The accounting treatment of intangibles – A critical review of the literature

Abstract

Intangible investments have become the main value creators for many companies and economic sectors. However, these investments are rarely recognized as assets by current accounting standards. We provide a critical review of the literature on the consequences of this lack of accounting recognition of intangibles for the value-relevance of financial information, resource allocation in the capital market, growth of intangible investments, and the firm's market value. We then review recent empirical research on voluntary disclosure of information on intangibles. Our survey concludes that disclosure can considered as a solution to the negative consequences of non-recognition of intangibles in financial statements.

Keywords:

• Intangibles
• Value-relevance
• Resource allocation
• Growth
• Market value
• Voluntary disclosure

Acknowledgement

We gratefully acknowledge the support of the CGA – Accounting Research Centre at the University of Ottawa.

Notes

1 The accounting treatment of intangibles is analyzed in this paper through the International (IAS/IFRS) and American (SFAC/SFAS) accounting standards.

2 This term particularly refers to internally generated intangible investments. A more comprehensive discussion on the accounting treatment of intangibles will be presented in Section 3.

3 According to the literature, intellectual capital is classified into 3 categories: human assets, structural assets, and relational assets. Human asset refers to the knowledge, qualifications, skills and know-how of employees. Structural asset constitutes the supportive infrastructure that enables human asset to function in an organization. It comprises procedures, practices, computer and administrative systems of the company. Relational assets concern the resources arising from the external relationships of the company with customers, suppliers and other partners (Kristandl and Bontis, 2007; MERITUM, 2002; OECD, 2006b).

4 By identifiable, the IASB (IAS 38) expresses the fact that they can differentiate assets from goodwill.

5 According to the IAS 38 and SFAS 142, the cost can be reliably measured, in this case, because the acquisition price was generally determined during the transaction and appears under monetary form or other monetary assets.

6 According to the IFRS 3 and SFAS 141, the asset cost is the asset's fair value at the time of business combination. The fair value can be reliably measured if there is a market price provided in reference to an active market.

7 These conditions are: (a) the technical feasibility of completing the intangible asset so that it will be available for use or sale; (b) its intention to complete the intangible asset and use or sell it; (c) its ability to use or sell the intangible asset; (d) how the intangible asset will generate probable future economic benefits; (e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and (f) its ability to measure reliably the expenditure attributable to the intangible asset during its development (IASB, IAS 38, §57).

8 Lev (2003) and Lev et al. (2005) used in their model three popular measures of company performance: return on assets (ROA), return on equity (ROE), and growth in earnings.

9 A financial item is generally considered as value-relevant if it has the ability to make a difference to decisions of financial statement users. The value-relevance is generally measured by explanatory power (R²) or response coefficient (ERC). In an efficient market, all value-relevant information would be immediately and completely reflected in share prices.

10 Their data includes subsamples representing new-economy companies.

11 The inside investors, also named the insiders, defined by the 1934 Securities and Exchange Act as corporate officers, directors, and owners of 10% or more of any equity class of securities. They are also defined as every person who possesses private information.

12 The cost of capital is the rate of return on an investment required by investors.

13 The authors used bid-ask spreads as a proxy of stocks’ liquidity. They found that stocks of R&D intensive companies have larger bid-ask spreads.

14 The international companies by country within region: Europe (Austria, Belgium, Croatia, Czech Republic, Denmark, Finland, France, Germany, Hungary, Iceland, Ireland, Italy, Liechtenstein, Luxembourg, Norway, Portugal, Russia, Slovenia, Spain, Sweden, Switzerland, The Netherlands, Turkey, UK); Americas (Bermuda, Brazil, Canada, Cayman Islands, USA); Rest of world (Australia, China, Hong Kong, India, Israel, Japan, Malaysia, New Zealand, Singapore, South Africa, South Korea, Taiwan).

15 The Scoreboard is an international league table of the companies investing most in R&D (DIUS, 2008).

16 The AICPA asked: “Should the FASB broaden its activities beyond financial statements and related disclosures to also address the types of non-financial information that would be included in a comprehensive business reporting model?”

17 http://www.fasb.org/brrp/brrp2.shtml (accessed the 22nd November 2009).

18 http://www.sec.gov/rules/interp/33-8350.htm (accessed the 22nd November 2009).

19 http://www.osc.gov.on.ca/documents/en/Securities-Category5/rule_20031219_51-102_con-dis.pdf (accessed the 22nd November 2009).

20 http://www.iasplus.com/resource/ecaccdir0305.pdf (accessed the 22nd November 2009).

21 The AIMR is an association of financial analysts who provide, among other activities, rankings of US companies based on their disclosure activities. In 2004, the association changed its name to CFA Institute after it ceased to provide such disclosure ratings in 1997.