The Financial Reporting Council (FRC) has launched a major review of the reporting of intangibles at companies as business moves towards a more knowledge-based economy
The paper sets out ambitious plans to radically change the accounting for intangible assets and will be putting the ultimate proposals to the International Accounting Standards Board (IASB).
Intangibles include patents, copyrights, trademarks, knowledge, skills, permits, licenses, computer software, customer lists, relationships, business processes, and dynamic capabilities (such as the ability to adapt to new working methods).
Proposals include changes to reporting on balance sheets and extending the definition of intangible assets in accounting standards.
This will also include a review of the implication of the IASB’s Conceptual Framework’s requirements that an intangible can only be recognised as an asset in financial statements if it meets the definition of an asset; and recognition provides relevant information about the asset and a faithful representation of it.
There are mixed views on the value of intangible reporting with those who take the view that the shift to the new economy has caused financial statements to lose much of their relevance for investment decisions often cite the divergence between the accounting value of equity (net assets) and companies’ market capitalisation.
They suggest that this is due to the failure to recognise the value of intangibles in financial statements. However, the FRC is sceptical about this argument stating that ‘although financial statements may be expected to provide information that is useful to an assessment of the value of a company’s equity, they have never pretended to provide that value directly’.
The main proposals on recognition include:
- an intangible should be recognised at cost only where:
— the costs to be incurred on development of an intangible asset can be estimated at the time when a project to develop an intangible is undertaken. The amount capitalised should not exceed these estimated costs in view of the difficulty of establishing the future economic benefits; and
— the economic benefits to be derived from the intangible can be specified when the costs are first incurred, and hence a relevant method of amortisation or monitoring for impairment can be established.
(ii) For many intangibles the measurement uncertainty of fair value is so great as to call into question whether it could provide a representationally faithful depiction;
(iii) The requirements of existing accounting standards should be reviewed in light of these conclusions.
The FRC proposes that:
- relevant and useful information could be provided without the need to recognise more intangible assets in companies’ balance sheets;
- such information could cover a range of factors, broader than the definition of intangible assets in accounting standards, that are relevant to the generation of value;
- improvements could be made on a voluntary basis within current reporting frameworks (such as the strategic report); and
- participants in the reporting supply chain could collaborate to bring about improvements.
There is also a focus on the use of narrative reporting so that it usefully complements the information provided in financial statements, in terms of recognised and unrecognised intangibles.
Paul George, executive director for corporate governance and reporting at the FRC, said: ‘It is unrealistic to expect the value of a business to be fully represented in its balance sheet; there is always likely to be a gap between the balance sheet total and the market capitalisation of a company.
‘The paper suggests several ideas for expanding the information provided, both quantitative and qualitative, to improve users’ assessment of corporate value.’
The consultation closes for comment on 30 April 2019.
FRC Discussion paper - Business Reporting of Intangibles: Realistic Proposals, released 06 February 2019