Executive Summary
In recent years there has been a growing realisation that a companys stock of intangible assets is a key contributor to its capacity to secure a sustainable competitive advantage. Knowledge-based intangibles in particular are recognised to be central to the value creation process. Such assets have increasingly been referred to by a new term, that of intellectual capital, in order to distinguish them from the financial capital that has traditionally provided the foundations for wealth creation. Intellectual capital refers to a much wider range of assets than those normally recognised as intangible, e.g. goodwill, brands, company reputation, etc. Consequently, it is often referred to as intangibles, particularly in the European literature. Successfully managing intellectual capital has emerged as a significant challenge to management, and is intimately related to another contemporary development, knowledge management, the management of knowledge-based assets in the pursuit of competitive advantage.
Accounting and intellectual capital are linked to each other because of the necessity to provide an accounting perspective on value creation. At one level there is a need to explain the hidden value attributed to intellectual capital by the capital markets, i.e. the excess of the market value of a company over the book value of its assets, determined in accordance with prevailing accounting principles. At the same time, it is important to set about documenting the growth of the value creation capacity of a company in some way, and in particular to provide an account of the prospects for continued value creation. In addition, there is a necessity to clearly distinguish intellectual capital from intangible assets in order that the repertoire of accounting treatments of the latter is not stretched to accommodate the former.
All of this proceeds against a background of growing interest in the establishment of a model of business reporting as a more comprehensive, customer oriented approach to the tasks traditionally associated with financial accounting and reporting. Given intellectual capitals central role in the value creation activities of companies, there is a pressing need to ensure that the information that accountants make available in any business report includes appropriate details of a companys stock of intellectual capital.
Prior research
Intellectual capital has been the subject of a rapidly expanding research effort since the term was first introduced into the literature in the mid 1990s. It is possible to identify several interlocking strands within this research:
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taxonomies of intellectual capital : there have been a number of attempts to identify the various constituents of intellectual capital. A key distinction is between human capital and structural capital, or the people capital in an organisation and the capital the people leave behind when they go home after work. The latter is often sub divided into external (or customer) capital, and internal (or organisational ) capital.
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management of intellectual capital : here the focus is upon the requirement on management to grow the stock of an organisations intellectual capital, in order to ensure the sustainability of competitive advantage. The links with the knowledge management literature are very evident here, not least the observation that it is important to recognise how reliant organisations are on intellectual capital before it is lost to the organisation.
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valuing intellectual capital : intellectual capitals hidden value status has resulted in a number of attempts to estimate the value of an organisations stock of intellectual capital. Underlying such work is the belief that it is possible to devise an enhanced balance sheet that will provide information in greater accord with market valuations.
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case studies and field studies : there have been a number of companies in which intellectual capital and attempts to account for it have been extremely influential in promoting interest in the topic, e.g. Skandia, CIBC, Celemi, and more recently Coloplast. There have also been a small number of field studies of intellectual capital measurement and reporting practice, documenting the extent of interest in accounting for intellectual capital. Surveys of intellectual capital accounting practice are less numerous.
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reporting intellectual capital : mechanisms for reporting the success (or failure) that organisations have enjoyed in growing their stocks of intellectual capital, together with a number of additional reporting frameworks have appeared in the literature. These frameworks overlap with the idea of a business reporting framework to a considerable extent, confirming that despite their distinct origins, intellectual capital and business reporting are in fact intimately related developments.
An extensive literature has evolved since intellectual capital was first publicised. Until recently, apart from a small number of professional magazine articles, very few contributions have been made by UK researchers. This suggests that intellectual capital, and its close associates knowledge management and intangibles, are not presently of great importance within the UK. In this way it continues the situation previously evident in the case of human resource accounting, with which intellectual capital shares a number of continuities, that of limited interest. This, of course, is in stark contrast to interest in accounting for intangible assets, which has been both widely subscribed and is intimately linked with the established financial accounting and reporting model.
The research project
In the light of this lack of UK research on intellectual capital, a study was proposed to establish the current level of managements interest in, and knowledge of intellectual capital and related ideas, and what approaches, if any, to accounting for intellectual capital, both internally and externally, were presently in place. As these enquiries were viewed as exploratory in nature, the research design adopted was a field study of companies identified by a form of selective or purposive sampling as being heavily reliant on their stocks of knowledge-based assets. In parallel, a series of interviews was pursued with a range of experts with an interest in intellectual capital, including consultants, user groups and key opinion formers. Overall, the focus of the study was on the management of intellectual capital, and how this impacts on business reporting. Interviews were secured with representatives of a variety of management functions in six companies, the case companies, and with twelve experts, expert opinion.
The findings
In general, the managers in the case companies were not familiar with the term intellectual capital, and did not use it during our discussions. This did not mean that they were unaware of the importance of what the intellectual capital concept incorporates, nor that they did not focus significant attention on it. People, their experience and expertise, skills and commitment, together with customers, suppliers and relationships with them, and intellectual property, organisational cultures and knowledge networks, were all recognised as key assets that provided the foundations for sustained value creation. There was also evidence that managers were recognising the need to ensure that the stock of their intellectual capital was being grown successfully. In order to facilitate this process, a number of initiatives were in place that involved the measurement of intellectual capital, using a range of soft metrics, often some distance removed from conventional financial numbers.
The greater part of this intellectual capital related activity was being pursued in the absence of any familiarity with the literature on the subject. Much of it seems to have occurred because such activities fit with the prevailing set of management practices that have been embraced by the different companies, rather than as a consequence of the diffusion of the intellectual capital fashion within the UK. Whether it will be possible to take the next step, reporting on intellectual capital management initiatives, both internally and externally, on the same basis, is debatable. There was evidence that management already recognises that reporting will be a more problematic exercise, and have made comparatively limited progress in this direction. They are also aware that it will not be easy to link such reports with those of a financial nature, which continue to be accorded significant importance by all parties. A collective lack of understanding about the possibilities for intellectual capital reporting, with its intimate business reporting associations, therefore exists as the major obstacle to further progress.
Expert opinion on intellectual capital and related topics confirmed that in the UK these are not yet widely understood ideas. A number of the consultants were concerned that what was beginning to be put in place in this regard might readily be replaced by the next wave of management prescriptions. The difficulties that intellectual capital poses for accountants and their financial reporting practices were widely recognised, with some respondents arguing that this might contribute to a failure to embed it within organisations. At the same time, however, there was evidence of concern about the continuing value of these reporting practices, and by implication support for the exploration of new and expanded approaches to reporting the value creating endeavours of companies. The sub-group of investment analysts and corporate lenders claimed to be able to take the growing importance of intellectual capital into account when assessing financial propositions. This was despite the absence of an informed view of either intellectual capital or how to report it. Of particular interest is the importance they place on the quality of management as a key determinant of prospective business performance.
Moving forward
On the basis of these findings it would appear that the process of managing and accounting for aspects of intellectual capital in the UK has just about reached the limits of possibility. Almost all of what has been achieved to date has happened with only a very limited understanding of, or familiarity with, the growing body of literature on intellectual capital and related ideas including intangibles and knowledge management. In order to ensure that intellectual capital practices become more firmly established, and thereby less likely to be swept away by the next management fashion, it is necessary for the UK accountancy profession to become better acquainted with the expanding stock of developments in accounting for intellectual capital. Of particular relevance are those exemplars of intellectual capital reporting practice that have been developed in the Nordic countries in recent years. Exhibiting a much greater reliance on narrative information than has traditionally been commonplace in conventional financial reports, these intellectual capital statements may also serve as a basis for a more general business reporting model, one that could be further enhanced by the inclusion of a corpus of intellectual capital self-accounts.
ISBN 1 871250 98 6
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