The growth of internet-driven business, where name and reputation is all-important, has pushed the debate to the top of the agenda.
On one side, accountants argue ‘uncertain items’ should not be included on the balance sheet. On the other, business leaders contend that current practice is anachronistic and urge immediate reform.
One of the main points of contention is the speed of change. Standard-setters err towards caution, while others in the business world want the pace of change in accountancy to reflect the speed of economic shifts.
Some onlookers have even suggested that these pressures could lead to accountants being pushed out of the equation altogether. There have been some recent moves to recognise the value of intangibles in company accounts.
An accounting standard, FRS 10, went part of the way to recognising intangibles on the balance sheet when it was issued at the end of 1998. And there are other initiatives underway.
Many, however, argue the fledgling FRS 10 is already outdated. The standard, which applies accounts with a year end after 23 December 1998, required companies for the first time to show acquired goodwill and intangible assets in their balance sheets and depreciate them according to their presumed useful life.
The Accounting Standards Board’s predecessor, which attempted to bring in a similar standard, failed to do so due to enormous opposition.
But the ASB’s outgoing chairman, Sir David Tweedie, was determined to stamp out unfair accounting procedures and successfully managed to push through the new standard.
It arose because proponents argued that acquired goodwill and intangible assets should be capitalised and amortised because acquisitions reflect future profits.
‘If a company buys another company on the stock market then they buy something that is valued in the future,’ explains Allan Cook, technical adviser to the ASB. Management has spent money and therefore it ought to be shown on the company’s balance sheet.
The ASB also shared some sympathy with the view that although expenditure is made, the acquired goodwill or intangible asset will not necessarily lose value. A concession allowed, therefore, companies to capitalise acquired goodwill without amortising, but only in special circumstances.
Paul Holgate, senior accounting technical partner at PricewaterhouseCoopers, says: ‘FRS 10 is quite restrictive, but it is realistic given the current economic environment. The direction is to allow more intangibles on the balance sheet.’
But some businesses have complained that FRS10 reduces their profits through the amortisation of capitalised intangible assets. They argue that goodwill and other intangible assets, such as brands and reputation, do not wear out in the same way as a building. In fact, they say the worth of a business in reputation and brand terms grows over time.
Paul Richardson, financial director at WPP, media giant, fiercely opposes the whole concept of FRS 10. ‘We believe that brands have an indefinite life. It is frustratingly inconsistent with the US standard. It does not take account of organically formulated brands,’ he says.
The problem is vividly demonstrated by the accounts of drinks giant Schweppes.
It was worth #7bn in 1998, yet its tangible assets made up only #100m of this, leaving 98.6% of its market cap as goodwill – and not reflected in its accounts.
If a company’s accounts don’t recognise the value of its brands, they do not help readers value those companies. And it does not help, therefore, with making business decisions.
There are increasingly loud voices that argue that a new economy needs a new accounting structure. Everywhere there is talk of the valuing human capital, reputation, brands and goodwill. Business leaders and academics are getting on the bandwagon urging a new valuation model.
The days when you could understand the value of a company just by looking at its balance sheet are gone. Many of the traditional benchmarks for value have disappeared causing much confusion for investors, stakeholders and other users of financial reports.
So, if so many are pushing for change, why can’t the accountancy profession rise to the challenge? With the advent of web start-up companies, which have few, if any, tangible assets, the relevance of the balance sheet is repeatedly being brought into question. Dot.coms are on the whole reliant on ideas and people, neither of which get a mention on the all-important balance sheet.
Stock markets have valued many young companies at billion of pounds.
Initially it looked like there would be no end to the internet gold rush.
But many of the rising corporate stars fell quickly to earth, either collapsing completely or surviving, but with much-reduced share valuations.
This prolific rise and fall helped those who were against radical changes in accounting rules put across their arguments.
Many brand names, the dot.com revolution illustrated, are not as enduring as it was once thought.
Ken Wild, technical auditing partner at Deloitte & Touche, questions what the markets would have thought if intangible values had been incorporated in the balance sheets for those dotcoms companies and other older companies that initially had high values on the stock markets, but have since collapsed.
‘The value of brands, for example, shifts for all sorts of reasons that are not predictable. Brands values take nosedives with the fashion of the moment,’ he explains. ‘Unless it is a very stable brand, will the value be a useful piece of information to have on the balance sheet in six months time?’ asks Wild.
For example, the biggest children’s fad at the moment is Pokemon cards.
Before that Beanie Babies. How long will they last? And what of the computer industry, for example? There have been unprecedented advances in the field of technology that would have been extremely difficult to have foreseen and therefore measured.
‘There are very difficult judgement to make as far as valuing intangibles assets is concerned,’ said PwC’s Holgate. ‘We are at a stage of experimentation,’ he adds.
‘Users expect the balance sheet to contain hard figures. If we included these values now, analysts would probably just knock those figures off the balance sheet,’ Wild who sits on the ASB board, said in defence of the slow pace in finding methods of valuing intangibles.
Despite growing criticism of the accountancy profession’s perceived reticence to face up to these changes, initiatives are afoot aimed at incorporating values of intangible assets.
The English ICA recently issued a publication, Human Capital and Corporate Reputation: Setting the Boardroom Agenda, which if nothing else brings the discussion to the table. When John Hunt, professor of organisation behaviour at the London Business School, recently attacked the profession for its poor attempts to value human assets, Graham Ward, institute president struck back.
Ward outlined the profession’s moves to capture value of human capital and among other assets.
The booklet identifies four steps. The first to provide detailed reporting to help investors understand how human capital affects long-term corporate value. Second, development of agreed measurement techniques and benchmarks for human capital. Third, creation of new strategies for creating and sustaining human capital including a learning culture. Fourth, the ethical underpinning of corporate activities.
Ward says: ‘Measuring intangibles like human capital may seem like a break with my profession’s traditions but it’s essential to building Britain’s sustainable economic success.’
He also points out that the value of the accountancy profession is founded purely on its employees and their knowledge, not physical assets, such as buildings and equipment.
The Company Law Review, as part of the three-year long process aimed at bringing the law into the 21st century, is also attempting to capture the value of intangibles.
The Review has included proposals to incorporate a statutory narrative allowing companies to outline the value of their intangible assets in financial reports.
At the landmark conference of International Federation of Accountants Committee held in Edinburgh this year, demands to update the balance sheet came from both sides of the Atlantic.
In their keynote speeches, Richard Bolton, Arthur Andersen’s partner for worldwide strategy and Bob Elliot, chairman of the American Institute of Certified Public Accountants requested a financial reporting framework that accounts for intangible assets to respond to the new economy.
Today’s balance sheets no longer represent the real value for companies emphasising the growth of e-commerce, they said.
The trend to place more emphasis on brand values can be reflected in the growth of brand valuation companies like Interbrand and Brand Finance.
A recent survey carried out by Interbrand, concluded that Coca-Cola is about to lose its status as the world’s most valuable brand to Microsoft.
The survey reveals a sea change in the history of brands as the famous old economy names are pushed out by those of the new economy. The value of a brand is calculated according to estimates of its future earnings potential based on the company’s financial statement and analysts’ reports.
Another brand survey by Brand Finance revealed that 80% of 292 financial analysts polled said listed companies should publish more information on intangible assets.
Brand Finance chief executive David Haigh says: ‘A financial picture of reality that excludes many intangible assets wilfully denies the every day evidence of a changing society where the real wealth creators are often the intangible assets.’
MEASURING UP TO THE INTANGIBLE CHALLENGE
‘If a company buys another company on the stock market then they buy something that is valued in the future,’ Allan Cook, technical advisor, ASB
‘Measuring intangibles may seem like a break with my profession’s traditions but it’s essential to building sustainable economic success,’ Graham Ward, president of the English ICA
‘Users expect the balance sheet to contain hard figures. If we include these values now, analysts would just knock those figures off the balance sheet.’ Peter Holgate, PwC.
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