How intangibles are used in the production of goods

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Intangible is a difficult term to define. One reason for the lack of consensus about a definition is that the elements of what could or should be regarded as intangibles depend on whether one is talking about accounting concepts or measures of national income and wealth or how to develop and manage the nonphysical inputs into a business.

For the purpose of this analysis, the task force has adopted the following broad definition: intangibles are nonphysical factors that contribute to, or are used in, the production of goods of the provision of services or that are expected to generate future productive benefits to the individuals or firms that control their use. (Intangible assets: value, measure and risk, J Hand and B Lev)

Financial reporting should provide information that is useful to present and potential investors and creditors in order to make rational investment and credit decisions.

Intangible factors play a predominant role in the ability of companies to innovate and their subsequent competitiveness within a knowledge-based economy. Such assets enable knowledge-intensive economies to maintain their competitive position compared to resource or labour-intensive economies.

Goodwill is often described as the corporate reputation of the acquired party.

Goodwill is often thought of as the value of the company's trade identity.

Goodwill is only valued when a business is sold and is therefore not valued for firms that have not been acquired.

There is a general consensus among managers that intangibles are important factors in company performance. (The economic importance of intangible assets)

In July 1998, the International Accounting Standards Committee (IASC) approved accounting rule that represent a step forward towards the recognition of some intangible assets in financial statements and provide a better understanding of investments in intangible assets.

Also in July 1998, after almost 10 years of debate, the International Accounting Standard Committee (IASC) approved a new International Accounting Standard, IAS 38, Intangible Assets. The IAS 38 follows two Exposure Drafts (E50, Intangible Assets, published in June 1995, and E60, Intangible Assets, published in August 1997) and a Draft Statement of Principles (published in January 1994). Its development was controversial and it raised significant emotional debates around the world, particularly on two issues - the recognition of internally generated intangible assets and the amortization of intangible assets.

The required disclosures on intangible assets under IAS 38 will enable users to understand the types of intangible assets that are recognised in the financial statements and the movement in their book values during the year. IAS 38 also requires disclosure of the amount of research and development expenditure recognised as an expense during the year. (1)

IAS 38 states that an intangible asset must be identifiable to distinguish it from goodwill. As stated in paragraph 12 of IAS 38, "an asset meets the indentifiability criterion in the definition of an intangible asset when it (a) is separable, i.e., is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or (b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations." (2)

It has been state that for many organisations the intangible assets e.g. organisational structure and employees' competences are more important than its tangible assets.

From a managerial point of view, the definitions and classification of intangible assets offer information on which intangible assets could be important. In other words, important components of intangible assets can be identified. It is also possible to consider the intangible assets as success factors that can be improved and also measured. (3)

Intangible Assets are all around the business world.

Intangible research has been relevant to management, because there is the awareness that persons, their knowledge and abilities are great importance for the competitive advantage of the organisation.

Markets assets consist in the potential that an organisation has due to intangibles related to the market that gives a competitive advantage like clients' loyalty, brands, distribution channel, contracts and advertisement. Assets centered on humans are composed by experience, creativity, solving problems ability, and leadership, entrepreneurship, and management skills such as psychometric data and to perform under great stress. Infrastructure assets are technology, methodologies, corporate culture, hedging, data cases, communication systems, etc. Intellectual property is know-how, trade secrets, trademarks, patents and design rights. (4)

One of the reasons intangible assets are o important is because they can be converted to tangible assets, ultimately generating revenue. (5)

With the introduction of IFRS (International Financial Reporting Standards) most of the intangibles are expensed on the income statement and hence they "disappear" from the balance sheet, while investments in tangible assets are capitalized.

Study finds that ISA 38 reduces the amount of intangible assets recognised on the balance sheet small and medium enterprises, whiles large firms do not appear to experience such large reductions in their intangible assets. The Small and Medium Enterprises largely depend on internal parts of growth and intangible assets that typically arise from internal growth strategies are eliminated from the balance sheet under IAS 38. Larger Firms are less exposed to such reductions in their intangibles assets, because they mostly follow external paths of growth and the treatment of those intangible assets that typically arise from external strategies required the impairment test.

Many companies are driven by the creation and use of intangible assets. They often 'interact with tangible and financial assets to create corporate value and economic growth" (Lev 2001)

However, most of them are expensed on the income statement and hence they "disappear" from the balance sheet, while investments in tangible assets are capitalised. "This asymmetric treatment of capitalizing (considering as assets) physical and financial investments while expensing intangible leads to biased and deficient reporting of firms' performance and value" (Lev, 2001).

The introduction of IAS/IFRS has a different impact on accounting and measurement of the intangible assets in the balance sheet: Some categories are expensed on the income statement, other are capitalised and some of them evaluated according to the impairment test.

According to the IAS 38, intangible assets are classified into specific and generic. The first ones are divided into finite and indefinite useful life. Only the specific assets can be valuated analytically, while the value of the generic ones is obtained as a difference between the prices paid for the acquired entity and the sum of the fair values of its specific assets (tangible and intangible). The Intangibles with indefinite useful life (e.g. goodwill) are valuated through the impairment test, which updates the accounting value of the assets to the fair value, if this one is lower than the carrying value. The impairment test does make the valuation process more subjective than the historical cost criteria with the consequent possibility of manipulating values.

When considering the implication of this different treatment of intangible categories in terms of growth strategies, most of the internally originated intangibles cannot be capitalised, while externally generated intangible assets are recognised in the balance sheet. This implies that alternative strategies of growth are reflected on the financial reporting and disclosure differently for the stakeholders of those companies that follow internal paths of growth.

The results of the IAS 38 application

IAS 38 is note neutral with respect to the strategies of growth in terms of intangible assets. The internal path of growth implies expensing most of the intangible investments on the income statement that are consequently excluded from the assets.

It is possible to appreciate a combined reducing and increasing effect of the intangibles due respectively to the capitalised costs expensed on the income statement and to intangible assets with indefinite useful life under the impairment test.

This different treatment is particularly significant for Small and Medium Enterprises because it causes the loss of the capitalised expenses which represent the bulk of their investment in intangible assets, with consequent negative results on the equity.

A Close examination of the intangibles affected by a reduction highlight that the IAS 38 implies the elimination of start-up, advertising and research expense as well as some other costs under the category "other intangibles". (6)

Accounting for intangibles (that is, goodwill and identifiable intangibles such as patents or brand names) has been one of the most controversial issues in the globalisation of accounting standards.

The adoption of IFRS will have a significant impact on the recognition and valuation of intangible assets.

Global tax management of intangible assets is becoming increasingly important as intangible assets become more important to company values, and because of the relative ease of transfer compared to tangible assets. For example, the relative profits attributable to Australia in a global supply chain would be reduced if contractual agreements are varied such that insurance, currency or other risks are moved to another jurisdiction.

Intangibles are becoming increasingly important to the scientific community as well as the business world. This is mainly due to a highly competitive business environment combined with exceptionally limited resources and the growing importance of knowledge as a commodity.

Intangible assets are a company's "weightless wealth" that helps it to obtain real profit. Every company should understand the nowadays paying much attention to knowledge management in general and to Intangible assets especially may help to create and develop its core competences and thus yield competitive advantage on the market.

At the level of the economy, the main intangible assets are knowledge, innovation, organisation, human capital and social capital.

Intangible assets are difficult to measure both at firm and country levels.

The growing importance of intangible assets has meant the necessary for firms to build networks with other economics actors, be they suppliers, rival firms, universities or other institutions.