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This report examines the new economy and business and financial reporting and explores approaches that can improve it. They would consider accounting's failures and find out the solution (usually proprietary).
The problem/ issue to users is to understand the difference between the company value and the accounting book value. As we can see here, a changing of economy would cause the accounting being failure. Three propositions imply this issue. The proposition one is that traditional financial statements are backward-looking. The new financial reporting paradigm should not only focus in the past event, but also more towards to value bases. Beside, this paradigm would supplement or replace. Second proposition is in the new economy the value driver not be presented and non-financial. However, a method a measurement of value should be developed. Third proposition is the financial statement recognizes assets only when they are found. In this case, accounting standard should be setter.
A Problem of terminology
This Special Report avoids the terms like knowledge capital, human capital, and intellectual capital unless describe the others' use of terms. Meaning of that terms are so diverse. So, this Report uses the traditional accounting terminology. Such as, in preparing and presentation the financial statement, asset should be defined in FASB Concept Statements & International Accounting Standards Committee Framework.
Is There Really a New Economy
The interpretation of new economy is difference from one another, because what is acceptable to one might not acceptable to the others. So, we should know the mean of new economic in general which the characteristics are described as intellectual capital, the network internet, technology, information, intangible asset, knowledge sharing and new of organization, network effects and globalization. Financial reporting and new economy are disconnecting. New economy that is supported with the not developed accounting is not appropriate.
Efforts to solve the Problem
First, Special Committee's recommended that to achieve users' need, business reporting must provide future oriented information and perspective, focus on key performance measurement not matter is non-financial or financial. Besides, compile the information that prepared to senior management with the information that was previously reported externally.
Second, Steering Committee was formed to conduct a research project. Steering Committee issued a report Improving Business Reporting. Five elements are included in the framework that described by the Improving Business Report which is concerning by Financial Accounting Standard Board (FASB). First, have to identify the important aspects of company's business, management plan and strategies, and data measurement method. Besides, considered how much significant for the measurement method and explain the metrics presented and measured the metrics disclosed period to period.
Third, Perfomance Measures in the Economy focus on knowledge intensive activities, consider the alternative and technology available, and a strong theoretical case can be make. Organization in concern must actively take part in such issue.
Fourth, Bookings Institution project is to help to make a better way for measurement and reporting of intangible source and consider public policies that effect the development and the public sector making decision. It could reduce the negative outcome.
Fifth, Intellectual Capital Accounts study was created by the Danish Agency. This study specifies intellectual capital accounts to human resources category, customer category, technology category and processes category.
Sixth, developing models are requested by the Netherlands Ministry of Economic Affairs to the KPMG, Ernst & Young, PricewaterhouseCoopers and Walgemoed four accounting firms on issue of the presentation of intangible assets information. The four accounting firm respectively proposed "dashboard", reconciliation, disclosed approach and expanded recognition of identifiable intangible assets.
Seventh, intellectual capital are measured and reported by Symposium that sponsored by the Organization for Economic Cooperation and Development. The symposium chairman observed that having better information to suit the current economy, making full use info and then monitor and evaluate carefully the experimentation results. Besides, reporting framework concerning about company performance and in favour of potential uses. Understanding of innovation in reporting is needed. Real time and instantaneous made of it information system and reporting system is preferable based on the cost analyze.
Eighth, Charles Leadbeater authored a study which published by Institute of Chartered Accountants in England & Wales (ICAEW). Three alternative approaches that propose by Leadbeater which are incremental, radical and hybrid approach. The incremental approach reports the intangible assets. Radical approach is to invent new balance sheets entirely for companies. For hybrid approach, it consist more sweeping changes and most radical.
Ninth, method that they approached to problem is Securities and Exchange Commission. Chairman Levitt described that there would have more people or more company are concerning to Intangible Assets, since it keeps growth.
CHAPTER 2: NEW REPORTING PARADIGM
Traditional financial statement focus on the ability of the entity's to realize the value of the assets and the liabilities. Traditional financial statement is usually backward looking. Whereas, new reporting paradigm is to capture and report the entity's value creation and it might replace the existing financial statement. There have two approaches for the new reporting paradigm in the monetary measures but it avoids using traditional financial statements.
Two proposals for new reporting paradigms
The CICA Total Value Creation (TVC) System.
TVC is the system of measurement and report on the "value-creation" performance. It is begins with the financial reporting and move through the non-financial performance measurement that can link to the value-creation. TVC is the profession's concern about the performance measurement in the new economy. The creator claims that this new accounting method will allow the management, boards, investor and other stakeholders to evaluate and assess the organization's performance. Besides that, it is better to know that where the things going to instead of where the things coming from.
Accounting For The Future (AFTF)
AFTF is like the TVC model that AFTF is a system projected future cash flows to present the corporation's financial activities. AFTF use the traditional terms such as assets, liabilities, and the equity but with the different meanings. AFTF is the current value of all the net future inflows at the market cost of capital. Market cost capital is the shareholder will buy the company's stock if the yield rate reach at the shareholder requirement. AFTF assets are defined as the current value of all the future cash inflows into the company. AFTF liabilities are the current value of all the future cash inflows from the company. AFTF shareholder equity equals to the AFTF assets less the AFTF liabilities.
Issues from developing a new reporting models
Cost, Complexity and Extension
Cost is one of the issues in developing a new accounting model. Developing a single project can be costly and difficult but the cost of implementing a prospective model in a complex organization can be considerable. It is very difficult to define the life of the business as it is a continuing entity.
Commentators will think that traditional GAAP are hard to understand and difficult. GAAP framework divided into three components that are definition, recognition and measurement. A prospective system cannot avoid the question of "definition, recognition and measurement". Designers must develop some similar decision or rules that will provide information that are understandable and comparable from one entity to another. Besides that, disclosure will not solve the problem.
Existence and Completeness
Existence is the assets and the liabilities presented in the balance sheet exist and belong to the entity. Whereas, completeness is the assets and liabilities in the entity didn't left out from the balance sheet. The accountants and the auditors will have more experience and familiar with this but a prospective system will make the same assertions about the element in its reporting model. In some cases, management might want keep the secret from potential competitors, customers. In the worst situation, management might also keep the secret from the investors.
CHAPTER 3: NEW METRIC
Nonfinancial information measurement is important value driver in the new economy metric. There are 5 approaches about the nonfinancial which discuss in this chapter are Balanced Scorecard, Skandia AFS, Karl-Erik Sveiby and the Swedish Movement, The Value Chain Scoreboard and The Value Creation Index(VCI).
Balanced Scorecard is a management reporting tool which not for public using and labeled as "intellectual capital". It is create base on 4 parts which are financial, customer, internal process and learning and growth. Measure in its perspective on key success factors using balanced scorecard is not guarantee for a win situation.
Skandia AFS is a Swedish insurance company which presenting nonfinancial metric and intellectual capital supplements. Skandia Value Scheme has 2 parts which are financial capital (traditional economy) and intellectual capital (new economy). Intellectual capital also divides to 2 parts which are structural capital (customer capital and organizational capital) and human capital. Skandia Navigator is created to show how those components related one and other. The disadvantages of Skandia are short of comparability and it is hard to define the metrics. Voluntary disclosures provide the completeness assertion in Skandia AFS. Some members of corporate community worry about charges on the changing of metrics if the performance measurement is long-lasting used. John Rutledge disagree the Skandia AFS.
Karl-Erik Sveiby and the Swedish Movement present an "intangible assets monitor" with 3 parts which are External Structure, Internal Structure and Competence with the other 3 indicators which are growth/renewal, efficiency and stability. The intangible assets monitor only suitable for service industry. Celemi thinks that it is not accurate to use the number to measure nonfinancial performance, it replace by the color coding.
The Value Chain Scoreboard creates for commercial development. Professor Lev promotes 3 criteria for the indicator of measurement which are quantitative, standardized and confirmation with evidence. It takes advance in the comparisons assertion which Professor Lev using the standardization.
The Value Creation Index (VCI) is method that explains the market value of company using different nonfinancial measure. There are 2 important insights which are speeches from management will differ from how it behave and industry specific.
In conclude of this chapter, purpose of nonfinancial metric should report business information whenever it is during the new or old economy. The 5 methods of nonfinancial metrics are useful in different industry and have their own advantages and disadvantages on the nonfinancial measurement.
CHAPTER 4: INTANGIBLE ASSETS
The intangible asset is important in distinguishing the feature of new economy. Intangible assets are non-current assets with nonphysical sources. For instance, patents, copyrights, franchises, rights, agreements and contracts, and others.
1. Cost-Based Measurement
Certainly a number of intangible assets offer the likelihood of cost-based measurements. Cost-based measure is the investment value that is based on the cost of investment. Investments in software, R&D projects, some databases and other similar intangible projects have eagerly determinable costs except brand names. There are some barriers to cost-based measurement:
Amounts spent on an activity always produce findings that are benefitial in other effort. Should some or all the failed effort costs be attributed to the successful one?
A number of intangible assets, such as computer software, run the revisions during their marketable lives. The Version 1's code developed may still be a crucial component of Version 5. Should some or all the Version 1's costs be added to the Version 5's costs?
During Statement 86 development, a lot of the software developers said that they did not have sufficient systems with which to collect the cost of individual projects. The research and related efforts transform and shift as the effort progresses. An effort that began as Project A may shift in the middle into Projects X, Y, and Z.
Indication of whether the cost-based measurement is relevant. For instance, the cost of an asset is not the asset, whereas the asset is the future economic benefits of the asset.
2. Fair Value
The present measures of intangible assets, mainly fair value, presents information that is more relevant. Fair value is defined as the amount at which that the asset could be purchased or sold in a current deal between willing parties, excluding in a liquidation. If a quoted market price is available, it can be deemed as the best indication of fair value and should be used as the foundation for measurement. If it is not available, preparers should compose an estimate of fair value by using the best information available in the situations. In many situations, quoted market prices are not available, therefore as a result, there are some difficulties arise when making estimates of fair value.
3. Approaches Other Than Fair Value
Some observers concern that fair-value measurement are probable to devalue the "true" value of many intangible assets. Those who favor a recent measure, but be in opposition to fair value, support an entity-specific measurement of intangible assets. Entity-specific measures/ value-in-use defined as the present value of the predictable future cash flows expected to occur from the ongoing use of an asset and from its removal at the end of its useful life or expects to lead to when settling a liability. In the Concept Statement 7, FASB unwanted the use of entity-specific measures as a purpose of accounting measurement.
4. Measurement and Real Option
Real option analysis is useful in estimating the intangible assets values that are under development and it may not verify to be commercially practical. Real option approaches try to enlarge the intellectual strictness of option-pricing models to assessment of non-financial assets and liabilities. There are five business situation examples that can be modeled as real option, which are waiting to invest options, growth options, flexibility options, exit options, and learning options. Other examples of real options, like opportunities for M&A, R&D, and licensing.
Does the Rationale Hold Up? (FASB Statement No 2)
Reasons of not capitalizing the costs of R&D
Is it an asset?
Uncertainty of future benefits
When the costs are incurred in the R&D effort, there is substantial uncertainty on whether the attempt wills consequence in success or failure.
Lack of causal relationship
The deficiency of a causal relationship mention in Statement 2 is possibly true of a person project; but, the sweeping dialect of the foundation.
Does the item have a Relevant Attribute Measurable with Sufficient Reliability?
Inability to measure future benefits
Part 1 question, relevant measurement attributes. Three candidates involve- cost, fair value, entity-specific value.
Part 2 questions, the selected attribute can be considered with adequate reliability
Is the information about it Capable of making a Difference in User Decisions?
Is the information Representationally Faithful, Verifiable, and Neutral?
Lack of usefulness
Reliability obviously is more than just the capacity for different measures to create alike answer given the same facts. Reliability also requests representational faithfulness.
Objections to recognizing Intangible Assets
Cost and benefit
The expenditures of any accounting rule are straight away and bear by an enterprise. The benefits are dispersing. Good accounting advantages the users of the capital markets and financial statements as an entire.
Lack of Relevance
There is a perceived separate among the expenditure of intangible assets as well as the future benefits to those intangibles might create.
Persons who resist incorporating internally generated intangibles are probably argue that cost is not a reliable measure of fundamental value and that compute other than cost be short of sufficient reliability.
Intangible assets might be the spirit of a doing well in business, and then some will oppose incorporating information concerning those objects in balance sheets.
The exercise benefit, and then the value, of a lot of intangible assets are naturally subject to move caused by issues not completely within management control.
Disclosure in the notes is applied to give additional information on the issue of recognized assets and liabilities.
Conclusion for this Special Report is debating over "new versus old" is fundamentally unhelpful. It is also means that no proposal finds a comprehensive solution to disconnect between business & financial reporting in the new economy on the other. Only a few proposals recognize its limitation. In "new economy", an improved business and financial reporting is require to the recognition of intangible assets that are generated internally in financial statement and enhanced the measurement of the intangible assets. Besides, they require expanding and systematic use of non-financial performance metrics. Expanded of forward-looking information is also required by the improved business and financial reporting of the "new economy".