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Intangibility scaling
I have just updated my web site page on intangible asset definition by providing a short discussion on "intangibility scaling". Hereunder is a small excerpt.
Assigning a measurement of intangibility to an intangible with respect to one criterion (e.g., identifialibility) means to scale the asset according to this criterion. Typically that does not mean to assign a numeric absolute value (a ratio scale) like for instance the monetary value. Most often all that we can do is to assign a ordinal value (an ordinal scale), namely to say that an asset is more intangible than another (according to the specified criterion). Sometimes we may not even be able to establish an ordinal relationship; a mathematician would describe that situation by saying that the order is partial, not total.
We may measure the intangibility of an asset by combining the measurement of the first three fundamental attributes. In other words we assume we can measure the identifiability, the measurability and the controllability of an asset and that by combining all these measurements we get a composite measurement of the intangibility of the asset.
See http://www.itdec.eu/Intangibles_Overview.html for the whole discussion.
I would really appreciate if anyone would comment on this concept. Although the first formulation of this concept goes back to discussions I had several years ago with Chris Holloway, Dan McGrath and Douglas McDavid (in this community), the formulation is still far from being satisfactory.
Tags: asset, control, intangibility, intangible, intangibles, measurement
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Replies to This Discussion
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Permalink Reply by Mary Adams on
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Mauro- My first reaction to this was why bother measuring how intangible something is. But reading the article in your link, I understand that you are linking intangibles with accounting criteria and I like any effort that tries to bridge IC and accounting.
The one bit of data that management accountants could provide (but don't) is the amount of intangible investment that gets expensed every year. Much of this investment will never be eligible for capitalization (especially the high intangibility areas like people and networks) but it is still important and by tracking the investment in a management report this importance would be much more clear.
I also think that intangibility as a stand-alone metric could be dangerous. If it is highly intangible, is it less important? Probably not. So maybe it needs to be paired with other metrics. One that occurs to me is strategic importance. This could also be measured.
I like the direction of your thoughts and thank you for bringing it to ICKC. I've been debating with myself how to get our conversations going again and you did it for me! Let's see what others have to say...
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Permalink Reply by Peter Spence on -
Mary,
I agree with the rationale of expensing intangible investment annually but find myself questioning the thought that much of the investment will never be eligible for capitalization. It appears that the volatile nature of IC (like say the Share and Property Markets)leaves it open to rapid and signicant fluctuations in capital value depending perhaps more on perception of value - however, unlike shares and realty with their market fluctuations, assigning value to itemised intangible capital would be difficult based on broad market valuations - yet, perhaps broader groupings of IC may be eligible?
Value network analysis may assist in determining value at a given time based upon level of contribution to organisational performance/output (assett productivity)yet as you say, highly intangible assets (reputation, trust, branding, knowledge etc) would be more difficult to capitalize and this takes me back to the grouping question. I like your suggestion of linking or pairing highly intangible capital with other (perhaps more visible and hence measurable) metrics - benchmarking against these standardized metrics may enable us to determine the 'value added' component of IC.
I look forward to more conversations on this topic as I am curious to see if it takes us closer to more accurate methods of assigning value to IC.
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Permalink Reply by Jayaraman Rajah Iyer on -
Thanks to Mauro to raise the question of Intangibility of the asset, that I see as the primary focus for Measurability. Taking note of Mary's comment 'that intangibility as a stand-alone metric could be dangerous' and Peter's 'questioning the thought that much of the investment will never be eligible for capitalization' we have all that is needed to transact a business with a Balance Sheet. Balance Sheet is the only document a stakeholder is greatly concerned. Management is also concerned with the same - Earnings Per Share. For a dividend paying company a continued rate of dividend ensures stability for the organization giving confidence to the stakeholders. Cost of innovation will be tempered by the dividend paying capability lest the investors leave the scene for another green pasture.
There are four types of expenditure that create an opportunity for the CFO on expenses for capitalization, a leeway to balance dividend rate and asset base. The four types, e.g. for an automobile industry, are: 1. Re-tooling cost, 2. Re-engineering cost, 3. Patented new technology product e.g. new fuel injection system and 4. Electric Cars. Re-tooling costs are mostly absorbed within the year. Re-engineering costs are necessitated by market circumstances such as the heavy expenditure after yam kippur war on account of escalation of fuel prices. This expenditure would have been difficult to absorb within the year and hence spread over a few years say 5, with the given target of EPS. The 3rd and 4th types are the trouble makers for the CFO.
Mauro's referred to the Working Paper by Leanord Nakamura where he refers to the empirical importance of 'Creative Destruction' with reference to the estimate of US Investment in intangibles. I like this reference. 3rd and 4th types are innovative outputs that tend to displace the current products or processes. The 4th type may be the one that provide a fillip to the 3rd type as a by-product of innovation and truly the 3rd can be a stand-alone destroyer. Meaning an IPR can altogether replace the current ones after a heavy expenditure greater than the type 2. In order to justify the change-over the 'intangibility of the asset' becomes a crucial measurement yardstick. Treatment of the 4th type will be on a much larger scale than the 3rd but is identical in its journey towards a completed IPR.
Measurability is on two distinct levels - 1. Intangible Asset and 2. Asset.
Intangible Asset is not an asset. It is sitting in an incubator trying to come out of the shell targeting the existing asset base to join them or replace them. So long it is in the shell it cannot be termed as an asset. The incubation time must be minimum and the rate of acceleration to reach the asset base high, in order to maximize the profits. The moment it reaches the status of an asset it ceases to be an intangible asset. An IPR is an asset having come out of the shell. An IPR can replace a product or process within the company as well be marketed outside earning revenue of its own. Capability of the IPR is directly related to the 'intangibility of the asset' outside the company where it competes with similar IPRs that could bring down its longevity. When total cost of creating the Asset, that is now an IPR sitting under the heading Fixed Assets, is always under the threat of creative destruction of another IPR. It is the creative destruction faced by the IPR that would be the yardstick of measurement for the 'intangibility of the IPR'.
For example, Windows Xp, followed by Vista and then Windows 7 goes through the same 4 types of challenges from re-tooling to re-engineering to a new product altogether. So is the case of 1G, 2G, 3G to 4G Telecom services. The 4 types are repeated in both these instances but the life of the asset diminishes thereby necessitating the absorption of total cost of the IPR in question, in shorter accounting years with enormous stress on its dividend policy.
Intangible Asset type 3 as well 4, go through an identical process of transformation from conceptual stage to an IPR stage when it emerges as an asset. In fact the process of transformation is identical to every other intangible asset everywhere. Intangible Asset has a linear growth pattern comparable one with the other adding one layer over the other and therefore it is measurable. Intangible Asset however has a finite purpose which is creative destruction that it starts with the self-destruction. The faster it does is better for the company. 'Intangibility of the asset' can never be a reference to 'Intangible Asset' lest it becomes a burden on the CFO to treat it as Peter says, much of the investment will never be eligible for capitalization.
Intangibility of the asset refers to the asset base not intangible asset base. An asset's intangibility is in the market. If market comes out with an equally innovative IPR with a creative destruction far superior to others then it would have a better stay in the market. Creative Destruction will be the yardstick of measurement for assessing the Intangibility of the Asset. The one that cannot accommodate the changes goes back to the drawing board to start another intangible asset in order to avoid downsizing its scalability.
Hence when the focus of attention is shifted from 'intangible asset' to 'asset' intangibility as a stand-alone metric does not look dangerous. On the contrary it has to be the only metric when the war between one creative destroyer and another takes place in the market place.
In the Prism Project Mauro has referred in his website, contains this suggestion: "a limited revision of the international standard on accounting for intangible assets (IAS 38) would open up the field for the much-needed development of new management tools in this area." Left to me I would strongly recommend reinstating IAS 9 that IAS 38 had replaced in 1998.
Please do visit to see the much-needed development of new management tools in this area: http://jayaribcm.wordpress.com/ I enjoyed participating in this forum.
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Jayaraman- At this point, I try to ignore the question of capitalization and focus on the question of what is being spent on intangibles that will have a value beyond one year (the basic definition of investment vs. expense). I recommend that managers track these investments in their management accounting.
This standard would lead a lead to the identification of a lot of spending on training, process development, R&D, innovation, IT, branding and external partnerships--as intangibles investment.
However, for now, just because management says something is an investment will not get it on the balance sheet. Formal recognition of intangibles will come later--after we understand how these investments behave.
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Permalink Reply by Jayaraman Rajah Iyer on
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Agreed. Leanord Nakamura mentions a figure of more than $1 trillion. Balance Sheet inclusion provides the right perspective of the risks involved that otherwise let the expenses go beyond one's capability to absorb. Capitalization is also only postponing the absorption maybe over the years that I tried to clarify. But I am with you for accounting for it fully. To me expense & asset are the same like addition & multiplication.
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