Reporting on and understanding the value of intangibles has been a hot topic for investors for many years. With the evolution to a service economy, businesses are increasingly investing in intangible sources of value that are often not reflected in financial statements. As the significance of intangibles to value creation continues to increase, stakeholders have expressed a growing and broader interest in intangible reporting. Specifically, the focus has been on the usefulness of the current accounting for intangibles and its relevance to decision making. This past June, the International Financial Reporting Standards (IFRS) Foundation hosted a workshop for stakeholders of different backgrounds to consider enhancements to the current intangible reporting standard.
Definition of intangibles
Intangible assets are defined by the IFRS Standards as ‘identifiable’ non-monetary assets without physical substance. The Standards suggest that such an asset is considered ‘identifiable’ when it is separable, or when it arises from contractual or other legal rights. Examples of common intangible assets that meet the definition of an asset include rights, licenses, goodwill and other intellectual property (e.g. patents, trademarks, copyrights). Examples of intangibles that do not meet the definition of an asset includes human capital, brands, and knowledge.
Inconsistency in accounting for intangible assets
Stakeholders expressed concern that current IFRS Standards generally do not allow companies to recognize internally-generated intangible assets on their financial statements, whereas the same intangible assets are recognized if acquired through a business combination or other transaction.
As a result, a company’s financial statements do not provide investors with a full picture of all the intangibles that produce future cash flows and growth. This inconsistency also diminishes comparability of financial results between companies that grow through acquisition, or that grow organically. With the increasing importance of intangibles in corporate value creation, many stakeholders want to see amendments to the IFRS Standards to recognize and measure more intangibles, to improve consistency, as well as to introduce new disclosure requirements outside a company’s financial statements.
The intangibles information gap
Many stakeholders expressed concerns that the information gap on intangibles – both in a company’s financial statements and in other parts of its annual reporting package – is contributing to the declining relevance of reported accounting earnings to assessing a company’s value. In the absence of changes to accounting standards, participants in the discussion agreed that companies should provide more information outside of the financial statements on: their ‘value drivers’ and associated intangibles; the management of and strategy behind intangibles; and the value of intangibles.
In principle, participating stakeholders (including investors) broadly accept that this information gap can be addressed in narrative disclosure. Some international and national standard-setters have developed frameworks for such disclosure, with limited adoption by some listed companies. However, participants agreed that the absence of harmony in current requirements was a significant obstacle to consistent progress. The International Accounting Standards Board’s (IASB’s) Management Commentary project will include guidance on narrative reporting on intangibles, with an exposure draft expected to be published in the first half of 2020.
Value drivers and KPIs
Participants also discussed the use of Key Performance Indicators (KPIs) to assess the performance of certain intangibles. Many non-GAAP KPIs are broadly used by investors to analyze the performance and value of companies. For example, ‘load factors’ in the airline industry, or ‘same store sales’ in the retail sector, are non-GAAP KPIs that analysts and investors rely on heavily to assess company performance. KPIs can similarly be designed for critical intangible value drivers and to track the performance of the associated intangibles. For instance, a ‘repeat customer ratio’ can be used as a KPI to assess an intangible related to customer loyalty. There are differing opinions on whether the IASB should get into the business of developing or prescribing the use of KPIs, or whether this should be left to companies or market forces.
Irrespective of any future IASB disclosure requirements, it is clear that investors and analysts are looking for more insight and reporting relative to the value and performance of a company’s intangible assets. A narrative discussion on a company’s ‘value drivers’ and KPIs could be a useful way to begin to address this evolving market demand.
Terry Liu, CPA, CA is a Senior Manager, and Rob Brouwer, FCPA, CPA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.