Assets and financing are two sides of the balance sheet representing the same information about the financial position of the company. The asset side represents the aspects upon which a company or a corporation capitalizes. These are the aspects which belong to a company. The financing side represents the ways through which the assets have been financed. The assets can either be financed through liabilities or through equity.
There can be several ways to categorize assets of a company. One way is to classify them as current or non-current assets depending upon their maturity and presence in the company. Another way to classify the assets is by considering the tangibility aspects. Tangible assets or touch assets are those which can be physically touched or tracked. These represent the core capitalization of a company. These are the assets which have a physical form (Investopedia, 2011).
Intangible assets are those which do not have a physical form. It is an asset which is not physical in nature (Investopedia, 2011). It actually can be classified as a claim to future benefits which does not have a physical form. Examples of Intangible assets include patents, copyrights, goodwill, brand names and unique organization infrastructures (Helen H Kang, Sidney J Gray, & Professor Sidney J Gray, 2006). These are called intangible assets because these cannot be physically touched or felt.
The way to record the intangible assets has evolved over time since various practices for recording them have evolved over time as investors and creditors have kept on demanding a clearer representation of the financial status of the target companies (Helen H Kang, Sidney J Gray, & Professor Sidney J Gray, 2006). Therefore, the financial aspects of the companies must be properly mentioned and justified in order to be presentable and financially palatable.
However, the isolation of intangible assets is often confused and many beginners feel that it is really difficult to isolate the intangible assets from each other. In other words, they feel that it is difficult to assign absolute value to each and every in tangible asset. The International Accounting Standards define the intangible assets by telling that these are the assets which have their own identity and are completely separable. It is possible to isolate it completely from the entity sold, transferred, licensed, rented or exchanged either individually or through a contract. It is an identifiable non-monetary asset without any physical substance (Exposure Draft GN 16: Valuation of Intangible Assets for IFRS Reporting Purposes, 2009).
It is important to note that to meet the definition of an intangible asset, the following criterion must be met (Standards, 2007):
- These assets should be identifiable. This means that these should be separate from the entity and from contractual as well as legal rights.
- These assets should be controlled by the entity.
- There should be a proper existence of future economic benefits arising from these assets.
The above conditions also prove that these assets are identifiable and separate from the entity. The AASB 138 is an Australian Equivalent International Financial Reporting Standard (AIFRS) applicable to the financial years beginning on or after January 2005. No standard other than this one deals with the intangible assets in a better way. It also covers some of the general principles covered in Statement of Accounting Concepts (SAC) (ACT AIFRS Policy Summary AASB 138, 2004). This new system also admits and recognizes the intangible assets as those having separate identity and existence isolative from the entity (Standards, 2007). This new standard defines the intangible assets as the non-monetary ones which have no physical existence (ACT AIFRS Policy Summary AASB 138, 2004).
The new rules are different from the previous ones because these regard the intangible assets in a different fashion and also provide a different accounting treatment to these assets. The primary assets of concern for this project (Michael West, 2004) are:
- Brand Names
- License Agreements
- Management Rights
The accounting treatment for the intangible assets according to the newer rules is as follows. The AASB 138 does not allow the internally recognizes assets such as brand names, license agreements and management rights to be recognized. An intangible assets arising from research and development shall be recognized if specific conditions can be demonstrated (Standards, 2007). This means that such intangible assets cannot be shown on the balance sheet just like the tangible ones and if a company is doing so, it will have to lay these assets off the balance sheet to adopt according to the newer standards. According to the new rules, the internally generated goodwill cannot be categorized as an asset. This cannot be done as it is not an identifiable source controlled and measured reliably by the entity. Tangible assets have an identifiable source and can be controlled reliably by the business entities. On the other hand, these assets do not have one. AASB 138 specifies that an intangible asset should be identifiable and separable from the entity. Goodwill is such an asset which can neither be recognized nor be separated from the entity. In other words, this so called asset does not have its own recognition or existence. It is only there because the business exists. Cutting short, it derives its value from that of the company. Therefore, it cannot be categorized as an asset.
The new system prescribes the following treatment for the intangible assets:
- Intangible assets which arise from a combination of different businesses should be recognized at their fair value at the date on which the acquisition took place irrespective of whether the assets had been recognized by the acquired before the business combination. Those assets which can be identified and isolated i.e. are separable need not to be valued isolative. It also prescribes that if an intangible asset is identified as a result of a business combination, then sufficient information will exist for the fair value of the intangible asset to measure it reliably.
- The new standard specifies that the estimates made about the value of the intangible assets result in a range of different possible outcomes of fair value. It is important to note that just because a precise value is difficult to calculate, the fair value practices should not be abandoned and the intangible value should be specified at the fair value.
- It has been specified that the inputs of valuation which have to be used in different valuation approaches should clearly reflect those which would be made by market participants and not someone else.
The different constituents and parties related to the effects of this new regulation would certainly not welcome this new move of accounting law. This is because it would result in the laying of immense value which otherwise was a crucial component of the balance sheet of companies. This move would be opposed highly by those companies which rely a lot upon the intangible assets e.g. the software companies, the technology companies, the management companies, contract research organizations and many others (Prof. Günter R. Koch, Dr. Karl-Heinz Leitner, & Dr. Manfred Bornemann, 2000). Companies will have to face an inability to pay the dividends in the coming few years (Michael West, 2004). This might result in a disturbance in the stock market as the investors might become pessimist about the financial strength of different companies. It is also important to note that this new enforcement will affect different companies in different ways. As mentioned above, the technology reliant and the management companies will have to face lots of problems because of this new law. However, those companies which do not really rely upon the intangible assets might not even worry about the new law. This is because such a new move would not affect their financial position as bad as that of a company which relies a lot upon the intangible assets. This might also raise new disturbances in the market as different companies would welcome it in different ways.
In my view, the Australian should not resist against this new move because of the following reasons.
- This is a practice which is meant for every company. It is not aimed towards a particular sector or a particular industry. Therefore, every company will have to face a lay off and a decrease in the overall value. Although the knowledge based companies will have to bear greater losses, an in equality across rules cannot be implemented countrywide.
- Although such a layoff would decrease the overall value of the company, it would also increase the profitability as explained earlier.
- It is totally true that such a practice will also decrease the dividend paying ability of the companies (Michael West, 2004), it is also important to note that this disability of the companies would not continue in the future. Companies would start adjusting themselves according to the newer practices within a few years. This layoff in value would only be for one or a few more years. With the passage of time, companies will learn how to keep ties with this new system.
- Such a step would be a big relief for the investors and the analysts. This is because it would become easier to compare the financial performance of Australian companies with companies in other countries. Thus, if a company has one franchise in Australia and the other franchise in the United Kingdom, it would become easier for the parent company to compare performance as the standards of accounting would match well.
- The layoff in value would also be a temporary problem. This problem would not really be observed as years pass because companies would start adjusting themselves according to the newer rules and procedures. The impact of aligning the Australian accounting practices with the international ones will be great in the future.
In my view, there is a trade off for the Australian companies between a compliance with the international standards or keeping financial pool stagnant and as it is. Multinational corporations and global companies are termed so because they are aimed at keeping operational, financial and strategic aspects at par with the international standards. Following the international standards no only creates ease for the companies but also for the investors and creditors as they are not misguided by the financials of a company across different companies (Helen H Kang, Sidney J Gray, & Professor Sidney J Gray, 2006). Such a mechanism also helps to get rid of market inefficiencies as true and fair information about the financial status of a company is readily available to the investors as well as the creditors. However, such compliance can prove to be financially bed for companies as a big layoff of value will be seen which would also decrease the asset capitalization of the company. This would result in a decrease in overall corporate value which would not be appreciated by investors or creditors.
It is important to note that such a layoff would increase the overall profitability of the companies. By assessing the different profitability ratios, it can be assessed that the formula for the return on assets is; Net Income / Total Assets. These total assets comprise both the tangible as well as the intangible assets in the Australian case. If the intangible assets are laid off, the denominator would lose its value and this would give a higher value of the profitability. Such a high profitability figure might also give way to new investors or creditors.
However, many experts are of the view that intangible assets are such an aspect which generates greater value than the tangible ones in the current knowledge based economies (J.B. Backhuijs, W.G.M. Holterman, R.S. Oudman, R.P.M. Overgoo, & S.M. Zijlstra, 1999). Removing such high value aspects off the balance sheet can misguide the investors and other stakeholders related to the different companies. This holds especially true for companies directly related to technology or other knowledge based industries.
Exposure Draft GN 16: Valuation of Intangible Assets for IFRS Reporting Purposes. (2009, January). INTERNATIONAL VALUATION STANDARDS COUNCIL
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