Recently, while browing through the financial article, we noticed one interesting article from www.investopedia.com relating to intangible assets. We have extracted some paragraphs as below:
"Any business professor will tell you that the value of companies has
been shifting markedly from tangible assets, "bricks and mortar", to
intangible assets like intellectual capital. These invisible assets are
the key drivers of shareholder value in the knowledge economy, but
accounting rules do not acknowledge this shift in the valuation of
companies. Statements prepared under generally accepted accounting
principles do not record these assets. Left in the dark, investors must
rely largely on guesswork to judge the accuracy of a company's value.
But although companies' percentage of intangible assets has increased,
accounting rules have not kept pace. For instance, if the R&D
efforts of a pharmaceuticals company create a new drug that passes
clinical trials, the value of that development is not found in the
financial statements. It doesn't show up until sales are actually made,
which could be several years down the road. Or consider the value of an
e-commerce retailer. Arguably, almost all of its value comes from
software development, copyrights and its user base. While the market
reacts immediately to clinical trial results or online retailers'
customer churn, these assets slip through financial statements.
As a result, there is a serious disconnect between what happens in
capital markets and what accounting systems reflect. Accounting value is
based on the historical costs of equipment and inventory, whereas
market value comes from expectations about a company's future cash flow,
which comes in large part from intangibles such as R&D efforts,
patents and good ol' workforce "know-how". "
Our audit client may have invested research & development costs,
payroll costs in developing intangible assets, e.g. new drugs, software,
new machines. The invention may subsequently lead the Company to apply
for patents, which is essentially the intangible assets of the Company.
According to IFRS, internally generated goodwill should not be
recognised on the balance sheet of the Company. Some of the readers may
wonder why this asset should not be recognised on the balance sheet of
the Company.
Let us answer this question by giving you a scenario by assuming
intangible assets can be recognised. The Company would capitalise the
costs incurred as an intangible assets, i.e.
Dr. Intangible Assets
Cr. Costs (i.e. R&D costs, payroll costs)
By capitalising the intangible assets, the Company will be able to
reduce the costs and increase the profitability. There's a incentive for
certain Company to capitalise intangible assets as much as possible, in
order to reduce the costs incurred, even for certain costs that may not
yiled economic benefits to the Company.
Sometimes, it is hard to measure the real economic benefit of an
intangible assets. A Company should not recognise intangible assets if
it is not econmical benificial to the Company. This is the issue with
the recognition. Also, for the measurement, how should intangible assets
be measured. Some might argue that, it should be the full amount of
costs incurred. However, what if the full amonut of costs is not 100%
beneficial to the Company? Do we still recognise the full amount?
It will be a challenge for the accountant, auditor, and even general
invenstor to understand the nature or amount of the intangible assets
being recognised on the balance sheet. Hence, in order to protect
financial statement user, self generated intangible assets should not be
recognised. However, this amount can be disclosed in the financial
statement for financial statement user to understand the Company better.