The Art of the Disclosure: How your business will benefit from reporting intangible assets the right way

The Art of the Disclosure: How your business will benefit from reporting intangible assets the right way

Article summary:

  • Intangible assets are a major driver of corporate value and growth, but they are often not fully recognized on financial statements.
  • This is a problematic gap which can be addressed by making IA disclosures on company financial reports.
  • There is currently no universal standard or set of regulations for when and how these disclosures should take place.
  • Proactive voluntary IA disclosures can make for better understanding and communication of the value drivers of a business, improving relations with investors, supporting favourable valuations and enabling better strategic management of a company, utilizing the full set of value generating assets at a business-person’s disposal.
  • In our role as an innovation agency, IPOS will be conducting a series of webinars focused on IA disclosure and valuation over the coming months, find out more and sign-up here for the upcoming webinar – “Why Valuing Intangible Assets Matters in the New Normal" on 27 August 2020, 3 pm SGT.

 

For business people, investors, academics and armchair analysts interested in the performance of corporations, an understanding of what drives enterprise growth is key.  Anything more than a cursory analysis will reveal the potential breadth of assets which can contribute to enterprise growth, beyond the purely tangible elements, such as plant, property and equipment.  In fact, today’s digitally driven economy derives the majority of corporate value from intangible assets, which include both registrable and non-registrable intellectual property.

While intangible assets are an undeniably important component of corporate value creation, current standards for corporate accounting do not require a full and complete breakdown or disclosure of intangible assets in financial reports.  In line with International Financial Reporting Standards (IFRS) intangible assets which must be reported are ones which have been externally acquired, either through a merger or acquisition, or other business consolidation, as well as a subset of internally-generated intangible assets, which meet strict criteria for identification and being recognized in a company’s financial statements.

The majority of internally-generated intangible assets do not meet the technical requirements to be recognised on financial statements, which presents a potential gap between the true sources of value generation in a business and the snapshot of that business’ economic standing, as represented in their financial statements. Consider the case of Google, whose market capitalization is around US$991bn, at the time of writing, which the latest financial statements reflect intangible asset holdings of less than US$3bn.  This gap matters, as it causes difficulties for stakeholders both outside and internal to the relevant firms. 

Potential investors and shareholders are left to best efforts approaches to estimate the true nature of a business’ performing assets, the strategy around them, and the estimated value unreported intangible assets should contribute to the overall enterprise value.  For some, this increased uncertainty will disincentivize investment, for others it is likely to limit the value of potential bids.

Internal stakeholders are also likely to be disadvantaged in their own efforts to accurately measure, manage and deploy their entire suite of assets, whilst also facing similar uncertainty around the question of just how much their business is worth. 

With the current reporting standards as our backdrop, we believe that increased voluntary disclosure of intangible asset holdings and estimated values can be adopted by businesses looking to fill the gap left by under represented intangible assets on financial statements.

At IPOS, our ongoing contributions to nationwide efforts to maintain Singapore’s position as a top-ranked IP-regime, with the associated benefits of supporting domestic growth and attracting foreign direct investment, all mean we are in regular contact with businesses both in Singapore and overseas.  During these engagements, we often hear reservations about adopting voluntary intangible asset disclosures, as management are concerned about giving too much information away to potential competitors.  While careful consideration is required prior to voluntary disclosures, we wish to highlight certain advantages that can sway decision-makers’ thinking on the subject.

First and foremost is the increased clarity that management themselves will enjoy given a comprehensive understanding of their business’ total asset base, and the subsequent enterprise value that can be supported by a better understanding, and internal valuation of, intangible assets.  The more regular and more precise the measurement, then the better the scope for successful management.  This holds true for businesses that may not yet feel ready to engage in specific intangible asset disclosures today, but are keen to benefit from greater clarity and understanding of the intangible asset drivers of their business, in preparation for embarking on a policy of disclosures, as and when they see fit.

Following on from this is the innovation angle, whereby an increased engagement with the underlying intangible assets that drive business growth is likely to encourage more investment in additional intangibles that further support innovation and value creation, acting as economic propellant to the business.

A logical extension of these benefits is that better informed executive management, leading more innovative companies, with more transparent reporting of their entire corporate asset base, will tend to attract more potential investors, partners and opportunities for deal-making.  For many enterprises, a major investment or exit opportunity is a key objective, all of which require enterprise valuation to be conducted.  In these instances, both overall business valuation and intangible asset valuation can be positively influenced by a history of voluntary IA disclosures, supported by explanatory notes and clearly communicated assumptions underpinning value estimates.  Recent research focused on the impact of IA disclosures on deals transacted in the US between 2002 and 2011 suggests that a significant positive effect exists, especially where separately identifiable intangible assets and information about their amortization are included.1

In our view, the potential benefits of a carefully articulated set of voluntary IA disclosures can benefit the entire ecosystem of corporate stakeholders, and by extension can support improved economic performance across numerous industry sectors.  We are not alone in this viewpoint, and the combined efforts of many stakeholders around the world from accounting standards boards to investors, dedicated to finding the right balance between the issues involved, suggest that a broader requirement for IA disclosures is likely to materialize in future.

Around the world, efforts have been underway to address the issue of IA disclosures to varying degrees.  In the US, the Securities and Exchange Commission (SEC) made provisions for disclosures of the importance to the business of patents, trademarks, licenses, franchises and concessions held by a company that lists, the EU has a set of MERITUM guidelines that provide a framework for preparation of an Intellectual Capital Report, while Danish accounting law requires companies with significant IA to report on them, often with external auditor verification.  A recent UK Financial Reporting Council (FRC) discussion paper published in 2019 precisely highlighted multi-stakeholder support for improvements in the reporting frameworks around IA in relation to both their nature and value.

At this time of uncertainty we are all having to navigate, now may be a wise moment to reconsider the business as usual operations within your own organisation, and review the importance of IA to your business to emerge wiser and better-positioned to implement IA strategy and incorporate disclosures in your own financial reporting as part of the new normal of economic recovery.

As part of IPOS continued work in this area, we will be conducting a series of webinars on IA disclosure and valuation, which we invite interested parties to join.  The upcoming webinar is on “Why Valuing Intangible Assets Matters in the New Normal" held in conjunction with our IP Week. More details can be found here.

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1 “The usefulness of intangible assets’ disclosures for financial analysts. Insights from Purchase Price Allocation conditional on deal quality.” Anne Jeny, Luc Paugam, Pierre Astolfi, Comptabilité - Contrôlée - Audit, 2019/2 (French).

Posted on: 12 August 2020
James Cheah
James Cheah
IP Strategist