CPA Ontario has issued the paper You Can’t Touch This: The Intangible Assets Debate.
The paper explores the issues we touched on here, along with some comments on opportunities for the CPA profession (disclosure – I talked to the lead author and am briefly quoted in there). Here are some extracts:
- Intangibles are thought to explain at least some of the widening gap between tech company valuations and their book value. While book value is no substitute for fair market or business value, the widening of this financial reporting black hole correlates with the growing volume of intangible capital. Intangible-enabling advocates suggest that capitalizing intangibles has a ‘Trojan Horse’ effect boosting equity across the board. Guido Giammattei, Head of Research for RBC Emerging Markets Equity, put this to the test, examining what would happen if tech companies capitalized some of their intangible spending on R&D and advertising. “It showed the earnings are understated, but also the return on investment capital and the return on equities of these firms are understated too. It shows that the valuations you’re seeing are not necessarily accurate,” says Giammattei.
- This hasn’t been lost on investors. Preliminary findings from a study for the Institute of Chartered Accountants of Scotland…identified a disconnect between the views of users and preparers of financial statements. Almost 93% of users say financial reporting of intangible assets is inadequate, compared with 61% of preparers. The biggest gaps in information were related to R&D, human capital, intangible risks and opportunities, IP and brands. In a separate study, U.K. investors said that information about intangibles is unreliable, incomplete and inaccurate. This is a challenge for Canadian CFOs and financial controllers too. According to an EY survey, the lack of a formal intangible reporting framework is among the top barriers to these professionals in attempts to measure and report on their organizations’ long-term value.
- … Not everyone agrees that intangibles are inadequately represented in financial reporting. Skeptics of the ‘intangible black hole’ explanation for the gap between valuations and book value suggest that it is better explained by low interest rates and plentiful capital fuelling investors’ appetite for big-bet start-ups. Indeed, skyrocketing valuations may themselves answer concerns about under-leveraged intangible assets holding back growth in intangible-heavy sectors.
I touched on the argument in an earlier post, some of which I’ll post again here:
- … 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…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…?
IASB Chair Andreas Barckow recently referred to “the rise of self-generated intellectual property and its non-addressal in the accounts” as one of the key challenges to remaining relevant in an ever-changing environment,” and it came up many times in the responses to the recent agenda consultation. Many of the responses saw this also as an area of likely interest to the new sustainability standards board, although it seems possible that the newly-named Chair Emmanuel Faber, not being a technical accountant, might place the initial focus elsewhere.
The CPA Ontario paper sets out various areas of opportunity for accountants, for example:
- In light of the growing importance of intangibles, future-focused sections of the profession are encouraging CPAs to reposition themselves in the intangible economy. In an interview, Jim Balsillie has said, “The shrewd CPA will be the one that says, ‘I seek to fulfill this intangible asset generation and controllership function.’ They then become a critical aspect of the innovation commercialization function by helping to generate intangible stock assets … The CPA then becomes an engine of the market capitalization of the firm. Trust me, if you’re an engine of the market cap of the firm, you’re into the C-suite.”
Sounds like a novel strategy for getting ahead, if nothing else. More generally, the paper encourages further debate and conversation. No doubt there’s much more of that to come!
The opinions expressed are solely those of the author