Closing the financial reporting gap

Physical assets are no longer the mainstay of transactional and stored economic value for many organisations. Businesses are increasingly investing into and benefiting from a range of intangibles including technology, branding, research and development (R&D) and intellectual property. 

International Financial Reporting Standards (IFRS) have not kept pace with the rapid growth in organisational value represented by intangibles. IAS 38 Intangible Assets (IAS 38) was issued more than 20 years ago and, since then, minimal changes have been made to the definition, recognition criteria, measurement, presentation and disclosure requirements for intangible assets. 

There is broad consensus among preparers, auditors, valuers, regulators and users of financial statements that the current requirements would benefit from a review.

Upon taking up his role as chair of the International Accounting Standards Board (IASB), Andreas Barckow acknowledged, “the rise of self-generated intellectual property and its non-addressal in the accounts” as one of the challenges for the IASB.  

However, the inclusion of reliably measured information on intangibles that meet the IFRS asset definition and recognition criteria is no easy task. 

Clear definitions

To better understand the impact of intangibles on an organisation’s economic value, a distinction needs to be drawn between intangible “items” that do not meet the definition of an asset (e.g., corporate culture, employees, customer loyalty) and intangible “assets” (e.g., brand, R&D, technology).

The market places importance on information relating to both types of intangible value created and held by an organisation. However, for the purposes of reliably identifying, measuring, recognising or disclosing such intangible value, costs incurred in respect of intangible assets are likely to be more readily identifiable than costs relating to intangible items that are not assets.

Although the costs incurred in developing intangible assets might be separately identifiable, such costs may not always meet the IFRS asset recognition criteria as currently specified.

For example, a company’s expenditure on R&D may not always be expected to come to fruition in the form of future economic benefit, undermining the ability to consider such expenditure as an “asset.”

Standard-setters respond

While accounting challenges remain, standard-setters have now begun responding to the call to provide better information on intangibles in financial statements.

The Australian Accounting Standards Board (AASB) has published a research staff paper, Intangible Assets: Reducing the Financial Statements Information Gap through Improved Disclosures, which explores how disclosures could play a part in improved information on intangible assets.

The paper notes that, although IAS 38 (AASB 138 is the Australian equivalent) encourages some minimal voluntary disclosures about significant unrecognised intangible assets (IAS 38, para 128(b)), this is not widely adopted in practice. 

Reasons for the lack of uptake could include concerns about the challenges and costs associated with the audit of disclosed information and a potential loss of competitive advantage through disclosing proprietary or commercially sensitive information. 

Rather than immediately tackling the more difficult challenge of recognising internally generated intangible assets on the balance sheet or waiting until those challenges can be met, the paper puts forward the idea that the current perceived information gap around intangibles could be, at least in part, addressed through specified disclosures about unrecognised internally generated intangible assets. Such disclosures should be underpinned by: 

• a principle that intangible asset disclosures should focus on those significant internally generated intangible assets that play a key role in pursuing the entity’s objectives; and
• a disclosure objective that any information provided enables users to assess the current and expected future financial impact on the entity and management’s stewardship of those disclosed intangible assets controlled by the entity. 

The paper also suggests that consideration should be given to disclosing a range of factors for each significant unrecognised internally generated intangible asset, including the reason it is considered to play a key role for the organisation, any legal considerations or restrictions, its useful life and a range of financial and non-financial factors.

Phased approach 

While there are costs associated with incorporating more information on intangible assets into financial statements, the benefits to investors and other users of such information should not be ignored.   

Following a recent agenda consultation to establish the program of works for the next five years, the IASB has decided to include a research project to comprehensively review IAS 38.

In pursuing this project, the IASB staff is proposing a staged approach and, similar to the focus of the AASB staff paper, a focus on enhanced disclosure requirements could be the first stage of that project.

Further stages in the IASB project could also include a review of the scope of IAS 38 and a review of the definition, recognition and measurement of intangible assets.

The AASB is also expected to initiate a research project on the topic, as noted in its recent agenda consultation. The AASB is expected to deliberate this topic during 2022, with a view to including an intangible assets research project into its 2022-2026 program of works.

While the focus of the IASB and AASB projects is on the reporting of intangible assets in financial statements, the interaction between these projects and the development of sustainability reporting standards by the International Sustainability Standards Board (ISSB) needs to be kept in mind.

Given that the focus of the ISSB’s work is on the reporting of sustainability related risks and opportunities that affect Enterprise Value – or the sum of the value of the entity’s equity (market capitalisation) and the value of the entity’s net debt – there will be an overlap between the disclosure of information on intangible assets in financial statements and the reporting of information about intangibles in the context of the sustainability of the entity’s business.