VideoIntangible assets are at the core of what we do," says Steve Ruffini, CFO of HIT Entertainment. "Our business is owning and managing intellectual property."
But as anyone who has observed the growing gap between the market and book values of knowledge-intensive companies will testify, getting an idea of the real value of HIT's business isn't easy. Poring over the balance sheets of the small London-listed children's entertainment company certainly won't help.
The frustration now is that even after new international financial reporting standards (IFRS) go into effect next year, HIT's financial statements still won't be able to convey the value of its biggest assets—the brand ownership of Bob the Builder, Barney the Dinosaur, Angelina Ballerina and a host of other characters popular among pre-school children around the world.
HIT's situation is by no means unique. Increasingly, intangibles—ranging from intellectual property and brands to licences and R&D pipelines—dwarf the tangible book assets of all sorts of companies in all sorts of industries. That's left many CFOs in a bind. Most finance chiefs agree that the new accounting standards will not help them supply the depth and breadth of information that the investor community is clamouring for.
Reporting above and beyond the book assets appearing in financial statements "should be a critical exercise for every company wholly or partly dependent on intangibles for its value creation," says Marie-Ange Andrieux, a partner at accounting firm Mazars in Paris. CFOs should be "at the forefront of this process, using their skills in measurement and control to provide additional information to the financial markets to allow them to judge companies more precisely."
But can finance chiefs rise to the challenge to bring intangibles into sharper focus? The jury is out, amid plenty of debate within finance circles on how—and even whether—it can be done.
One thing is for sure, the debate will heat up soon. Starting next year, new rules on accounting for business combinations from the International Accounting Standards Board (IASB) will bring the issue of intangibles reporting to the fore. According to Stuart Whitwell, a partner at Intangible Business, a London-based consultancy, the proposed standards "will focus the minds of management, forcing them to manage brands and other intangibles as they would manage any other type of asset."
On the evidence of the exposure draft and subsequent announcements, the IASB's line of thinking is very similar to two US standards approved in 2001—FAS 141 on business combinations and FAS 142 on goodwill and other intangible assets. As in the US standards, there are three changes under discussion—the abolition of merger accounting, otherwise known as pooling of interests; the non-amortisation of goodwill; and a new impairment test for goodwill and other intangible assets. The latest word from the IASB is that the new standards— revising IAS 22 on business combinations, IAS 36 on asset impairment and IAS 38 on intangible assets—will be in place by the end of the first quarter 2004.
Among CFOs the reaction has been mixed. One of the three changes in particular—the impairment test—is drawing a lot of fire. As far as Kurt Bock, CFO of BASF, the German chemicals giant, is concerned, the tests promise to be "a very cumbersome and laborious process."
If the IASB has its way, companies will have to undertake impairment tests at least once a year. First, all goodwill and intangibles with an indefinite useful life acquired in an acquisition must be allocated to a company's smallest individual cash-generating unit—which is something that most companies are not accustomed to doing. The fair value of the reporting unit must then be calculated and compared to its book value. If the fair value is less than the book, the fair value of each of the assets and liabilities of the reporting unit must be calculated, including internally-generated intangible assets that are not recorded on the balance sheet and therefore may never have been valued before.
This doesn't sit well with Bock. "How is it possible to value intangibles in a consistent way across companies and countries, and in a way that a third party can claim is a due process and really works correctly?" Bock asks. "The lack of a theoretical foundation cannot be overcome—it exposes accounting to a grey area of guesswork and speculation, and that's probably the last thing we need right now." For the time being, Bock says BASF, which carried around €3.5 billion of intangibles on its balance sheet as of December last year—or around 10% of the firm's total asset base—is content not to capitalise anything "unless we really have to."
Ruffini of HIT shares Bock's concerns—to a point. HIT, currently reporting under UK GAAP, is "saddled with taking a goodwill charge, which our US competitors don't have in their earnings per share," he says.
Yet, what's troubling Ruffini is that the new IFRS standards still won't enable companies to capitalise the costs of creating and developing their own intangible assets in the same way that they do with home-grown tangible assets such as software. The new rules alone, he concludes, aren't able to provide the "full picture" of how a company is creating value from its intangibles.
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