A new report from the CFA Institute Research and Policy Center, Investor Perspectives: Intangible Assets, calls for accounting standard-setters to pursue a disclosure-first approach to make progress on the recognition of, and accounting for, intangible assets – one of the longest-standing, and increasingly important, debates in financial reporting.
Investments in intangible assets, as measured in GDP statistics, have eclipsed investments in tangible assets in developed markets, the association writes, adding that there have been significant increases in price-to-book ratios of major equity indices, partially as a result of unrecognised intangible assets.
The largest companies globally now tend to be intangible-intensive, and companies receiving venture-capital financing or going public via IPOs also tend to be weighted toward intangible-intensive sectors, the association says.
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are broadly re-examining accounting for intangible assets. Under current accounting rules, intangible assets (e.g., patents, brands, software, etc.) acquired in a business combination are often capitalised as assets, while the costs associated with intangible assets generated internally by a company are expensed as incurred. Beyond the lack of recognition, minimal disclosures are required – or voluntarily provided – for intangible assets, often leaving investors in the dark regarding the nature of these significant investments.
Matthew P. Winters, CFA, Senior Director, Global Advocacy, CFA Institute says: “In the current environment, where the prevailing mood tends toward fewer, not more disclosures, the debate around the accounting of intangibles is controversial, despite clear evidence that financial statements are missing important assets. Consider Apple Inc, which presents no intangible assets on its balance sheet and just three sentences on its research and development activities in the footnotes; however, the financial statements include extensive disclosure on its cash and marketable securities. All perfectly compliant, but not decision-useful to investors.
“Many of the stakeholders – mostly investors – who try to solve this conundrum want broader capitalisation of intangibles to properly reflect companies’ sources of value on balance sheets and to treat intangibles more consistently with tangible assets. However, others disagree. They believe that capitalisation would not provide more useful information than expensing, and that the conservatism and uniformity of the current rules are good things. Opponents also argue that granting companies more flexibility in capitalisation could have the perverse effect of greater earnings management.
“To move the debate out of the cul-de-sac and to inform the FASB and IASB with investors’ views, we surveyed our membership of predominantly portfolio managers and financial analysts regarding how the accounting for intangibles could be improved. More than 80 per cent of responding investment professionals want better disclosures and more disaggregation of investments in intangibles across financial statements.”
Key takeaways:
Intangibles are valuable: The existing accounting model does not recognise that value
More than 70 per cent of respondents agreed that for many companies: a) the most valuable assets do not appear on the balance sheet, b) the accounting model does not, but should, recognise important intangibles, and c) the unrecognised intangible assets are a significant driver of the difference observed between the book and market values of equity for many listed companies.
Greatest unmet needs: Improved disclosures and more detailed disaggregation – Only 39 per cent of respondents found current intangible disclosures useful. The greatest level of agreement (more than 80 per cent) in our survey was for better disclosures and for more disaggregation of investments in intangibles across the financial statements.
Investors Strongly Support a Variety of Disclosure Improvements – Investors broadly agreed with a menu of disclosure improvements – with most receiving greater than 80 percent support. Respondents saw improving disclosures as a path forward to achieving better valuation, measurement, and ultimately recognition of such intangibles.
Investors support existing accounting for acquired intangibles, improvements needed to impairment testing – More than 70 per cent of respondents agreed with continuing to separately recognise identifiable intangibles in an acquisition but a similar proportion of respondents expressed concerns with the transparency and timeliness of impairment testing.
Majority support for recognising internally generated intangibles but expressed caution – Many survey respondents want internally generated, identifiable intangibles recognised on the balance sheet. A significant plurality disagrees, however, seeing the potential for earnings management and believing that deferred recognition may not provide any more useful information than expensing. Comments suggest that this potential for earnings management stems from a lack of transparency regarding the investment in intangibles.
If internally generated intangibles are recognised, no clear consensus on initial measurement: cost vs. fair value – Nearly equal numbers of respondents supported cost and fair value models for measuring internally generated intangible assets, if they were to be recognised on the balance sheet.
Growing risk to relevance of financial, but no strong appetite for radical change – Investors see the financial statements as at risk of losing their relevance without action by the FASB and IASB on intangibles, but they do not have a strong appetite for radical change such as an entirely new balance sheet that shows the fair value of acquired or created intangibles.
Sandra J. Peters, CFA, Senior Head, Global Advocacy, CFA Institute says: “The central message emerging from our work is that improved disclosures and better disaggregation are necessary to understand the investments made in the creation of intangible assets before considering their recognition on financial statements.
“When we look back at standard-setting over the last thirty years, disclosures are what led the way to productive conversations and finally to recognition for stock-based compensation, fair value accounting, and pension measurement. Without more information, investors do not have insight into the specific intangible assets they know exist, and standard-setters lack insight on how to best approach changes to recognition. Without better disclosures, neither investors nor standard-setters can properly define and scope the issue they are trying to solve.”
