The relevance of financial statements of companies could be enhanced if accounting standards permitted companies to recognise internally generated intangible assets, argues Professor Janek Ratnatunga from the Institute of Certified Management Accountants.
Ratnatunga, ICMA’s chief executive, points to what he believes are weaknesses in the accounting framework related to accounting for intellectual property that make the notion of financial statements being true and fair as it is currently used a misnomer.
He urges accounting standard setters to revamp the accounting requirements so that a more complete picture is given to investors of the assets a company has under its control rather than financial statements only showing those assets that might have a carrying amount in accounts because of previous transactions or some kind of observable market.
The call for change in the way certain accounting rules treat knowledge economy assets comes at a time during which banks and other financial services institutions are grappling with how to estimate the values of credit losses that might come if their customers are unable to pay back monies owed due to the impact of the coronavirus.
Ratnatunga told Banking Day that the value of the work auditors do is also compromised because their audits must be conducted within the scope of a reporting framework that does not permit certain assets such as types of intellectual property to be recognised by the entity that creates them.
The ICMA chief rails against the practice of not recognising internally generated intangible assets on company balance sheets because there is no third-party transaction that provides a selling price. He notes that a company could buy an intangible asset from another entity and book it in its accounts while the previous entity would be unable to account for it itself.
Using some kind of valuation methodology to book these internally generated intangibles should be explored, Ratnatunga says, so that financial statements are more complete and auditors are signing off on accounts that contain a more complete picture.
“IFRS does not require third party transactions when it does fair value. It has three different fair values, which have nothing to do with third party transactions, such as market value, quoted prices or observable prices,” Ratnatunga says. “Many of them are based on estimates. Why can’t we estimate the intangible asset the same way? Why only the tangible asset?”