought leadership report What’s next for corporate reporting: time to decide?. The report summarises key stakeholders views on a variety of issues affecting the future of corporate reporting. What we heard in relation to intangibles is: ‘Reporting of intangibles is a key constraint on corporate reporting and raises questions about comparability and continued relevance. The inconsistent accounting treatment of intangibles needs to be looked at again. The IASB and other policy makers need to advance thinking and practice in this area, and sooner rather than later.’
While there was general consensus in our discussions that advancement on intangibles is required, there was less agreement on how this should be done. Identifying this as a key barrier to change, the report sets out two key policy options on intangible assets (entitled ‘Time to decide’) that stakeholders need to address collectively before substantial progress can be achieved.
Time to decide?
Is it time for standard-setters, with the support and active assistance of other stakeholders, to rise to the challenge and prioritise ways and means of bringing a much wider range of intangibles on to the balance sheet?
Should it be finally accepted that the intangibles question will not be resolved through financial reporting change, with attention firmly focused instead on a broader approach to reporting that looks beyond historical financial performance?
The answer?While those we spoke to did have varying opinions on this matter, on balance there was stronger support for addressing the gap through front half reporting particularly given that far-reaching changes to IFRS seem unlikely. ICAEW is continuing to gather views on this issue and the other key policy options highlighted in the report as part of on-going work on the future of corporate reporting. We welcome your views on any of these matters – comments can be sent to firstname.lastname@example.org.
You may also be interested in attending this years Information for Better Markets Conference this year which will ask ‘Corporate reporting: is it heading in the right direction?’, at which Professor Baruch Lev – one of four academics presenting at the conference –will specifically explore the issue of intangible assets as an example of whether financial statements give investors what they need? The conference takes place on the 18 and 19 December at Chartered Accountants’ Hall, London and is free to attend. To register for the conference, please visit our events page.
If accounts are to remain factual benchmarks of performance, it seems to me that they should avoid the inclusion of valuations of items which are difficult to define. The Facebook example is a good one, as a large part of its market value may simply be euphoric optimism rather than realisable or definitive value. History is littered with examples of companies that have gone on to justify high valuations, and those which have spectacularly failed to do so. It is no part of the function of accounts to second guess the stock market.
A very relevant and practical aspect.