The Importance Of Intangible Assets

The Importance of Intangible Assets

Evaluation of Transitional Issues from a Canadian Standpoint

Contents

Topic Page

1. Executive Summary 3

2. Report

I. The Trade-off Between Relevance and Reliability 4

II. "Nothings" are Something to Consider 5

III. Current Practice in Canada 5

IV. The Challenge of Valuation 6

V. Analysis of Potential Improvements to Canadian Standards 7

* Issue One - Valuation

 Valuation and Business Combinations

 Solution to Valuation Issues

* Issue Two - Improved Transparency

 Recommendation for Improved Transparency

VI. Comparison of Canada, USA, and International Standards 9

 Goodwill and Initial Measurement

 Impairment Testing

 Intangible Assets Recognition

 Impairment Rules

 Amortization of Finite Lives Intangible Assets

 Impairment Testing of Indefinite Lives Intangible Assets

 Business Combination

3. Bibliography 14

Executive Summary

While intangible assets are proving to become more significant in their role in business today, the policies and practices used in accounting for them seems to fall short when it comes to representing the needs of users of the financial statements. Many significant intangible assets go unrecognized on financial statements due to the current accounting standards. Due to the importance of these intangibles to many companies, the identification of them would better satisfy the needs of financial statement users. However, a trade off between reliability and relevance exists when trying to account for certain intangible assets. Traditional accounting standards stressing reliable information may be too conservative when considering intangible assets. Conversely, recognizing intangible assets may provide relevant information to users, but prove to be unreliable when more information is available. However, given the less than perfect nature of valuation itself, companies should identify and recognize intangible assets when they play a significant role in the respective firms' business.

Current accounting policies also inhibit a lack of transparency with regards to the disclosure of information relating to recognizable intangible assets. Items such as asset value fluctuations can go hidden to the financial statement users, thus affecting their decision making abilities. Creating an allowance accounting against the balances of the intangibles would provide users with a more reliable representation of the asset as a whole.

Comparison of current Canadian standards with current U.S. and international standards on the accounting of intangible assets indicates the overall policies are very similar. Therefore the harmonizing of Canadian accounting standards with U.S. and international policies will still leave room for improvement with regards to recognition, valuation and disclosure of intangible assets.

Report

The Trade-off between Relevance and Reliability

In order for financial information to be useful it should possess two qualitative characteristics--relevance and reliability. Financial statements that are relevant provide users with information about a company's future economic prospects, such us future cash flows, dividends and short/long-term earnings feasibility. Reliable financial information is defined as information that is precise and free from bias. In pursuit of relevance the accounting profession has attempted to move toward fair value accounting or a "measurement perspective" to report for items such as pensions, debt and equity securities, and intangible assets. In order to maintain relevance and shift toward "fair value accounting" a company must use a great deal of estimates in arriving at an accurate picture of a firm's market value. These estimates, in turn, become subject to future revisions and adjustments that compromise reliability of financial data, to the point where the benefit of increased relevance is diminished. Due to the fact that relevance cannot be supported by reliability the accounting profession favours historical cost accounting, or an "information perspective". Under this perspective unrealized net increases in the firm's value are not recognized on the balance sheet, subsequently failing to produce relevant information about firm's current financial position. To this end, it is fair to conclude that without ideal economic conditions complete relevance and reliability in financial reporting cannot be jointly satisfied. In essence there is the trade off between the two; that is when one is attained at the higher level, the other is sacrificed.

"Nothings" are Something to Consider

Accounting for Self Developed Intangibles

In the past few decades accounting for intangibles has attracted a lot of attention due to accelerated changes in the way the business world operates. The technological revolution and in particular, the information age, has brought intangible resources to the forefront of the business environment. Traditional assets such as property, plant, equipment and working capital generally constitute a substantial portion of a company's value. In addition to the physical and technological categories, revenue streams of every enterprise are heavily dependant on internally generated intangible "nothing" assets such as: human capital, relationships with suppliers and distributors, employee competence, employee and customer loyalty, and brand names and brand recognition.

The aforementioned items are internally generated