Traditionally, accountants have seen the whole in terms of "soft" stuff, which they find difficult to quantify. Accordingly, when one firm bought another one that owned a collection of household-name brands, the difference between the value of the target company's factories, plantand the like and the purchase price was seen as "goodwill".
However, this caused enough problems when the soft assets were confined largely to brands. For example, it became a little odd that brands gained a value when they were acquired but not when they were home-grown. Now that received opinion has it that the true value of companies such as Microsoft lies not so much in their brands as in the people who create them, the difficulties increase.
The issue is causing much soul-searching among members of the accountancy profession. A discussion paper issued earlier this month by the Institute of Chartered Accountants' financial reporting committee notes that the pressure for financial reporting to bridge the gap between the net assets of a business and the value of a business as a whole has been growing because the gap itself is widening and adds that - under existing financial reporting conventions - the cash spent on intellectual assets and brands has an adverse effect on reported financial performance.
"The benefits this expenditure will bring are considered too difficult to foresee, control and measure to allow any assets to be recorded.
"Consequently, there is no way of telling from a company's accounts whether pounds 1m spent on training or research expenditure has been a waste of money or money well spent," concludes the document - Financial Performance. Alternative Views of the Bottom Line. Absurd as this may seem, it is by no means the only issue worrying the committee.
In fact, Robert Hodgkinson, the Arthur Andersen partner who chairs it, believes that there is a danger that organisations such as the Accounting Standards Board have been concentrating on classification and presentation issues rather than on the main issue of establishing what exactly financial performance is and then exploring the implications for financial reporting. The paper - which is, Mr Hodgkinson stresses, designed to reflect a broad range of opinion from the managers, analysts and academics who joined the accountants on the committee - concludes by saying: "Reporting the numbers is not an end in itself but is the basis for clear communication, effective accountability, efficient capital allocation and improved performance."
In seeking to satisfy such aims, Mr Hodgkinson and his colleagues have put forward "six alternative views of the financial bottom line" - ranging from cash and historical cost to businesses at current value and market capitalisation.
Bearing in mind that the purpose of accounts is to communicate financial performance, they also look at how this can be conveyed. At one extreme is the "raw materials" approach, where investors are given various pieces of information and left to work out for themselves estimates of "underlying financial performance". At the other is the "ready made" method where managers simply report their own estimates of how the business is performing.
The reporting committee noted weaknesses in each and goes on to propose what it calls a "twin-track" approach, on the basis that nearly all users are given an overall view of what management has achieved. The benefits of this approach are:
n All users - rather than just sophisticated investors - are given an opportunity to judge whether managers are delivering what they said they would.
n Analysts are still at liberty to perform their own calculations of a company's underlying financial performance
n It enables managers to carry out self-assessment exercises effectively while giving investors, through the markets, the final say.
n Financial performance is likely to be enhanced if management is encouraged to report on the full range of its activities using the bases adopted by investors.
The committee is not breaking new ground in proposing this sort of assessment.The ASB's Financial Reporting Standard 3 has established the notion of setting about this sort of reporting via the profit and loss account and the statement of total recognised gains and losses, which is mainly used to report gains and losses on fixed asset revaluations and foreign currency differences on retranslating the net assets of overseas subsidiaries.
But with the ASB expected to review the standard shortly, the committee believes the whole area is ripe for re-examination.
Among the principles it regards as necessary for study are the idea that - because the future is uncertain - financial performance cannot be reported as a matter of fact; that financial performance reporting should therefore have the twin aims of enabling investors to make their own assessments of underlying financial performance and encouraging managers to report on their own view of underlying financial performance; and that - to meet investors' needs and encourage management accountability - accountants need to accept that financial performance can and should be measured in a variety of complementary ways.
If that sounds like an attempt to allow plenty of room for manoeuvre, Mr Hodgkinson is unrepentant. Just as he and his colleagues have concluded that the ASB approach of having two statements has led to one being seen as more important than the other, so he is adamant that making the balance sheet similar to an inventory of various types of assets does not work either.
"That's a blind alley," he says, adding that it is up to businesses to experiment with presenting the bottom line as it is in their interests to improve the standard of their communications with investors.Reuse content