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Despite the perception of a greater emphasis on the intangible elements of the business, accounting systems continue to provide only minimal information about the amount and types of expenditure on intangibles, states ‘Accounting for expenditure on intangibles,’ by Laurie C. Hunter, Elizabeth Webster, and Anne Wyatt (http://ssrn.com).
Surveying more than 600 senior accountants from large Australian listed companies, unlisted companies and not-for profits, the authors find that many firms do not separate out expenditure on intangibles in a format that would enable the estimation of rates of return from the expenditure. While this seems surprising in the era of sophisticated management information systems, the systems are only as good as the knowledge informing the systems, they underline.
After analysing the economic properties and accounting features of intangibles, the authors are of the view that the first-order issue for moving forward is to learn how to identify and classify the different types of expenditure on intangibles, using a scheme with a strategic focus rather than a product cost/operating cost focus. While the ‘capitalisation decision’ for expenditure on intangibles is an important part of the process of reporting externally on intangibles, it is a second-order factor, they note.
Rules of thumb
Reminding that capitalisation decisions rely on the accountants’ understanding of whether the probability of realising the expected future benefits from investment is greater than 50 per cent, the authors observe that to make this probability assessment, we need an understanding of the classifications of expenditure on intangibles most likely to generate future benefits. “More specifically, we need an understanding of how the different classifications relate to the firm’s final output. One piece of information that can be used to illuminate this latter relation is rates of return to the different classifications of expenditure on intangibles from the past periods.”
What can be a worrying finding of the study is that many firms tend not to separately collect information on intangibles in systematic ways; and that this type of information is available in only a limited way for managerial decision-making in many firms, despite the fact that the firms obviously do account for all monetary inflows and outflows. “Management tend to use rules of thumb and not rigorous quantitative analysis for their decisions relating to the firm’s amount and types of expenditure on intangibles.
If intangible investment is important for generating future revenues then managerial decisions about spending on intangibles are likely to be sub-optimal.”
Technology transitions
The paper cites studies that trace how a major focus of GAAP (Generally Accepted Accounting Principles) from early times has been ‘physical plant and equipment’ because physical assets such as printing press and steam trains were the key assets arising from early technological innovation (Dudley, 1999). And how, by contrast, technological innovation has moved from early mechanisation, steam engines and railways, electrical and heavy engineering, and Fordist mass production, on to information, communication technology and biotechnology including the genome, space, satellites, and environmental technologies (Dodgson and Marceau, 2000). “Growth of these major technology areas and the transitions from one major technology paradigm to another are accompanied by substantial business change (Freeman and Perez, 1988).”
The paper concludes by recommending that, by making it possible to compute rates of return, managers will be able to methodically evaluate investment, and compare realised returns to original expectations, in order to determine why an investment under- or out-performs expectations. Also, “Systematic treatment of expenditure on intangibles that also involves external reporting, would serve governance and efficiency functions by improving the transparency of the firms’ management of contributed resources,” as the authors opine.
Useful research about a topic of critical importance to accounting professionals.
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