The End of Accounting and the Beginning of Intangibles Accounting

I’ve been discussing The End of Accounting with a lot of people but hadn’t gotten around to reviewing it here. I definitely recommend it as a fresh take on the intangibles problem and a sobering view of the challenges facing accountants today.

Baruch Lev has been talking about intangibles about as long as anyone. I often quote this quick video that we recorded of Dr. Lev at an intangibles conference we organized in DC in 2011 where he say that intangibles are “the only assets that create value.” His logic is that tangible assets are commodities available to everyone. The only alternative is the development of intangible assets. Continue reading “The End of Accounting and the Beginning of Intangibles Accounting”

Corporate Value Drivers –  Closing the Intangible Information Gap

Ocean Tomom Intangibles in S&P 500

The intangibles information gap isn’t going away. In fact, it keeps growing. It’s the undercurrent of a lot of conversations about corporate value drivers, integrated reporting and even ESG.  So I figured it was time to review the latest data.

By the way, I’ve been using this data for years but I’m often surprised by the number of people who haven’t seen it.

We have this great time series thanks to periodic updates from Ocean Tomo, an Intellectual Capital Merchant Banc firm (they deal in IP so, yes, their corporate description is trademarked!). The calculation is simple. They start with the total corporate value of the companies on the S&P 500 and compare it to the tangible net worth of these companies. The gap is intangible assets, or what I call the “intangible information gap.”

You can see that this gap has increased steadily over time. The biggest change came in the decade ending in 1995. This corresponded to the adoption of the personal computer (IBM’s first PC was released in 1981). This was the moment when automation of our mental work began to take off. Although it lead to a crash, the dot comm boom lead to further growth as all the PC’s became interconnected through the internet (the dot comm boom grew through early 2000). This accelerated the accessibility and creation of data.

All this means that intangibles are essentially knowledge assets. They represent an information gap because very little information is tracked that identifies. specific sources of value.  A small amount of these intangibles are on balance sheets (relics of past acquisitions). But most of these drivers of corporate value are resources like people, knowledge, process, data, IP, relationships and even rights to natural resources. Very little of the money spent on building these value drivers is capitalized. So these “capitals” are not on the balance sheet.

The IIRC multi-capital framework has done a great job identifying the types of resources we’re talking about. My version of the framework includes:

  • Purpose – Strategic capital gives your organization purpose. It is what you do to create value for your customers.
  • Property – Structural capital includes all the knowledge that stays behind when your employees go home at the end of the day or leave the company.
  • Partners – Relationship capital connects your organization with its stakeholders.
  • People – Human capital is the creative engine of every organization. It is the intangible capital that goes home at night, and also leaves the company with people who resign or retire.
  • Planet – Natural capital. Every organization is part of our natural ecosystem and companies earn the right to access/use resources like air, water and energy as well as many other natural resources.

ESG practitioners come at this from the outside in, aiming to understand external capitals like natural, relationship as  well as governance (part of strategic capital). This sustainability perspective is still kept separate from the financial perspective. But integrating the two is an important goal going forward as the financial community is starting to talk a lot about ESG as a driver of performance.

After identifying your value drivers, the next step is measurment, especially the connection with the financials. In Intangible Capital, we suggested a concept called i-capex (intangible capital expenditure). The idea is that if you track investments in the above types of assets, you’ll get a better idea of the distribution of value in an individual company. (Just to be clear, this would be a management accounting exercise–it’s too early to talk about capitalization on the balance sheet).

Want to get started on identifying your company’s value drivers?  Feel free to use our free value creation worksheet.

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Graphic credit: Ocean Tomo

 

Three Paths to Integrated Reporting in the U.S.

Integrated reporting is still emerging in the U.S. It’s a mostly bottom-up phenomenon with individual companies forging their own path. I explored these journeys in a report I released a few weeks ago. Now that I’ve had time to digest the findings, I am seeing three basic approaches.  The first is the integrated summary report. This is the path taken by Coca-Cola, GE and JLL.  Average length of these three reports was 44 pages. In this approach, the company leaves its current financial and sustainability reporting as is and adds a new report on top of it. Dunstan Allison-Hope calls this the “triangular approach” with an integrated report sitting on top of the two traditional reports. You could say that this kind of report is a synthesis of the traditional reports that connects the dots between them but don’t include all the detail.

The second is the long-form integrated report.  This is the path taken by Arcelor-Mittal, AEP, Pfizer and Smithfield. Average length of these four reports is 141 pages which means that these reports are much more detailed and in Allison-Hope’s terms, cover the entire triangle. Three of the four reports that mention the IIRC Framework are in this category (Pfizer doesn’t mention IIRC, JLL in the summary category does).

The third is the short-form integrated report. This is the path take by Clorox, Entergy and Southwest. The average size in this category is 52 pages. Here, the companies seem to start from scratch and create a different report that is like the integrated summary but aims to be more comprehensive like the long-form report. Each of these reports are innovative and highly graphical.

Which is the right path? It depends on what works for you. In order of difficulty, shorter is probably harder just because it requires synthesis. In a recent interview, the CFO of GE made it clear how much of a journey it was for them to get to the integrated summary report.

This post was developed using data from our recent report called The U.S. Integrated Reporting Journey: One Journey, Ten Companies, Twelve Questions to Get You Started. Click here to download the report.

CLICK TO DOWNLOAD THE THE U.S. INTEGRATED REPORTING JOURNEY

 

Samsung and Apple – Contrasting Value Creation Models

Apple and Samsung are the leading global smartphone brands. They sell products that essentially do the same things. But ask just about any consumer and they’ll tell you that the companies are radically different. This post explores these two companies using an integrated capital model to explore how and why these differences exist. Continue reading “Samsung and Apple – Contrasting Value Creation Models”

Samsung’s Value Creation Model

As promised, here is a summary model of how Samsung creates value. It’s meant to be a companion piece to the post I wrote last week on Apple. Next week I’ll compare the two.

Of course, between the time I said I was going to research this post and now, Samsung’s Note 7 crisis escalated and the company ended up halting production of the product. 

Here’s a summary by Hiawatha Bray and the NYT of how things look right now on that front. Although it’s not the purpose of this post, this analysis might shed light on Samsung’s strength and capacity to survive this crisis. 

This post was created using the Value Creation Worksheet that’s available for download on our site. To fill it in, I reviewed public reports issued by the company including their  2015 Business Report and the Samsung Sustainability website pages and downloadable report. I used their words and approaches as much as possible. This means that the lists might not always be complete. But my hope is that it will stimulate others to think about the approach. 

Here’s the worksheet I’ve developed (click to see a larger version):

Samsung is an enormous and highly complex company with three major divisions and what looks like hundreds of different legal entities. There are three major divisions: Consumer Electronics, IT & Mobile Communications, and Device Solutions with a total of 325,677 employees.

The company does not talk in its reporting about the kinds of customers it serves or its business model, except to name the top five customers (Apple, Deutsche Telekom, Softbank, Verizon and Best Buy). While it doesn’t list its factories, it mentions training at 31 production sites around the world.

It does list key suppliers of many kinds in its sustainability report but it does not mention its relationship with the Android operating system community.  Google (which developed Android) is mentioned once for an unidentified patent cross licensing agreement. This omission was striking to me because I chose Samsung for this post because it’s a great contrast with Apple which uses its own operating system.

As in the Apple post, I had to use a proxy for culture. The list here comes from the statement by management of their core values. A true analysis of culture might include characteristics such as “move fast” as highlighted in this article from Bloomberg on How Samsung Became the World’s Number 1 Smartphone Maker.

The stakeholders listed in the worksheet are names and discussed specifically including those listed above and Suppliers, Customers, Employees, Shareholders.

With regard to the company’s processes and IP, this article from last year in HBR How Samsung Became a Design Powerhouse talks about a strategic decision in the 1990’s to bring design in house. A detailed discussion of innovation and R&D is included in the sustainability report (interestingly, not the business report) .

As explained in the New York Times, the company’s management has shifted to Lee Jae-yong, who

took the helm of the country’s largest family-controlled conglomerate, or chaebol, after his father, Lee Kun-hee, the chairman, became ill in 2014. The senior Mr. Lee, who has not been seen in public since, famously burned a pile of 150,000 defective Samsung phones 21 years ago to demonstrate the company’s commitment to quality

The employee competencies used here were taken from the presentation about core company training programs in the sustainability report

No list of key raw materials or hazardous substances. However, there is a list in the sustainability report of hazardous materials that have been eliminated from its products.

How does this compare with Apple? I’ll look at that in my next post. In the mean time, feel free to download this worksheet and prepare one for your own company.

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