Accounting for Intangible Assets and Reporting ... - Icabr.com

Accounting for Intangible Assets andReporting Intangible CapitalZuzana KřížováMasaryk UniversityFaculty of Economics and AdministrationBrno, Czech Republice-mail: krizovaz@econ.muni.czAbstractDiscussions about the role and reliability of information of the basic financial accountingstatements continue to be evoked by bankruptcies of large companies or by the ongoingglobal financial crisis. Questions are often asked what causes the profound differencesbetween the accounting and the market value of companies. Analyses and researchresults in this area often speak about very different ways of human capital management,differences in customer relationships, use of information technologies, employeeknowledge or specific corporate organisational cultures. All these “invisible” resourceshave recently been named intangible assets or intellectual capital in literature.Intangible assets have been more and more interesting not only for researchers butmainly for company managers and owners. This contribution deals with differences inintangible asset statements pursuant to the International Financial Reporting Standards(IFRS) in comparison to the United States Generally Accepted Accounting Principles (USGAAP) and the Czech accounting legislation. The thesis also lists current views andtrends, terms and definitions used in publications on intangible assets and intellectualcapital. This article is based on analysis and comparisons of relevant literature resources,mainly articles and conference papers, but also legislative acts and monographs.KeywordsAccounting, reporting, intangible assets, intellectual capital.

IntroductionThe ongoing financial crisis has again and again been inspiring numerous discussions inthe media, professional and academic communities about the role of financialaccounting and audit in corporate governance and management of other organisations.The discussions mainly focus on reliability and relevance of information included in thefinancial statements and annual reports. The need of fundamental change in basicfinancial information reporting is among other things evidenced by the decision of theUS Securities and Exchange Commission (US SEC), which already in August 2007established the Advisory Committee on Improvements to Financial Reporting with theaim to define recommendations for reduction of the American system of accountingstatements to make them more useful for investors. See at SEC's PozenCommittee toMeet Nov (2009).The United States Generally Accepted Accounting Principles (hereinafter “US GAAP”) isa set of accounting regulations used for preparation and submission of financialstatements. These principles are used by companies with publicly traded stock, nonprofitorganisations, governments etc. As follows from the title, they are not exactaccounting procedures but principles stipulating communication between the companymanagements and investors. According to Cohn (2009), the total scope of theseaccounting principles has already exceeded 17,000 pages.Another major global accounting system is described by the International FinancialReporting Standards (hereinafter “IFRS”). Its origin was called for mainly by companygrowth, growth of the number of investors and development of security trading on thecapital markets. As we can read in IFRSs in your Pocket 2008 and following currentinformation updated as to 18 August 2009 at IFRS are at present used in 117 countriesof the world. The standards that are part of this system have been issued by theInternational Accounting Standards Board (IASB), with the registered office in London,established in 2003. Its activities follow the activities of the International AccountingStandards Committee, dealing with formulations of international accounting standards inthe period 1973 - 2001. This institution has been financed by the central banks, largeaccounting and audit firms, financial institutions and industrial enterprises through thenon-profit association – the International Accounting Standards Board. The memberscome from nine different countries and possess knowledge and experience from variousenvironments. The purpose of the institution is to harmonise accounting procedures onthe basis of a single set of high-standard, comprehensible, enforceable and globallyacknowledged accounting standards providing transparent and comparable information.The scope of these accounting principles is currently reported to have reached about2500 pages (Cohn 2009).In the Czech Republic application of the International Financial Reporting Standards hasbeen compulsory for all accounting units issuing securities registered at the StockExchange and at the official RM system market. The other accounting units use Czechaccounting legislation represented by Act no. 563/1991 Coll., on Accounting, itsexecutive decrees and Czech accounting standards.This survey of basic information about some of the currently applied accounting systemsis followed in the first chapter of this account by a more detailed analysis of reportingand appreciation of intangible assets.The international (IFRS) and the numerous still functioning national accounting systemsproduce large quantities of information for all potential users. According to Boedker,Mouritsen and Guthrie (2008) surveys performed in the years 2003 to 2005 byinternational audit and consultancy firms (Accentures, Deloitte and McKinseyConsulting) show, however, that the managers and the investors feel lack of informationfor their decision-making and consider the indicators and financial analyses based onfinancial statement data insufficient. That is why the following part of my work will dealwith new trends and approached of the so called Enhanced Business Reporting

(hereinafter “EBR”), trying to increase the informative value of the reported informationabout companies and other organisations, or whole industries and even larger units.1. Intangible Assets Reporting in Different Accounting SystemsIntangible assets represent one part of the assets showing significant differences inreporting depending on what accounting system is applied for the accounting statementpreparation. After accession of the Czech Republic to the European Union a number ofCzech enterprises had to adopt IFRS for their balance sheet preparation instead of theso far used national accounting regulations. But as their tax base has still been basedon the Czech legislation these companies have to report in both systems in parallel.That is why this chapter will deal in detail with the rules of intangible asset reporting inthe individual accounting systems and conclude with a comparison in the form of a tableand individual notes.1.1 Intangible Assets in IFRSSince its origin the IFRS have been primarily focused on communication betweencompanies and investors. The standards have been issued by the InternationalAccounting Standards Boards (IASB) and contained both the accounting standardsthemselves (IAS/IFRS) and their interpretation (SIC/IFRIC) together with the conceptualframework for preparation and submission of accounting statements.Intangible assets are dealt with by IAS 38 – Intangible Assets, including criteria forrecognition, appreciation and publication of intangible assets. This standard becameeffective in 1999 and was amended in 2004 .As stated in the publication entitled International Standards of Financial Reporting(2005, p. 1596) intangible assets are defined as identifiable non-cash assets withoutphysical essence. The company may report an intangible asset in its balance sheet if itis intangible asset by definition, if there are probable economic benefits following from itfor the company and if the asset can be reliably priced. If an item does not meet thesecriteria it is recognised as cost.Features of intangible asset defined by the publication IAS 38 Intangible Assets asissued at 1 January 2009 are as follows:• Identifiable – the asset is separable from the company, may be sold, leased etc.or comes from contractual or other legal rights,• Controllable – the company is entitled for economic benefits following from theasset and can restrict third party access to these benefits,• Bringing future economic benefits – usually revenues from sale or cost saving.If an item is recognised as intangible asset it is first priced by its acquisition costs.Further expenditures after this recognition usually do not meet the asset definition andtherefore are recognised as costs. Acquisition costs, costs of employee training, costs ofadvertising and sale support, costs of moving or reorganisation of enterprise are thusdirectly recognised as costs. Expenditures once recognised as costs cannot beactivated anymore in future.Accounting standard distinguish among four types of acquisition of intangible assets andtwo types of in-house generated assets. The types of acquisition of intangible assets areas follows:• The most frequent type of acquisition is purchase from a supplier. Theacquisition price may be represented by the price stipulated by the purchasecontract or in the invoice. Acquisition price may include: import duty, non-

employee wages, registration and legal fees, depreciations of patents and licencesand potential interest paid.1.2 Intangible Assets in US GAAPThe rules of US GAAP are applied by the companies voluntarily, but in some cases theapplication is strictly required by an authority. The Securities Commission (SEC) hasalways required from all players at the US capital market to publish their financialstatements pursuant to US GAAP, only recently also accepting statements based on theIFRS methodology. Like IFRS the US GAAP are not formulated by legislators but byindependent experts. In the case of US GAAP these are represented by the FinancialAccounting Standards Board (FASB), the non-profit non-governmental organisation withindependent in-house source of financing. This basic information has been published byMládek (2005, p. 7 - 9) in his publication Světové účetnictví [Global Accounting].The basic characteristics and examples included in the following paragraph can befound on the web site of FASB, in the document entitled “Statement of FinancialAccounting Standards No. 142, Glossary”, on page 105:Intangible assets are assets (except for financial instruments) without any physicalsubstance.Types of intangible assets include but are not limited to the following:• Intangible assets following from the law – patents, copyright, trademarks, tradenames, broadcasting licences etc.• Intangible assets following from contracts – agreements with employees,manufacturing agreements, consultancy agreements, publicity agreements,distribution agreements, leasing agreements etc.• Intangible assets following from other agreements – licences for use of software,licences for use of technologies, patents, rights to mining, rights to copy booksetc.• Intangible assets following from technology – in-house developed computersoftware, manufacturing processes, technical documentations, drawings,databases• Intangible assets following from business relations – list of customers, suppliers,distributors, records on credit trustworthiness of debtors compiled by creditorsetc.• Goodwill – Decree no 142 defines goodwill also as excess acquisition value of apurchase unit over the value oft eh sum of the acquired asset and the assumedliabilities. There is no negative goodwill pursuant to US GAAP.The aspects relevant for asset pricing pursuant to US GAAP include the asset valuefollowing from the transaction. This value reflects the future economic benefitsfollowing from the asset for the company. The paid out amount is thus recognised inassets.If the asset is not purchase but developed in-house, its recognised value may onlyinclude the legal fees, the court fees, patent licensing, and similar costs necessary forthe asset registration and legal treatment.1.3 Intangible Asset Recognition Pursuant to Czech Accounting StandardsIn the Czech Republic application of the International Financial Reporting Standards iscompulsory for all accounting units issuing securities registered on the regulatedsecurities markets of the EU Member States.The intangible asset area is settled in the Czech accounting legislation in Standard no013 Long-Term Intangible and Tangible Assets. This standard contains definition and

pricing of long-term intangible and tangible assets, depreciation principles, procedure ofaccount recognition on acquisition, technical valuation and asset write off. Like the otherstandards the Czech Accounting Standard no 013 is governed by Act no 563/1991 Coll.,on Accounting, and Decree no 500/2002 Coll., executing some provisions of theAccounting Act. These legislative sources represented the basis for preparation of thefollowing part of my article.The standard contains the list of assets defined as long-term intangible assets. Theseinclude establishment costs, intangible results of research and development, software,rights of determinable value and goodwill. The condition for classification as long-termintangible asset is usable life of more than one year and the asset value higher than thevaluation limit determined by the accounting unit. This class also includes other longtermintangible assets, long-term intangible work in progress, and advances provided forthis type of assets.• Establishment costs are defined as all expenditures incurred for establishment ofthe accounting unit until the moment of its incorporation. These costs include inparticular the court and administrative fees, costs of business trips, remunerationfor mediation and advisory services and rent. Costs of acquisition of long-termtangible assets and inventories, representation costs or costs related to thecompany transformation are not included in the establishment costs.• Intangible results of research and development (R&D) – for results of researchand development to be eligible for inclusion in long-term intangible assets theyneed to be developed by in-house activity and intended for trading, or acquiredfrom other parties.• Software must be developed in-house for the purpose of trading or acquired fromother parties – suppliers.• Rights of determinable value – these are in particular subjects of industrial andsimilar ownership, results of creative activity and rights pursuant to speciallegislation, if created by in-house activity for the purpose of trading or acquiredfrom other parties. Rights of determinable value include for example industrialpatterns, usable patterns, registered trademarks and patents.• Goodwill is a positive or negative difference between the valuation of the entity,or its part in the sense of the Commercial Code, acquired by purchase, depositor asset and liability appreciation in the context of company transformation,except for change of legal status of the company, and the sum of the individuallyrevaluated asset items reduced by taken over liabilities.• Other long-term intangible assets include emission permits and preferential limitsand long-term intangible assets not recognised elsewhere. The emission permitsinclude greenhouse gas emission permits, and emission reduction units andverified emission reductions by project activities regardless the appreciationamount.• Long-term intangible work in progress includes acquired long-term intangibleassets in the period of their acquisition until establishment of the asset conditionsuitable for launch of operation.• Provided deposits for long-term intangible assets include short-term and longtermadvance deposits provided for the purpose of acquisition of long-termintangible assets.1.4 Comparison of Czech and International Accounting Standards Related toIntangible Assets

The basic difference between Czech and international accounting standards isrepresented by their respective legal frameworks. Both IFRS and US GAAP focus onprinciples, and thus do not defined exact accounting procedures. The Czech accountingstandards, on the other hand, are part of the legislation binding for all companiesregistered in the Czech Republic. The appearance of Czech accounting is considerablyaffected by the tax legislation, which may be a source of certain inflexibility of the systemand may lead to acceptance of standpoints based on tax considerations rather than onthe concept of faithful and fair reflection of a transaction in its essence. The Czechaccounting system is formulated by legislators, which both IFRS and US GAAP areformulated by non-governmental non-profit organisation. The Czech accountingregulations are focused on accounting from the tax viewpoint and partly from theinvestor viewpoint. On the other hand both international accounting systems areprimarily focused on reflection of the reality for use by investors.Tab. 1 Selected differences in reporting of intangible assetsArea IFRS US GAAP Czech accountinglegislationDefinitionEvaluationCapitalizationof R&DDepreciationSource: authors resultsEconomic sourcemanaged by acompany that is usedto profitAll costs directly linkedto creation of capitaland its usageAllowed only costs indevelopmentIt has no physicalvalue, company willretain na economicadvantage in thefutureAll costs necesseryro register andestablish legalcontractsForbiddenNot always compulsory Necessery to writeoff capital that has acertain expirationdateNo definition, list anumber of itemsAll direct and indirectcosts linked toexploitationAllowed for costsboth R&DFollowing regulationsexpressed in the lawThe differences between the Czech and the international regulations begin with the verydefinition of intangible assets. While the Czech accounting legislation defines this termby a list of items meting the definition, both IFRS and US GAAP define intangible assetsby their properties. Both international systems emphasize the absence of physicalessence of intangible assets, and IFRS in addition mention three signs of intangibleassets – they are identifiable, controllable and bring future economic benefits. TheCzech standards on the other hand emphasize usable life longer than one year and thefact that the asset value is higher than a limit specified by the company.The list of intangible asset items of the Czech intangible asset definition includeestablishment costs, recognised directly in costs by both international accountingsystems, for pursuant to their interpretation they do not bring and future benefits to thecompany.If the assets are not purchased but developed in-house, the Czech accountingstandards appreciate them on the basis of in-house costs of development. This isconditioned by the purpose of the asset, which is its trading. IFRS distinguish betweenthe research and the development stage in this asset type. Only the development stagerelated costs may be activated and only after fulfilment of certain conditions (completionis feasible, the company possesses sufficient resources for the completion etc.).

US GAAP are the strictest in this area and only include in the asset value the costsnecessary for the asset registration and legal treatment, for the other costs are notconsidered specifically identifiable. US GAAP do not consider research anddevelopment intangible asset at all.The international accounting standards in one of their interpretations (SIC 3) specificallydeal with costs of web sites. The costs of activities related to an internet applicationdevelopment must be activated. The costs incurred in the course of the planning stageand the costs related to operation are recognised as costs only. The Czech accountingstandards do not specifically deal with this.The new developments of the Czech accounting standards include the so calledgreenhouse gas emission permits. This issue is also settled by IFRIC 3 interpretation.Earlier (Krizova 2008, 2009) we demonstrated, via comparison of model examples, thata given company will report the highest profit when using Czech reporting standards. Incontrast, the lowest profit will be reported when using US GAAP standards. Thereported differences may then affect the manner in which the level of company efficiencyis reported, particularly when using traditional methods of share indexes of rentability.Companies striving to succeed within the European or the world markets need to reporttheir results using methods that are concomitantly used by others.2. Wider Specification and Definition of Intangible Assets and IntellectualCapitalTerms like intangible assets and intellectual capital have been subject of increasinginterest of scientists and practical experts. This trend corresponds to the development ofthe competitive business environment, which has discovered the importance ofknowledge as a separate commodity allowing for coping with resource limitations. Alsothe differences between the market and the accounting value of companies suggeststhat significant reasons for these differences are “intangible or invisible” in many cases.2.1 Terminology and Definitions in Current LiteratureSurveys of intangible assets and intellectual capital are classified in many differentways. Pursuant to the study (Kaufmann, Schneider, 2004) of available publications onthe terminology used intangible assets may be divided into four basic groups:• Most authors use the basic term intangible assets, or intangibles, such as B. Lev,F. Gu, L. Canibano, P. Sanches, K. E. Sweiby.• Some groups of authors use the term intellectual capital; they are J. H. Daumand others.• The third group of authors slightly modifies the above two basic approaches anduses for example intangible resources, intellectual property, immaterial values –see for example O. Granstrand, T. Gunter, C. Kriegbaum and currentlyespecially P. Sullivan.• The last group does not introduce any special term and only uses the generalword knowledgeAs follows from the above classification, the basic terms and definitions in this area arenot yet generally accepted. To further illustrate this variability I would like to add thefollowing two examples:

Sullivan (2000, p. 228) submits a working definition of intellectual capita in the followingwording: “…knowledge that can be converted into profit“. In his opinion intellectualcapital consists of two components - human capital and intellectual assets.Baruch Lev in his famous work “Intangibles – Management, Measurement andReporting” of 2000 states on page 5: “An intangible asset is a claim to future benefitsthat does not have a physical or financial embodiment. A patent, a brand, and a uniqueorganizational structure (for example, an Internet-based supply chain) that generate costsavings are intangible assets“.According to Sweiby (1997, p. 18) “the difference between the marked value of apublicly held company and its official net book value is the value of its intangible assets.In most companies, the value of intagible assets exceeds the value of tangible assets.”Intangible assets are also often defined by a list of their assumed properties, byclassification or sorting, which I will deal with in the following part of my article.Like in the case of the basic terms and definitions the authors of publications about IA/IChave not yet reached too much agreement about their sorting, classification orcategorisation. All classifications in effect remain very abstract, thus not offering a realinstrument for management and use of the intangible assets by corporate managers.A classification which – guessing from the number of quotations – has more significantlyinfluenced other researchers was published in 1997 by L. Edvinsson. This classificationis the simplest, and only consists of two basic categories: Human capital andOrganisational, or Structural capital. Some publications do not provide any classificationat all, or state that a classification would be very difficult.Other authors, with Sweiby, 1997, being one of the most often mentioned and quoted,divide intangible assets to three basic groups or levels: employee competence, internalstructure and external structure. Studies analysing publications on intangible assetsmostly deal with works by American and Western European authors.There are also two more detailed and more specified classifications, which are quiteexceptional in this area:• The first is the basic categorisation developed by the American FinancialAccounting Standard Board for the purpose of accounting reporting and alreadymentioned in the first part of the article, in the section on the accountingstatement systems. This categorisation distinguishes seven basic categories ofintangible assets based on: technologies, customers, market, employees,contracts, organisation and company status,• The second classification by the German working group investigating intangibleassets in accounting for Schmalebach Society includes human, customer,supplier, investment, process, allocation and innovation capital (Kaufmann,Schneider, 2004).2.2 Approaches to Appreciation and Reporting of Intangible Assets andIntellectual CapitalThe wide definition of the basic terms and classification shows the large variability in theopinions of researchers on appreciation and reporting of intangible assets. A survey firstpublished in 1997 by Sweiby and several times updated uses the essential classificationinto four basic groups.Survey of types of appreciations of intangible assets:• Direct Intellectual Capital methods (DIC) are based on the assumption that weare able to recognise the individual basic components which are then not difficultto appreciate individually or in aggregate,

• Market Capitalization Methods (MCM) are methods based on the founddifference between appreciation of market capitalisation of the company andaccounting appreciation of shareholders´ property,• Return On Assets Methods (ROA) use the traditional method of financial analysisand comparison of the results with the industry means,• Scorecard Methods (SC) present (sometimes appreciate or score) the variouslyidentified intangible assets in tables or diagrams.Methods allowing for appreciation of intangible assets in currency units (from the ROAand the MCM groups) are conveniently used in whole business mergers andacquisitions. They may also be used for comparisons of different companies within thesame industry. As they are for the most part based on accounting principles theyfacilitate communication with accounting and finance experts. The main advantages ofthe DIC and the SC methods include the possibility to create a more complex andimpressive image of status of the organisation and are more often used by non-profitorganisations and public legal entities (Sweiby, 2007).2.3 International Trends and Current Development in the Area of EhancedBusiness ReportingAccording to Boedker (2007), Ricceri and Guthrie (2008) “a growing number of reportingframeworks and measurement models have sought to address the changing informationrequirements of business executive and financial markets. Internationally, the lastdecade has seen the proliferation of a variety of reporting frameworks and models“.Tab. 2 International initiatives in enhanced business reportingInitiative Category Req. LevelIASB Management Commentary Broad based In disussion GlobalEBRAustralian quiding principles on Broad based In draft Nationalextended performance management EBRAustrian Universities Organisations Intellectual MANDATO Nationaland Studies ActcapitalRYDanish Guideline on Intellectual Intellectual Voluntary NationalCapital ReportingcapitalGerman Guideline on Intellectual Intellectual Voluntary NationalCapital StatementscapitalJapanese Intellectual BasedIntellectual Voluntary NationalManagementcapitalMERITUM Guideline (EU)Intellectual Voluntary NationalcapitalUK Operating and Finacial Review Broad based Voluntary NationalEBRUS Enhanced Business Reporting Broad based Voluntary NationalEBRBalanced Scorecard (Kaplan and Intellectual Voluntary CompanyNorton)capitalIntangible asset monitor (Sweiby) Intellectual Voluntary CompanycapitalValueReporting TM (PwC)Broad basedEBRVoluntary Company

Resource: amended according to Boedker, Mouritsen and Guthrie (2008)Table 2 briefly summarises information about twelve popular initiatives aimed atimproved reporting of information about organisations.The abovementioned groups and initiatives deal with information reporting on the global,national or corporate level. While the international initiatives are usually connected withalready existing institutions (IASB, OECD), the national groups are often inspired orcoordinated by the government or a ministry (Danish Ministry of Science, GermanFederal Ministry of Economics and Labour, Japanese Ministry of Economy, Trade andIndustry etc).On the corporate level the following instruments are considered most important andmost elaborate: Balanced scorecard (Kaplan and Norton), Intangible asset monitor(Sweiby) and Value Reporting TM (PriceWatterhausCoopers). With a single exceptionthe results, procedures and instruments ready to improve quality of the reportedinformation are recommended and their use is optional (Boedker, Mouritsen andGuthrie, 2008).The single exception is the Austrian University Organisation and Studies Act, passed inAustria in 2004. This act introduced the obligation to report intellectual capital as thebasis for evaluation of performance of the universities with planned impact on theirfinancing. It is also Austrian research (e.g. Schaffhauser - Linzatti, 2004) that deals ingreater detail with intellectual capital reporting and states that “information usage ismade difficult by missing uniformity of terminology and definitions“.ConclusionThe differences in intangible asset reporting pursuant to the three abovementionedaccounting systems also reflect in the indicators based on the financial statements, suchas the asset return indicators and the equity return indicators. Regarding the volume ofcosts of research and development incurred by many companies the method of theirreporting performs a significant role. In harmony with the trend of the growing share ofintangible assets in the overall assets of the company it is also very desirable to achieveinternational comparability of the companies´ economic results.The issue of harmonisation of standards is currently resolved both on the level ofharmonisation of the national standards of the individual countries and IFRS, and on thelevel of harmonisation of IFRS and US GAAP. The harmony between nationalaccounting standards and IFRS within EU is to be achieved by the project of theCommon Consolidated Corporate Tax Base, which should be accomplished by 2011.EU would like to achieve a unified legislation for calculations of tax bases for the legalentity income tax calculation, with the rate to be specified by each Member Stateindividually.The International Accounting Standards Board, the issuer of IFRS, and the FinancialAccounting Standards Boards, the committee responsible for the issue of US GAAP,signed a Memorandum of Understanding in February 2006. This document includes asequence of steps to be taken to formulate quality and compatible accountingstandards. The intangible asset area has not been included in the themes for short-termconvergence but research and discussion in this area have been carried outnevertheless.At present the variability of recommendations for reporting elements that are not part offinancial statements continues to grow. For that purpose various instruments in the formof guides, monitors etc. are produced. As my experience shows it might be beneficial tofocus on extension of the "accounting technology", software, such as the eXtendedBusiness Reporting Language (XBRL). If this reporting method was used the traditional

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