Finance: Taking intellectual capital into account

Why are accountants failing to take into consideration the value of intangible assets? By Paul Gosling

The accounting profession is failing to recognise the importance of intellectual capital - or the need to value intangible assets to provide a true valuation of a company, - according to a newly published book, Measuring the Value of Knowledge by David Skyrme.

Skyrme points to the widening gap between companies, book values and their share values. He quotes Microsoft's share price rising to 14 times its book value, and Glaxo Wellcome having a market value of pounds 40bn, of which only pounds 1bn represents tangible assets. While the British Technology Group was losing pounds 4m on a turnover of pounds 40m it had a share value of pounds 1.2bn, because of its ownership of 3,000 highly regarded patents.

One of the most worrying developments, suggests Skyrme, is the inconsistency of auditors in their treatment of intellectual assets. Grand Metropolitan's accounts show a valuation for the acquired Burger King brand, yet McDonald's more profitable brand shows no value in its accounts. It is peculiar, he implies, that only brands that have been purchased are usually given a value in the balance sheet.

Canada's accountancy profession is treating valuation of intellectual assets as an important issue but it is not a priority in Britain, despite the increasing globalisation of the capital markets.

The issue is of growing importance because of the increasing significance of knowledge industries, at the expense of traditional manufacturing. Booming share prices have occurred in biotechnology and software companies, whose real value is represented by their patents and copyright and the skills and knowledge of employees, not by their fixed assets.

Nestle's acquisition of Rowntree's in 1993 raised questions, as the $4bn purchase price was twice the value placed by most city analysts, reflecting the higher valuation Nestle gave to various Rowntree brands.

Skandia, the Scandinavian financial services company, is praised by Skyrme, not just for undergoing a fundamental corporate re-engineering to make its intangible assets work harder, but also for producing annual reports on its intellectual assets in parallel with its financial reports. Skyrme argues that this has given shareholders a more transparent view of Skandia's real worth, and encouraged the company to focus on its wealth- generating activities, leading to its jumping from 300th to No three in its world market sector within five years.

But many accountants in Britain believe that existing practices are adequate. Ken Wild, director of the National Accounting and Auditing Department at Deloitte & Touche, says: "The role of the accounts and the accountant is to give good information on what has happened to the company. The value of the company is all about the future, and the accounts are all about the past. Otherwise it is about judgement. We have reservations about doing the job of analysts. There is a feeling, not just among accountants but in the market as well, that it is not our job."

One concern of Wild and others is that if auditors move into the field of valuing intangible assets they will find it difficult to do so objectively. He points out that while it might be possible to provide a market value for airline slots which could be sold, it would be almost impossible to place a value on an unused brand such as Strand cigarettes. The radical solution offered by Mr Skyrme is to create an exchange in intellectual property, modelled on the commodity exchanges.

Another problem highlighted by Wild is that intangible assets can become worthless overnight. Staff die or leave, and consumer demands may change. A major change in accounting practices might overcome the problem of under- valuing companies compared with share prices, but lead instead to many becoming over-valued.

Allan Cook, technical director of the Accounting Standards Board, says it is true that there is more concern in the US than in Britain about accounting for intellectual capital, but he suggests that this mostly due to differences in tax rules.

From the current financial year, under FRS10, intangible assets can be treated the same as goodwill in British company accounts.

The ASB did consider going further - by disclosing revenue investment on research and development, training and advertising - and consulted on this, but, Cook says: "the more we looked at it the more difficult it was".

Kenny Shobelle is director of intellectual property at Ernst & Young. He believes it is easier to account for intellectual property (such as brands, patents and copyright) which has a discernible market value, than for softer intellectual assets (such as employees' knowledge) that cannot always be valued separately. He says: "I think that all intellectual property should be on the balance sheet. You carry more of a risk of volatility of the balance sheet... but you should allow the reader to have the information. The downside is that by disclosing how you value your intellectual property, you may reduce its value by disclosing confidential information."

Suggested solutions on measuring and valuing intellectual capital have been made by the US academics Abdolmohammadi, Greenlay and Poole, who suggest that valuations can be based on projected returns on assets; by writing in as intellectual capital the difference between tangible assets valuation and share price; or by value of each patent, brand and other component element.

It is a safe bet that this is an issue that is not going to fade away.

`Measuring the Value of Knowledge', by David Skyrme, is published by Business Intelligence. `Accounting Methods for Measuring Intellectual Capital' by Abdolmohammadi, Greenlay and Poole can be obtained on the World Wide Web: www.round.table.com/ scholars/ articles/acctg-intellectual- capital.html