Mental Arithmetic: Most Elements of a Business's Intellectual Capital Don't Find Their Way on to Its Balance Sheet, but the Lack of a Standard Evaluation Method Shouldn't Prevent Companies from Trying to Gauge Their Worth. Tony Wall Reports on Research into How Firms in Ireland Are Measuring Their Intangibles. (Finance Intellectual Capital)
Wall, Tony, Financial Management (UK)
Financial accounting professionals have spent the past decade debating how companies should report their intellectual capital (IC). Some people argue that many more of these intangible assets--beyond those associated with intellectual property such as patents--should appear on the balance sheet, because without them shareholders aren't aware of all the elements that contribute to the overall market value of their company.
The main argument against their inclusion is that no universally acceptable method of measuring them has yet been determined. Until such an agreement is reached, these assets--generally categorised as human capital, customer capital or organisational capital (see panel 1, below)--could appear at randomly selected valuations, thereby distorting the picture for investors.
Other people see the debate as far too narrow and feel that a lot of work can be done on the strategic management of IC to increase the value of any company.
IC therefore cannot be ignored and, while financial accountants may have to wait for regulatory guidance before these assets can appear on the balance sheet, it doesn't mean that the annual report can't be used as a medium for communicating how an organisation's IC is adding value. In Scandinavia--particularly Sweden--shareholders already receive a great deal of information about IC, although the reporting of such assets is more piecemeal in the rest of the developed world.
In order to gather the relevant information, financial accountants will have to rely on management accountants to capture, measure and value these assets, and to monitor any changes on a yearly basis. This, of course, will require a robust accounting system. Although several generic frameworks for this exist, the suggested measurements will have to be adjusted to fit an organisation's particular circumstances. Proxy measurements are seen as better than no measurements at all, and there are many that can be made--for example, tracking your company's investment in training and seeing whether employee turnover decreases or productivity increases as a result of that training.
In order to see how companies in Ireland (both Northern Ireland and the Republic) have been dealing with IC, the University of Ulster conducted a survey last year. Its main aim was to see what stage they had reached when it came to measuring IC. A mixture of traditional manufacturing firms and new-economy companies--ie, those in telecoms, software ere--were used for the survey.
Part of the questionnaire asked the companies to rank certain elements of IC in order of importance (see panel 2, opposite page). It's notable that the three most highly ranked elements represented each of the three categories of IC. These were software (organisational capital), customer satisfaction (customer capital) and workforce expertise (human capital).
The questionnaire also attempted to determine which elements of the three categories of IC were already being measured. The most measured elements of human capital were concerned with employee loyalty--ie, length of service and staff turnover, which were both measured by more than two-thirds of the respondents. Perhaps surprisingly, the next most popular measure concerned the number of employees with professional qualifications. Although this might seem less crucial than other elements, the large proportion of respondents measuring it is probably explained by the simple fact that the information is easy to find.
Two elements that were measured by a surprisingly small number of companies were value added per employee and new ideas generated. The first finding can possibly be explained by the problems of developing an accurate method beyond simple ratio measurements such as turnover divided by the number of employees. On the other hand, there is nothing new about staff suggestion schemes. You would assume that, if a company were to have such a scheme, it would assess how well it was working. …