Accounting of Intellectual
Property Assets: an Overview
Guriqbal Singh Jaiya
Director. SMEs Division
Guriqbal.jaiya@wipo.int
1
The Main Take Away
While discussions continue on how to
adequately account for IP assets,
businesses are best advised to develop
a voluntary annual IP report, so as to:
(1) enhance their market position,
(2) facilitate access to funding, and
(3) improves overall decision-making
and effectiveness of management!
2
Fixed Assets
• Fixed assets (non-current assets) represent future
economic benefits which are expected to be
consumed at a slow pace (generaly over more than
one financial year)
• Every fixed asset can be considered an unexpired
expense, and at balance sheet date a company
must review to what extent the individual asset has
been consumed during the accounting period
3
Fixed Assets (cont.)
Two central accounting issues:
1. How do we determine tha
appropriate value of an asset at the
point of acquisition?
2. How do we systematically
recognise the expensing of the asset
over time?
4
IAS 38 - Intangibles
• An intangible is an identifiable nonmonetary asset without physical
substance
• Main characteristics:
– They meet the definition of an asset
– They lack physical substance
– They are identifiable
5
IAS 38 – Intangibles (cont.)
• Definition refers to “identifiability”
– Separability, or
– Arising from contractual or other legal rights
• Recognition criteria challenge - Degree of
uncertainty with respect to the future economic
benefits
– Magnitude and timing of future economic benefits?
– Control over economic benefits
• The useful life of an intangible asset can be finite or
indefinite
6
Intangible Fixed Assets
• These are intangible resources such as
scientific and technical knowledge,
development of new processes or systems,
intellectual property, privileged customer
relationships, etc.
• Typical examples:
R&D, patents, brands, copyrights,
computer software, licences
7
Definitions
•Accountants – intangible assets
•Economists – knowledge assets
•Managers and lawyers – intellectual capital
All are the same except for:
•Legal – intellectual property, which is
intangible assets legally secured for patents,
trademarks, designs, copyrights, etc.
8
Classified Balance Sheet...
Generally contains the following standard
classifications:
– Current Assets
– Long-Term Investments
– Property, Plant, and Equipment
– Intangible Assets
– Current Liabilities
– Long-Term Liabilities
– Stockholders' Equity
9
Cost Principle
An asset must be carried on the
balance sheet at the amount paid for it.
The cost of an asset equals the sum of
all of the costs incurred to bring the asset
to its intended purpose, net of discounts
10
Traditional Distinction Between
Capital and Revenue Expenditures
Does the expenditure increase capacity or efficiency
or extend useful life?
YES
NO
Capital Expenditure
Revenue Expenditure
11
Accounting of Intangible Assets
Intangibles
Purchased
Specifically
Identifiable
Capitalize
InternallyCreated
Goodwilltype assets
Specifically
Identifiable
Goodwilltype assets
Capitalize
Expense,
except direct
costs
Expense
12
How Accounting meets IP
Copyright/Related Rights
protects reproduction &
performance in arts/software
Industrial Design
Patents
protect
products, business
processes
protects
look of products,
packaging, aesthetics
Trade Secrets
Mark/
Geographical Indication
protects, logo,
slogans, symbols
protect business plans,
know how,
client portfolio,
tacit knowledge,
processes
Only IP that
generates
direct cash flows
in a commercial
transaction
is considered
Protection against Unfair Competition
13
IP is an intangible asset, ...
Knowledge Content
Transferability
Background of users &
context determine relevance
of IP to business
IP is transferable to a new
or similar business context
Perishability
Over time IP may
become outdated,
e.g. technology cycles
Nature
of IP
Spontaneity
Successful IP creation is
risky since there is a creative
& a business element to it
Non Rivalry in
Consumption
IP can be used
simultaneously
by different people
without diminishing
in its worth
Partial Excludability
IP guarantees a firm exclusivity and
freedom to operate in the market
14
Why Measure Intangible Assets?
(Purpose in order of popularity)
1. Monitor Performance (Control)
Six Sigma, Balanced Scorecard,
2. Acquire/Sell Business (Valuation)
Industry rules-of-thumb ($ per click, $ per client, brand valuation)
3. Report to Stakeholders (Justification, PR)
IC supplements, EVA, Triple-bottom line,
4. Guide Investment (Decision)
None! (Discounted Cash Flow still best)
5. Uncover Hidden Value (Learning)
None! (Scorecards and Direct IC methods probably best)
15
… which Accounting finds difficult to grasp
Rationale behind Accounting
• Historically evolved to report
tangible assets/liabilities
• Quantitative stock of
performance
• Documentation of past
financial position
• Factual, precise, objective,
comparable information
• Determines perception of a
firm’s management and other
market participants
Impact on Type of Language
developed for IP
• Silence about a lot of a
firm’s IP due to inherent
definitions and
assumptions in
accounting
• Internally and externally
generated IP is treated
differently
• Goodwill
16
How Accounting Concepts Impact Business
Concept
Internally Generated IP
is immediately expensed,
Acquired IP is valued at its acquisition cost,
amortized or subject to an impairment test
Fair value: “Amount at which an asset could
be bought or sold in a current transaction
between 2 willing parties, other than a
liquidation.”
Intangible Asset: “… identifiable, controlled by
an enterprise as result of past events & should
generate future economic benefits for the firm.”
Goodwill: “price a market participant is ready to
pay in excess of the value of a firm’s tangible
assets.”
Impact
The same IP may be
perceived to be
worth nothing or
100 Mn $
Implies a benchmark,
yet worth of IP
depends also on context
& background
Much IP won’t
qualify since it has
an indirect impact
on cash flows
Difficult to make
worth of IP explicit &
compare Goodwill
of different firms
17
Accountants Recognize the Challenge
• FASB & SEC recommend Voluntary IP Reports
“Companies are encouraged to continue improving their
business reporting & to experiment with types of information
disclosed & the manner by which it is disclosed.”
• US GAAP allows to account IP explicitly in M&A
FAS 141 & 142 require to identify each single asset
& determine its fair value
The amortization of Goodwill is replaced by an annual impairment tests
• Basel Committee on Banking Supervision recognizes
the inadequacy of “fair value” for financial assets
“In the absence of active markets it will be difficult to obtain
or calculate a reliable fair value for certain
non-marketable financial instruments held at cost.”
18
Explicit IP accounting gains momentum
— Comparison of different Accounting Standards —
German HGB
Recognition of
IP
Acquired IP
Internally
Generated
IP
IAS/IFRS
US-GAAP
• Forbidden: § 248/2
HGB
• Exception: acquired
IP
• Recognition of IP if
IAS criteria are met:
IAS 38
• Recognition of IP:
Novel approach under
FAS 141 &142
• Recognition of
acquired IP:
§ 255/4 HGB
• Recognition of
acquired IP if IAS
criteria are met:
IAS 38
• Purchase Price
distributed across all
items: FAS 141
• Impairment Test of
Goodwill: FAS 142
• Immediately expensed
• Immediately expensed
• Immediately expensed
Trend towards the explicit recognition of IP increases
19
Advantages of Reporting IP
F
O
R
M
A
N
A
G
E
R
S
• Communicates the value of IP to investors
• Shows what IP the company owns
• Puts a value to the IP
• Explains how the IP relates to business segments
F I
O N
R V
E
• Get information on how IP drives growth
S
• Receive adequate inputs for earnings/sales forecasts
T
• Can better estimate risks/revenues of an investment
O
• Can better understand the nature of a business
R
• Increases predictability while decreasing volatility
S
20
The IP Reporting Process
Build IP
Business
Culture
•Align IP
portfolio
to overall
business
strategy
•Explain
to all in
the firm
why IP
matters
Create IP
ownership
Create
IP
Ownership
•Ensure
market
position
through IP
ownership
Understand
IP
Ownership
• Audit IP
Report
IP
Generate
Superior
Results
• Use
a reporting
•Set
system
ownership in demonstrating
correlation to the value of
expected
IP to your
•Establish an results
business
enabling IP
policy and
• Understand
environment legal scope
of IP
$$$
or
¥¥¥
or
£££
21
Elements of an IP Report
• Executive Summary
How does IP relate to the bottom line of your business?
How do you make money and what role does the IP play in it?
• Relate your income streams to IP
What were the returns from IP protected business segments?
Does the IP help you to gain market share or profits?
• Relate IP to your position in the Market
How did IP give you an advantage over competitors?
Do you have freedom to operate & exclusivity in the market?
• Demonstrate your managerial skills
How determined are you to extract revenue from IP?
What experience do you have in managing IP?
• Understand the legal scope of the IP rights
What level of protection does your IP guarantee you?
Is there a risk that you infringe the IP of competitors or that competitors
(legally) steal your IP?
22
The Agenda
A) The today’s rise of intangibles
B) Consequences of the Non-treatment
of intangibles
C) Initiatives and actions undertaken
(by companies/academics, and institutions)
D) Policy indications
E) Some open problems and conclusions
23
“The substantial foundation of the
industrial corporation is its
immaterial assets”
“There may be peculiar difficulties
in the way of reducing this goodwill
to the form of a fund, expressing it
in terms of a standard unit”
Thorstein Veblen, 1904
24
Why did market
values diverge
from book
values?
What information
does the market
use that is not
included in the
financial
statements?
Reprinted from Baruch Lev’s Intangibles Management Measurement and
Reporting, The Brookings Institution 2001
25
A) The Rise of an Interest in Intangibles
• Change in the bases of creation of firm value
- from industrial to post-(post-)industrial
economy (e.g. advanced service firms)
- post-fordist, interactive mode of production
- decentralization/diffusion of knowledge
• From unidimensional to multidimensional performance
of an organisation
• Obsolescence of traditional accounting systems (2004:
Market-to-Book ratio  3)
• Scarcity of data on intangibles in National Accounts
26
Goodwill and Intangibles
• The Stock Market Perspective
– If the market is efficient
• The nature and treatment of intangible assets should be
sufficiently disclosed to help users assess the treatment used
– If the market is inefficient
• Skepticism exists concerning analysts adjustments
• Markets are affected by international and national political
and economic factors
– More disclosure means fairer stock prices
27
Goodwill
• Only an issue when purchase method is
used
• Controversies
– Should goodwill be included as an asset?
– Should goodwill be amortized?
• Accounting Methods
–
–
–
–
Asset without Amortization
Asset with Annual Impairment Testing
Asset with Systematic Amortization
Immediate Write-Off
28
Purchased Goodwill
• Goodwill - the excess of the cost of an
acquired company over the sum of the fair
market value of its identifiable individual
assets less the liabilities
– Goodwill often results from such factors as:
•
•
•
•
•
•
brand recognition
reputation
market share
earnings potential
location
customer list or base
29
Goodwill and Abnormal Earnings
• The final price that a company will pay
for another is the culmination of a
bargaining process.
– The amount of goodwill is subject to
the negotiating process.
– Goodwill is essentially the price paid
for “excess” or “abnormal” earning
power.
30
Amortization of Goodwill
• Goodwill does not have a perpetual life, but
it may be maintained by continuous efforts.
• GAAP requires that goodwill be amortized
and charged as an expense against net
income for a period not to exceed 40 years.
– Many companies use a much shorter
amortization period.
– Most companies use straight-line amortization.
31
Goodwill
• Comparative National Practices
– Conflict existed between U.S. and U.K. over benefits
derived from immediate write-off
• Problem magnified by increased merger activity
• Conclusions
–
–
–
–
Goodwill is not an asset under “separability”
Goodwill meets the “reliability” criterion
Goodwill meets the “relevance” criterion
Accounting for goodwill should be flexible, but fully
disclosed within competitive limits
32
Brands, Trademarks, Patents,
and Related Intangibles
• Should brands be capitalized?
– Brand capitalization would
• Restore equity
• Enhance borrowing capacity
• Facilitate takeovers without consultation with
shareholders (U.K.)
• Avoid undervaluation of firms
33
Brands, Trademarks, Patents,
and Related Intangibles
• Methods of Accounting
– Asset without Amortization
– Asset with Systematic Amortization
– Immediate write-off
• “Current Cost” approach – U.K.
• Capitalization without amortization if no limit
to useful life – France
• Brands are identified as intangible assets in
Australia, France, and the U.K.
34
Brands, Trademarks, Patents,
and Related Intangibles
• U.S. – combination of asset-withoutamortization method and asset-withsystematic-amortization method depending on
estimate of useful life
• IFRS requires recognition of intangible assets
for consolidated statements
• U.S. and Canada must write off internally
developed intangibles immediately
35
Brands, Trademarks, Patents,
and Related Intangibles
• International Accounting Standards
– IAS 38
• Intangible assets only recognized if future benefits
will flow to the enterprise and cost of asset can be
measured reliably
• Systematic amortization required for finite lives
• Impairment testing for assets with infinite lives
36
Brands, Trademarks, Patents,
and Related Intangibles
• Conclusions
– Problems are linked with the goodwill issue
– Brand names qualify as assets under
“separability”
– Measurement of intangibles may not be
“reliable”
– Value-oriented approach to brands and
intangibles should be used
37
A) The New Value Creation
Process and Its Implications
• Change in production processes: strategic
phases are research, marketing and
know-how, and not so much
manufacturing  phases where
intangible assets are key
• Today main determinants of growth at
firm (micro) and country (macro) levels
are, therefore, intangible assets
A) Benefits of Intangible Investments
Scalability, non-rivalry, non-scarcity
•Large sunk costs, negligible marginal costs
•Not subject to diminishing returns
•Use by one user does not preclude the use by
another user
•Scalability only limited by the size of the market
i.e. A computer operating system, a drug
•Increasing returns to scale
39
A) Benefits (continued)
Network Effect
•Metcalf’s law – the value of the network increases
geometrically with each new user
•i.e., software:
• Window Office suite – the more users that can share
documents the more valuable the software is
•Instant messenger – the more people on your buddy list
the more valuable it is to you.
•The more travel agents and airlines that use Sabre the
more valuable it became
•Positive feedback loop – Napster, AOL, Win 95/98/2000 XP
40
A) Costs Unique to Intangible Investments
Partial Excludability and Spillover
•Difficult to exclude non-owners
•Employee training benefits the employee and if the
employee quits, the new employer gets the benefits
•Non-patented employee know how
•Electronic devices can be reverse engineered
•New software functionality can be incorporated in
rival products
41
A) Costs (continued)
Partial Excludability and Spillover (continued)
•Intellectual property laws for patents, trademarks,
copyrights etc. vary from country to country
•Not recognizing the value of an innovation and giving it
away
•AT&T – cellular telephony
•IBM – PC architecture, cpu, DOS
•Xerox PARC – Laser printing, Ethernet, GUI and the
mouse
42
A) Costs (Continued)
Inherent Risk
•Intangibles are inputs into innovation and innovation is
risky
•10% of patents account for 81-93% of total patent
value
•Most new products fail
•Earnings volatility (risk) is three times greater for R&D
than physical investments
Risk mitigation
•Portfolio of patents
•Many R&D projects
•Research alliances
43
A) Costs (Continued)
Non-tradability (except for intellectual property)
•No organized and competitive markets
•Measurement and valuation difficult without
market prices
•None or little value if projects abandoned
•Result – most innovation in corporations and
research centers
•But, companies cannot use all of their
innovations and there is no market for
selling them(except patent licensing and
royalties)
44
A) Problems encountered by firms
capturing benefits from intangible
investment…
Economic attributes of intangible assets make it:
– Difficult to exclude other users (public good problem)
so firms cannot appropriate the full benefits from the
investment (Geroski 1995)
– Difficult to estimate ex ante the precise use of
intangible inputs, potential products, and timing and
magnitude of benefits
– Difficult to write contracts for transfer or exchange of
intangibles that are not embodied in a physical asset
45
A) Effect of uncertainty
• Investment in intangibles is also associated
with high levels of uncertainty/risk
• While there is evidence that investment in
intangibles leads to tangible investment, there
is a lag between intangible investments and
economic benefits (intangible investment
occurs early in the life cycle)
• To overcome problem associated with this risk,
most accounting standards require expenditure
on (particularly internally generated) intangible
assets to be expensed  considered more
reliable
46
A) Measuring Intangibles
Accounting and economic models relate inputs to output
•For tangible assets you know costs (input), risk, and
return (output)
•For intangibles:
• you don’t know the cost, risk, and returns
•There may be no relationship between cost of input
and value of output, but, you do know the risk is
enormous.
Without knowing how to measure intangibles you cannot
understand them, and, therefore cannot manage them !
47
A) The Logic of
Traditional Accounting
- ECONOMIC TRANSACTION AS THE “ENGINE”
OF TRADITIONAL ACCOUNTING
- ECONOMIC TRANSACTION SETS ACCOUNTING
VALUE  PRICE  HISTORIC COST/FAIR VALUE
- MEASUREMENT CATEGORIES LINKED
MAINLY TO “FORDIST” INDUSTRIAL ACTIVITY
- MEASUREMENT OF PERFORMANCE &
SURPLUS IN A SHAREHOLDER PERSPECTIVE
48
B) Traditional Accounting for Intangibles
(e.g. International Accounting Standard 38)
• General suspicion
• Recognition issues (R&D, Brands, Training)
• Conservative measurement criteria:
- General principle: Immediately expensed as
a period cost
- If recognised as an asset, then valued at Cost
or Revalued Cost (not value)
- Amortisation over a short period of time
• No attention to the intangible drivers of value
49
B) Accounting for Goodwill
• Most countries treat goodwill as an asset subject to
systematic amortization
– Maximum amortization periods of 5 to 40 years apply in
some countries
• U.S. and IASB treatment is an annual impairment test
of goodwill
• Some countries use immediate write-off method
against reserves
– Not permitted in U.S., Australia, Japan
• Some countries retain goodwill as a permanent asset
50
General Guide for Financial
Accounting (GAAP)
• Generally
• Accepted
• Accounting
• Principles
51
What is financial accounting
supposed to accomplish?
Provide the the most useful financial
information for…
Decision Making
52
Primary Accounting Setting
Body in the USA
• Financial
• Accounting
• Standards
• Board
53
U.S. Government Agency That
Oversees Financial Markets
• Securities
• Exchange
• Commission
54
Remember…
GAAP Are the Rules
The FASB makes the rules.
The SEC enforces the rules.
55
Statement 141: Business
Combinations
• All business combinations initiated after June
30, 2001 must use the PURCHASE METHOD
• Pooling-of-Interests method is no longer
permitted
56
Statement 141: Business
Combinations
• Requires disclosure of the primary reasons for a
business combination and the allocation of the
purchase price paid to the assets acquired and
liabilities assumed by major balance sheet
caption.
57
Statement 141: Business
Combinations
• Application of the purchase method requires
identification of all assets of the acquiring
enterprise, both tangible and intangible.
• Any excess of the cost of an acquired entity
over the net amounts assigned to the tangible
and intangible assets acquired and liabilities
assumed will be classified as goodwill.
58
Statement 141: Business
Combinations
• Fair Value is defined in SFAS No. 141 & 142 as
“The amount at which an asset (or liability) could be bought (or
incurred) or sold (or settled) in a current transaction between
willing parties, that is, other than in a forced or liquidation sale.”
• It is more of an “Investment Value” concept as the benefits of
synergies and attributes of the specific buyer and specific seller
are included.
– The ability of a controlling shareholder to benefit from synergies and other
intangible assets that arise from control might cause the fair value of a
reporting unit as a whole to exceed its market capitalization.
59
Intangible Asset Recognition
• An intangible asset shall be recognized as an asset
apart from goodwill:
– If it arises from contractual or other legal rights
– If it is separable; that is, it is capable of being
separated or divided from the acquired entity and sold,
transferred, licensed, rented or exchanged.
60
Intangible Asset Recognition
• An acquired intangible asset (other than
goodwill) with an indefinite useful economic
life should not be amortized (regardless of
whether it has an observable market) until its
life is determined to be no longer indefinite
• If no legal, regulatory, contractual, competitive,
economic, or other factors limit the useful life
of an asset, the useful life of that asset should
be considered indefinite.
61
Intangible Asset Recognition
• “The accounting for a recognized intangible
asset is based on its useful life to the reporting
entity. An intangible asset with a finite useful
life is amortized; an intangible asset with an
indefinite useful life is not amortized. The
useful life of an intangible asset to an entity is
the period over which the asset is expected to
contribute directly or indirectly to the future
cash flows of that entity.”
62
Intangible Asset Recognition
• A number of pertinent factors that should be considered
in deciding the useful life of an asset:
–
•
•
•
Expected use of the asset by the entity
Legal, regulatory, contractual limits to useful life
Ability to renew/extend contractual or legal life
Effects of obsolescence, demand, competition and other
economic factors
• Level of maintenance expenditures required to realize
expected future cash flows
• Useful life of another asset (or asset group) to which useful
life of intangible relates
63
Intangible Asset Recognition
• Separable intangible assets that have finite lives
will continue to be amortized over their useful
lives.
• A recognized intangible asset that is not
amortized must be tested for impairment
annually, and on an interim basis if an event or
circumstance occurring between annual tests
indicates that the asset might be impaired.
64
Intangible Asset Recognition
• The FASB has classified intangible assets into
five categories:
• 1. Marketing-related intangible assets
• 2. Customer-related intangible assets
• 3. Artistic-related intangible assets
• 4. Contract-based intangible assets
• 5. Technology-based intangible assets
65
Marketing-Related Intangible Assets
•Trademarks, trade names
•Service marks, collective marks,
certification marks
•Trade dress (unique color, shape or
package design)
•Newspaper mastheads
•Internet domain names
•Non-compete agreements
66
Customer-Related Intangible Assets
• Customer Lists
• Order or Production Backlog
• Customer Contracts and Related Customer
Relationships
• Non-Contractual Customer Relationships
67
Artistic-Related Intangible Assets
• Plays, operas, ballets
• Books, magazines, newspapers, other
literary works
• Musical works such as compositions, song
lyrics, advertising jingles
• Pictures, photographs
• Video and audiovisual material, including
motion pictures, music videos, television
programs
68
Contract-Based Intangible Assets
• Licensing, royalty, standstill agreements
• Advertising, construction, management, service or
supply contracts
• Lease agreements
• Construction agreements
• Franchise agreements
• Operating and broadcast rights
• Use rights such as drilling, water, mineral, timber
cutting and route authorities
• Servicing contracts such as mortgage servicing
contracts
• Employment contracts
69
Technology-Based Intangible Assets
• Patented technology
• Computer software and mask works
• Unpatented technology
• Databases, including title plants
• Trade secrets, such as secret formulas,
processes, recipes
70
GAAP
FASB Statement No. 142 Goodwill and Other Intangible
Assets (June 2001)
This statement carries forward without reconsideration the
provisions of Opinion 17 related to the accounting for internally
developed intangible assets. This statement also does not change
the requirement to expense certain acquired research and
development assets at the date of acquisition as required by FASB
Statement No. 2.
AICPA APB Opinion 17 (August 1970)
A company should record as expenses the costs to develop
intangible assets which are not specifically identifiable.
71
Statement 142: Goodwill and
Other Intangible Assets
• This Statement addresses how intangible assets
that are acquired individually or with a group of
other assets (but not those acquired in a business
combination) should be accounted for in financial
statements upon their acquisition.
• This Statement also addresses how goodwill and
other intangible assets should be accounted for
after they have been initially recognized in the
financial statements.
72
Statement 142: Goodwill and
Other Intangible Assets
• Goodwill and intangible assets that have
indefinite useful lives will not be amortized
but rather will be tested at least annually for
impairment.
• Intangible assets that have finite lives will
continue to be amortized over their useful
lives, but without the constraint of an
arbitrary ceiling.
73
Statement 142: Goodwill and
Other Intangible Assets
• Goodwill will be tested for impairment at
least annually using a two-step process that
begins with an estimation of the fair value
of a reporting unit.
– The first step is a screen for potential
impairment, and
– The second step measures the amount of
impairment, if any.
74
Statement 142: Goodwill and
Other Intangible Assets
• This statement requires disclosure of information
about goodwill and other intangible assets in the
years subsequent to their acquisition. Information
to be disclosed:
– The changes in the carrying amount of goodwill from
period to period,
– The carrying amount of intangible assets by major
intangible asset class for those assets subject of
amortization and for those not subject to amortization,
and
– The estimated intangible asset amortization expense for
the next five years.
75
Statement 142: Goodwill and
Other Intangible Assets
• The provisions of this Statement are required to
be applied starting with fiscal year beginning
after December 15,2001.
• This Statement is required to be applied at the
beginning of an entity’s fiscal year and to be
applied to all goodwill and other intangible
assets recognized in its financial statements at
that date.
76
Impairment of Goodwill and
Other Intangible Assets
• SFAS No. 142 mandates that goodwill and
intangible assets without a defined live
shall not be amortized over the defined
period; rather they must be tested for
impairment at least annually at the
“reporting unit” level.
77
Impairment of Goodwill and
Other Intangible Assets
• All acquired goodwill should be assigned to reporting
units. This will critically depend on the assignment
of other acquired assets and assumed liabilities.
• The amount of goodwill allocated to a reporting unit
is contingent upon the expected benefits from the
synergies of the combination. This goodwill
allocation is required even though other assets or
liabilities of the acquired entity may not be assigned
to that reporting unit.
78
Impairment of Goodwill and
Other Intangible Assets
• The measurement of the fair value of
intangibles and goodwill can be
performed at any time during the fiscal
year as long as the timing is consistent
from year to year.
79
Impairment of Goodwill and Other
Intangible Assets
• The annual impairment test is to be
accelerated and goodwill of a reporting
unit should be tested for impairment on an
interim basis if an event occurs that would
more likely reduce the fair value of a
reporting unit below its carrying value.
80
Impairment of Goodwill and
Other Intangible Assets
• Impairment Test Triggering Events:
– A significant adverse change in legal factors or in the
business climate
– An adverse action or assessment by a regulator
– Unanticipated competition
– A loss of key personnel
– A more-likely-than-not expectation that a reporting unit will
be sold or otherwise disposed of
– The testing for recoverability under SFSA No. 144 of a
significant asset group within a reporting unit
– Recognition of a goodwill impairment loss in the financial
statements of a subsidiary that is a component of re
reporting unit
81
Goodwill Impairment Test
• The Two-Step Impairment Test:
• Compare estimated fair value of each
reporting unit to the carrying amount of the
unit.
– If FV > Carrying Amount, no need to perform
Step 2
– If FV < Carrying amount, then Step 2.
82
Goodwill Impairment Test
• If the carrying amount of a reporting unit goodwill exceed
the implied fair value of that goodwill, then an
impairment loss must be recognized for an amount equal
to that excess.
– In order to determine the implies fair value of the goodwill, all
assets must be valued.
– The impairment loss cannot exceed the carrying amount of the
goodwill. Only the value of goodwill is adjusted through this
process.
– The adjusted carrying amount of goodwill will be its new
accounting basis.
– Goodwill cannot be increased to its original carrying amount in
the future. Once written down, it stays down.
83
Goodwill Impairment Test
• Ex: Assume a company has a reporting unit with a fair value of
$10,000,000 including goodwill of $3,000,000. further assume
that the relative fair values of the assets have been valued and
recorded on the books of the acquirer as:
• ______________________________________________
• Recognized tangible assets
$5,000,000
• Recognized identifiable intangible
2,000,000
assets (with definite life)
• Goodwill
3,000,000
•
==========
•
$10,000,000
• ______________________________________________
84
Goodwill Impairment Test
• After one year assume the carrying amount of certain assets
after amortization are:
• ______________________________________________
• Recognized tangible assets
$3,500,000
• Recognized identifiable intangible
1,500,000
assets (with definite life)
• ______________________________________________
85
Goodwill Impairment Test
• Assume that an impairment test is performed at this time one
year later and the fair value of the reporting unit is $9,000,000.
A new asset allocation must be performed to determine the new
goodwill amount:
• ______________________________________________
• Recognized tangible assets
$3,800,000
• Unrecognized tangible assets
1,000,000
• Recognized identifiable intangible assets
1,400,000
• Unrecognized identifiable intangible assets
800,000
• Goodwill
2,000,000
•
___________
• Fair Value of the reporting unit
$9,000,000
• ______________________________________________
86
Goodwill Impairment Test
Net Carrying
amount
Fair Value
Impairment
Amount
SFSA Citation
(Taiwan)
Recognized tangible assets
$4,000,000
$3,800,000
200,000
142
Unrecognized tangible
assets
0
1,000,000
0
Recognized identifiable
intangible assets (with a
defined life)
1,800,000
1,400,000
400,000
Unrecognized identifiable
intangible assets
0
800,000
0
Goodwill
3,000,000
2,000,000
1,000,000
Total
$10,000,000
$9,000,000
$1,600,000
144
142
87
B) Consequences of Accounting Standards
Current GAAP
•Except for R&D almost no reporting and disclosures on
intangibles
•Required capitalization of software development costs is
often ignored
•Result
•Investors and some levels of management are kept in the
dark about investment and return on intangibles
•Asymmetry of information
•Abnormal gains to those that know the potential
return on intangibles – insiders
•As investment in intangibles increases, volatility and
risk increases, asymmetry of information increases,
and insider gains increase
88
B) In company reporting, once upon a
time there was Goodwill...
Purchase price – Fair value of net assets =
Goodwill
- Poor (synthetic) representation in cognitive terms of
the intangibles possessed by an organisation
- Residual value used to represent all the
“unidentifiable”/“unseparable” intangibles of the
acquiree
- Managerial and users’ need for a more analytical
knowledge, control, and representation of intangible
elements of a firm’s wealth (brands, organisational
capabilities, IPR, etc.) and of its drivers
89
B) Unmeasured intangible inputs
and outputs in the economy
• Problem: Changing composition of investment is not
reflected in financial reporting
• Problem: Accountability of management for
actions/decisions in managing the firm’s resources
• Problem: Lack of data for analysis and rational
resource allocation  info. asymmetry
90
B) Micro-Economic consequences
• Serious economic consequences for the firm from
the poor accounting treatment of intangibles
• The non-measurement of intangibles at the
company level has adverse economic
effects in terms of:
- Investment decisions
- Level of information asymmetry concerning
a firm (volatility of share prices & insider
trading)
- Internal/management information systems
91
B) Intangibles at a macro level
• Intangibles as connecting tissue, the “glue” that
allows the homeostasis of the economic system
• We need to better understand how tangibles and
intangibles combine to create collective value
• Intangibles are not measured or quantified –
more often under-measured – at a macro level
• Potentially serious consequences at a policy level
 wrong indicators  wrong diagnosis of a
country performance and policy recipe
92
Current US GAAP
Criteria to be considered an asset
•Defined and distinct
•Effective control
•Possible to predict future economic benefits
•Possible to determine impairment
Asset Examples:
•Property, plant, equipment
•Financial assets
•Purchased identifiable intangibles such as patents,
trademarks, copyright and mailing lists
•Purchased goodwill
93
GAAP (continued)
Internally developed intangibles
•Expense when incurred (Except for software when
certain conditions are met)
Examples:
•R&D
•Training
•Advertising
Inequity in accounting treatment – intangible assets have
future economic benefits—the matching principle is violated.
94
Relevance
Reliability
Comparability
Consistency
1. Provides a basis
for forecasts
1. Is verifiable
Different
companies use
similar
accounting
PRINCIPLES
Company uses
same accounting
METHODS from
year to year
2.Confirms/corrects
prior expectations
2. Is a faithful
representation
3. Is neutral
3. Is timely
Characteristics of Useful Information
95
95
Basic Terms
Relevance - information makes a difference in
decisions
Reliability - information must be free of error
and bias
Comparability - ability to compare
information of different companies because
they use the same accounting principles
Consistency - use of same accounting
principles and methods from year to year
within the same company
96
GAAP (continued)
Inequity between:
acquired intangibles—capitalized
and
internally developed intangibles – expensed
Cannot compare a company that acquired
intangibles with another company that internally
developed intangibles even though cost and
benefits between the two companies are identical
97
Constraints in Accounting
Permits companies to apply GAAP without
hurting the usefulness of information
• Materiality - The constraint of determining whether
an item is large enough to likely influence a decision.
• Conservatism - The approach of choosing an
accounting method, when in doubt, that will be least
likely to overstate assets and net income.
98
B) The Issue
Improving information used by decision makers for the
optimal investment in intangibles:
• Investors and creditors – which companies to invest
in or liquidate?
• Business managers – which projects to invest in or
drop?
• Government policy makers, Regulators, and
Standard Setters– what research needs to be funded
and should increased information reporting and
disclosure on intangibles be mandated?
99
B) Costs of Non-measurement
- Firm level: risk of poor or wrong strategies
- Industry level: misallocation of resources
within and between industries; skill bias
- Capital market level: under- or overvaluation of companies; misallocation of
resources; volatility
- Country level: policy making based on
imperfect set of indicators may result in
inappropriate policies
C) A series of initiatives:
company and academic reactions
• In 1992 Kaplan and Norton propose the
Balanced Scorecard  non-financial measures
break in
• In 1994 Skandia starts the production of an
Intellectual Capital Statement
• Many measurement and reporting models are
put forward by practioners, academics,
companies
C) A framework of analysis
10
Balanced Scorecard, Norton & Kaplan 1992
Financial Perspective
(goals and measures)
Internal business
perspective
(goals and measures)
Customer
perspective
(goals and measures)
Innovation and
learning perspective
(goals and measures)
10
Skandia Navigator, Edvinsson & Malone 1998
FINANCIAL FOCUS
CUSTOMER
FOCUS
HUMAN
RESOURCE
FOCUS
PROCESSES
FOCUS
INNOVATION AND DEVELOPMENT FOCUS
OPERATIVE ENVIRONMENT
10
Intangible Assets Monitor, Sveiby 1997
INTANGIBLE ASSETS
External Structure
Internal structure
Personnel Competence
Growth/Renewal
Growth/Renewal
Growth/Renewal
- Growth of personnel
- Growth of market share
- Customer satisfaction or
quality
- Investment in IT
- Time for R&D
- Personnel behaviour
towards managers,
culture, customers
- Competence-enhancing
customers
- Growth of average
professional competence
(years)
- Turnover of competence
Efficiency
Efficiency
Efficiency
- Revenues per customer
- Sales per agent
- % of administrative staff
- Sales per staff
- Value added per
employee
- - Changes in the
proportion of highest
competence employees
Stability
Stability
Stability
- Repeat orders
- Age of structure
- Age of organisation
- Rookie ratio
- Employees turnover
10
Value Chain Scoreboard, Lev 2001
Disc. and learning
1. Internal renewal
-
Research and development
Work force training and
development
Organizational capital,
Processes
Implementation
4. Intellectual
property
-
Patents, trademarks and
copyrights
Licensing agreements
Coded know-how
2. Acquired
capabilities
5. Technological
feasibility
-
-
Technology purchase
Spillover utilization
Capital expenditure
-
Clinical tests, Food and
Drug Administration
approvals
Beta tests, working pilots
First mover
Commercialisation
7. Customers
-
Marketing alliances
Brand values
Customer churn and value
8. Performance
-
Revenues, earnings, and
market share
Innovation revenues
Patent and know-how
royalties
Knowledge earnings and
capital
3. Networking
6. Internet
9. Growth prospects
-
-
-
-
R&D alliances and joint
Ventures
Supplier and customer
Integration
Communities of practice
Threshold traffic
Online purchases and sales
Major internet alliances
-
Product pipeline and launch
dates
Expected efficiencies and
savings
Planned initiatives
Expected breakeven and
cash burn rate
10
C) A series of initiatives
at an institutional level
• Half ’90s: OECD Studies
• 1999: International Conference in
Amsterdam (OECD + Dutch and Danish
Governments)
• 2000: European Commission’s High Level
Expert Group on the Intangible Economy
• 2001-2003: Research projects Prism and
Meritum/E*Know-net funded by the
Commission  Meritum Guidelines on ICR
C) A series of initiatives
at an institutional level (cont’d)
• 2002: International Conference in Madrid
(Autonomous University Madrid + Spanish
Government + OECD + European Commission)
• 2002-2003: Official Study for the European
Commission on the measurement of intangible
assets (Ferrara+New York+Melbourne)
• 2004: International Conference in Helsinki
(Sept.) + OECD Forum in Paris (Oct.)
C) A series of initiatives
at an institutional level (cont’d)
• 1997-2003: Danish Guidelines on IC Reporting
as a result of a Government-driven project
• 2002-04: Various documents on intangibles by
the UK Department of Trade and Industry
• 2003: Letter on Intangible Economy signed by
the UK, German and French Governments
• 2004: German Guidelines on IC Reporting by
the Ministry of Labor
C) A series of initiatives
at an institutional level (cont’d)
• June 2004: The Japanese Government issues a
White Paper about making economic policy in
the knowledge era  strong emphasis on
intangibles and intellectual capital reporting
• April 2005: A new policy by the city's Pudong
New Area  recognition of human resources as
capital contribution up to a maximum of 35% of
the enterprise's registered capital, and a report and
filing system for enterprise annual reviews (for
both domestic and foreign companies)
C) A series of initiatives
at an institutional level (cont’d)
• 2004-05: High Level Expert Group set up by
the DG Research of the European Commission
with the task of producing an official report on
Intellectual Capital Reporting especially for
research-based SMEs
• 2005: Action Plan of the European
Commission on business-related services 
strong recommendation to these co’s to
prepare an intangibles-based report
C) A series of initiatives
at an institutional level (cont’d)
• June 2005: World Bank has organized a
Conference on “Intellectual Capital for
Communities in the Knowledge Economy:
Nations, Regions and Cities” held in Paris
• 20-22 Oct. 2005: OECD will hold an
International Policy Conference on Intellectual
Assets in conjunction with the University of
Ferrara (www.ferraraonintangibles.net)
C) Official Study for the European
Commission
A 2003 STUDY ON “THE MEASUREMENT OF
INTANGIBLES” MADE BY THE UNIVERSITIES
OF FERRARA, NEW YORK AND MELBOURNE
FOR THE DG ENTERPRISE. Available at:
http://europa.eu.int/comm/enterprise/services/
business_services/index.htm
11
C) Definitions of Intangibles
• Far too many definitions & different classifications
and taxonomies of intangibles (micro & macro)
• Need for reducing them through consensus
• In the Study intangible assets defined as a source of
future benefits that is without a physical embodiment:
• Intellectual property is an intangible asset with legal rights
• Includes innovation-related intangibles (patents), but also
market-related (brands), human resource (compensation
systems, training policies), and organizational intangibles
(internal structures, systems and processes)
• “Hard” intangibles (tradable) vs. “Soft” intangibles
11
Objectives of Financial Reporting
FASB Concepts No. 1
Financial reporting should provide information:
• That is useful to potential investors and creditors and other
users in making rational investment, credit and similar
decisions.
• To help present and potential investors and creditors and
other users in assessing the amounts, timing, and uncertainty
of prospective cash receipts and net cash inflows to the
enterprise.
•About the economic resources of an enterprise, the claims to
those resources, and the effect of transactions, events, and
circumstances that change its resources and claims to those
resources.
11
C) New measurement & reporting
models for Intangibles
• Various innovative methods for the recognition,
measurement, and disclosure of intangibles and
intellectual capital (IC) have been analysed
• A taxonomy of the different new methodologies (holistic
vs. atomistic; monetary vs. non-monetary)
• The rise in company practice of IC statements
• Analysis and comparison of the four main Guidelines on
IC statements proposed so far (Meritum, Nordika, IFAC,
and DATI)
• Exploration of the relations between IC statements
& Corporate Social Responsibility (CSR)(e.g. GRI)
11
C) A working definition of IC
Intellectual Capital – IC – is the internal
(competencies, skills, capabilities, etc.) and external
(image, brands, customer satisfaction, etc.) stock of
intangibles of an organisation, which allows the
latter to transform a bundle of material, financial
and human resources in a system capable of
creating stakeholder value through the pursuit of
sustainable competitive advantages (Zambon, 2000)
Organisational knowledge becomes IC only when it is
durably and effectively internalised or appropriated by
an organisation
11
IC as New Concept for
Representing & Managing Intangibles
A concept that encompasses the various types of
intangibles, including social and environmental
intangibles
- a “new” notion of the wealth of an organisation
- thrust towards information relevance instead of
reliability in reporting
- a concept in evolution  different accents
- a concept on whose basis company reporting
might be reformed?
11
C) Towards a New Reporting Tool
Intellectual Capital (IC) Statements or Report on
Intangibles
Based on indicators  many without a financial
nature
The partitioning of IC into three interrelated
sections is quite widely accepted: Human
Capital, Organizational Capital (including
Innovation Capital), Relational Capital
visualized/measured through indicators and
parameters
11
C) Guidelines on IC statements: some
emerging convergences and differences
- International Federation of Accountants (IFAC) –
Study no. 7 (1998)
- Danish Agency for Trade and Industry (DATI)
Guidelines (2000, but new edition 2003)
- Nordika Project Guidelines (2001)
- Meritum Project Guidelines (2002)
- “Intellectus Model” (Spain) (2003)
- German Guidelines (2004)
- Japanese Guidelines (2005)
Other documents deal with some aspects of IC reports, but
without focussing on them (e.g., GRI, EFQM, ISO)
12
C) INTANGIBLES AND INFO. USERS:
THE CASE OF FINANCIAL ANALYSTS
In 2001, the Italian Association of Financial
Analysts (AIAF) set up a study group on
Intangibles
In January 2002, a model has been developed – in
collaboration with the University of Ferrara – to
measure the level of disclosure on intangibles by
companies in their external reports
This model has now been refined/extended in order
to represent/rank European companies on the basis
of their level of disclosure on intangibles
12
C) The Basic Framework for Ranking
the Level of Disclosure on Intangibles (AIAF 2002)
LEVELS OF COMMUNICATION
ON INTANGIBLES
Level 3
Extended information
FIVE DIMENSIONS OF COMMUNICATION
Level 2
“Reasoned” information
Organisation
Innovation & IPR
Human resources
Level 1
“Minimum” information
Customers & Market
Strategy
Actual
Forecast
NATURE OF INFORMATION
IC Statements and Environmental
and Social Reports: The case of GRI
• The Global Reporting Initiative (2002) is:
- a reporting framework for non-financial aspects
- based on the three-dimensional concept of
“sustainability” (economic, environmental and
social)  so called triple bottom line
- evidence of an overlapping between IC
statements and social & environmental reports
(e.g., indicators on employees’ training and education,
supply chain management, quality of management,
investment in R&D, stakeholder engagement)
12
An Intangible Perspective on
CSR and Stakeholder Value
THE BASIC IDEA 
SOCIAL CAPITAL & ENVIRONMENTAL
CAPITAL AS PARTICULAR
INTANGIBLES TO BE MANAGED BY
COMPANIES (AND PUBLIC SECTOR
ENTITIES)
12
The Integrated Reporting System
SOCIAL
Collectivity
REPORTING
Intangibles /
Intellectual
Capital
Reporting
ENVIRONMENTAL
REPORTING
Society
TRADITIONAL
FINANCIAL
REPORTING
Investors/Auditors/Financial Analysts
12
D) Main Policy Implication
• Urgent to better measure intangibles both
at micro and macro level
• Priority: better measurement at firm level
because good indicators at micro level
allow also to build better indicators at
macro level
D) Intangibles Reporting:
policy recommendations
• Policy aim: Develop and promote a new,
integrated, reliable and verifiable
company disclosure system which is
based on intangibles
• What is needed is CONVERGENCE
between existing methods and reports
D) Intangibles Reporting:
policy recommendations (cont’d)
• Identify a standardised set of intangibles
indicators serving as minimum common
information denominator
• Consistent data at micro level as
foundation for more aggregated analyses
 in this respect we need rather detailed
categories in the prospective intangibles
taxonomy
D) Intangibles Reporting:
policy recommendations
• Provide incentives to firms to adopt a new
reporting system based on intangibles, as
well as to use and reveal that information
• Favor the emergence of a generally agreed
taxonomy and definition of intangibles
• Encourage voluntary experimentations &
exchange of best practices  good IC
reporting guidelines are already in place
D) Intangibles Reporting:
policy recommendations (cont’d)
• Induce information system/software
providers to develop the collection of data
on intangibles  e.g. XBRL
• Promote the gathering of the reported
information on intangibles in a systematic
and coherent way (cf. US Edgar)
• Support ad hoc research
D) Intangibles reporting:
policy recommendations (cont’d)
• Convergence to be searched for with statistical
•
•
offices, but starting point of intangibles
information should be corporate reporting  a
delta, not a substitute
Drawing on other forms of voluntary/
supplementary reporting (such as social,
environmental, sustainability reports etc.) for
inducing companies to produce information on
intangibles
Looking for synergies in the efforts  e.g.
OECD + European Commission + US
Institutions + Japanese Institutions
E) Some questions
on IC Reports
Despite their value and innovativeness, IC reports face
some criticisms concerning their:
- consistency
- reliability/subjectivity
- thoroughness
- meaningfulness:
a) high subjectivity in the choice of the useful
indicators
b) indicators do not possess additive properties
c) high specificity of indicators
13
E) Some questions… (cont’d)
However, some open problems:
- Value in absence of a market price (value in use vs in
exchange) (i.e., credibility and meaningfulness)
- Specificity vs Generalisability (i.e., consistency &
comprehensiveness problems)
- Regulation vs Voluntary Compliance
- Atomistic vs Holistic measurement approach
- Common vs Different Measurement Units
- Relevance vs Reliability
- Users  stakeholders?
13
Final consideration
We face a major PARADOX:
- The more the system is based on intangible assets,
the stronger it is (because intangibles are major
determinants of growth and value creation).
- However, at the same time:
the more the system is based on intangibles, the
more vulnerable it becomes.
The challenge we all face is to learn how to measure
and report in this intangibles environment
13