Treasury Today Country Profiles in association with Citi

You don’t know what half your assets are worth

Person using old an wooden abacus to calculate

Traditional accounting methods of valuation and recognition of intangible assets are such that many companies around the world have little or no idea of their true value. The negative impact this has on risk management, tax and lending decisions, to name but a few, should not be underestimated.

If a company knew that half the value of its assets was either uncertain or unrecognised on its balance sheet, it would probably cause a storm of protest from stakeholders and potentially even have a negative impact on share price. However unlikely this scenario may sound, it is an unfortunate reality for many companies around the world.

Intangible assets – such as brands, trademarks, people, know-how, relationships and other intellectual property (IP) – make up almost half the total value of many businesses. Whilst their tangible counterparts (such as plant, machinery and property) are fully recognised on the balance sheet, intangibles are either not regularly revalued or, in some cases, even recognised. For directors, analysts, investors and other stakeholders in these companies, it is an effective denial of understanding of half the value of their business. Major decisions being taken without the full facts is a huge risk.

When a company trades downwards on a stock exchange, for example, this could eventually trigger a takeover bid. As a result, because standard accounts models seem poor at expressing the value of a business, shareholders may not know the true value of that firm’s intangible assets and as a result could unnecessarily sell out at a price below actual value.

It comes as no surprise then that a recent study of around 57,000 companies across 160 jurisdictions (the largest undertaking of its kind) has shown that amongst CFOs, CEOs and analysts there is strong demand for major accounting reforms to help recognise this blind spot.

The annual Global Intangible Finance Tracker (GIFT) report – produced by asset valuation specialist Brand Finance for the last 15 years – reveals that over 50% of respondents say the value of intangibles is increasingly important in their risk management and lending decisions. The study, supported in the last two years by the Chartered Institute of Management Accountants (CIMA), and for the first time this year by the Institute of Practitioners in Advertising (IPA), further discloses that over 70% of respondents feel this value is becoming increasingly important in M&A activity, whilst 68% of analysts and 58% of CFOs think all internally generated intangible asset value (through brand and trademarks, for example) should be separately included in the balance sheet and that all intangible assets should be revalued each year (a process currently not allowed under IAS 38).

To put this ‘lost’ value into context, the GIFT survey corporate sample had a total enterprise value of around $89trn, of which some $46.8trn was in net tangible assets, $11.8trn was in disclosed intangible assets and $30.1trn represented undisclosed value.

What does this mean?

The problem from the analyst perspective is that pricing company shares with insufficient information about company assets leads to a broader spread of values. As such, investors are acting on incomplete information which, says the report, can lead to share-price volatility, ultimately affecting the stability and sustainability of finance. It confirms the threat of a hostile takeover as another significant risk, warning that “lack of information about the true value of their assets leaves boards and shareholders in a naïve position” and leaving companies “prone to acquiesce to acquisitions that should not take place or to sell individual assets below their true price”.

Why are reforms not forthcoming?

IFRS 3 adoption has made some inroads into intangibles reporting but the rules state that companies are only allowed to put on the balance sheet an asset which has been identified and valued at the point of acquisition. There is thus no allowable valuation for internally generated intangibles (such as brands or trademarks). Subsequently, companies are only allowed to either amortise an intangible asset’s value or to execute an impairment review which will reduce its value. There is no provision to increase the value of that asset although clearly intangibles do vary in value. The main IFRS reasoning for not allowing this is simple: it stops firms indulging in ‘creative accounting’.

However, in the view of Brand Finance CEO, David Haigh, companies should be able to undertake an annual revaluation of all company assets. “The transparency and clarity this would afford would enable boards to make more effective use of their assets; accountants to have a truer picture of asset values; and investors and analysts to more accurately price shares.”

For this to happen, a proper valuation of intangibles is essential. An annual valuation of all assets is feasible, argues Haigh. This could be produced by an independent third party valuation firm (such as Brand Finance or the Big Four accountancy firms). Although obviously partisan, he points out that this process is simply what happens during any M&A activity in order that a ‘fair value’ be reached and as such is entirely practicable. “There are companies that are habitually doing these valuations, both of the companies and their underlying assets, and I see no reason why, given the right safeguards and caveats, it would not be possible to replicate those valuations on an annual basis.”

The use and value that this change has for investors assumes that a reporting mechanism or framework can be established within companies to provide revalued numbers to relevant parties. The likelihood of this major change taking off also remains a matter of principle, admits Haigh. Traditional accountants may feel this is a bad idea whilst some directors may feel it gives away too much information or that it may hold them too much to account as they will have to explain to stakeholders any movement in intangible asset valuation each year.

Haigh clearly believes that a new approach to intangibles reporting would be beneficial for corporates and investors alike. The fact that this study mentioned above is published with the CIMA (650,000 members worldwide) clearly adds weight to the view that integrated accounting is the way forward. A previous survey carried out by Brand Finance of 100 equity analysts further endorses the view that all intangibles should be revalued each year.

Intangibles are real

Whilst internally created intangibles may have the demeanour of barely acknowledged “Cinderella assets”, Haigh says that in law they certainly are assets in their own right and have been for many years. An asset is an economic resource which will produce returns into the future, which can be transferred, and is dependent on legal rights. Intangibles are all these things, he notes. But the problem has always been in demonstrating economic return and finding a reasonably accurate way of valuing them. To this he points to the existence of an international standard – ISO 10668 – which specifies how brands are valued. This allow forward-thinking companies to formally recognise their intangibles as real assets that can be properly valued.

Treasurers take note

With the mechanisms in place and the will to use them, the problem is entirely solvable. What’s more, there is added value to be had for treasurers. “Intangible assets potentially can be used as securities against borrowing,” says Haigh. “This obviously affects the cost of money. If it can be demonstrated that these assets are long-lived, strong and able to create great stability, I would expect to see many institutions lending money for longer terms and at lower rates than they would otherwise.”

Indeed, it has been noted that many firms have already realised that the value of their intangibles – such as a brand, trademark or patent – can have a significant effect on the way they negotiate deals and the prices obtainable. Some, including Dunkin’ Donuts, Yale University and the fashion brand Guess?, have gone as far as putting these assets into tax-efficient separate special purpose vehicles (SPVs), securitising and borrowing into those vehicles. And now, brand values are set to be used as exchange traded funds and structured products as a new index, due to be launched in Q2 2016 by Brand Finance, will uniquely use a basket of funds based on very strong brand value and used by a major financial provider to create a fund. “Intangibles are beginning to be treated much more like real assets,” notes Haigh. As the uncertainty over their value recedes, he believes that treasurers “will soon see them affecting the terms and conditions on which they are able to do their business”.

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