Are we approaching a revolution in accounting for intangible assets…?

Asked in an interview about major current challenges and opportunities, the new IASB Chair Andreas Barckow commented as follows:

• The biggest challenge I see is to remain relevant in an ever-changing environment. While I think that our literature has generally stood the test of time, there have been changes in the environment that clearly could not have been anticipated when the Standards were developed. I am thinking of economies becoming more service than manufacturing oriented. I am thinking of low and negative interest rates and their impact on discounting future cash flows. I am thinking of mega trends such as sustainability, and climate change in particular, as well as the rise of self-generated intellectual property and its non-addressal in the accounts, to name but a few…

That last point about the intersection of financial- and sustainability-standard setting is drawn out in a recent publication by five leading sustainability and integrated reporting organizations, Reporting on Enterprise Value:

• Sustainability-related financial disclosure is different from financial accounting and disclosure insofar as it is about an additional information set that is intended to provide insight into drivers of long-term enterprise value, including drivers of intangible value that may not be recognized in financial accounting and disclosure. As (a study by the organization Ocean Tomo) found, the intangible asset market value of companies now commands 90% of the S&P 500 market value and 74% of the S&P 350 Europe market value. It is this significant variance that sustainability-related financial disclosures, which can provide insight into drivers of intangible value, help companies explain to providers of financial capital.

The publication doesn’t try to suggest that sustainability-related reporting might provide a basis for specifically recognizing and measuring such assets – the point seems to be more about addressing them in broad narrative form. But a comment letter submitted by Accountancy Europe in response to the IASB’s ongoing agenda consultation takes it further:

• We suggest the IASB undertakes a comprehensive review of IAS 38 Intangible Assets (IAS 38), marked by the IASB as a large project to:
  • better reflect the ever-increasing importance of intangibles in today’s business models, including addressing internally-generated intangible assets, by revising the definitions and capitalization requirements of IAS 38
  • improve comparability between companies that grow organically with those that do so through acquisitions, by reconsidering the conditions for capitalization. IFRS 3 Business Combinations (IFRS 3) allows recognizing identifiable intangible assets from an acquisition, whilst such an option is currently not permitted under IAS 38 for (perhaps very similar) internally-generated intangible assets.
  • address emerging types of transactions and assets, including emissions trading rights and crypto-assets (i.e. more broadly than just cryptocurrencies)…
• The IASB should coordinate with the (future international sustainability standards board) in undertaking a comprehensive project on IAS 38 as many of these topics, particularly internally-generated intangibles, also affect how a company creates and maintains long-term value. These issues are also material to enterprise value, and would therefore, also be in scope of the ISSB. Nonetheless, it is important to determine the scope of both the IASB and ISSB from the beginning in order to avoid inconsistencies and duplications.

I noted in the past that some of the commentary on this seems to stamp the accounting profession as a bunch of dolts, endlessly fussing about secondary aspects of the 10% or 20% of market value represented in the financial statements while behaving as if the rest were the province of God (this puts a grim perspective on the arguments against recognizing biological assets of marijuana companies at fair value, which in effect amounts to a crusade for financial statements to withdraw from even attempting to represent the market value of those companies, rather than advancing toward it). That said, such projects do carry elements of art and advocacy: although some of that 80% or more of non-IFRS-captured market value certainly derives from such factors as intellectual capital, relationships and human capital, we know it may also reflect wild speculation, unsound economic analysis and the like. As with much of IFRS itself, the 20/80 concept certainly works better for large, relatively stable entities (those for which, you might say, the object is to understand the value of an annuity) than for those that are actively and rapidly evolving.

Still, it seems like a reasonable bet that more attention will be focused on this area in coming years. As Accountancy Europe (and even Chair Barckow) imply, the current transaction-based model just seems clunkier and more arbitrary over time. One also wonders though, even if a new standard were implemented to plug some of the gap, would most analysts do anything more with those newly-conceived intangible assets and resulting amortization charges than promptly reverse them out of their long-established valuation models…?

The opinions expressed are solely those of the author