EXECUTIVE SUMMARY
Intellectual Capital: Tomorrow’s Asset, Today’s Challenge
by Barry Brinker, CPA

As technology continues to transform the workplace and markets, intellectual capital will become one of the most critical issues CPAs will have to grapple with in order to continue providing clients and employers high-quality, value-added services and advice.

Intellectual capital has been around for as long as companies have had customers. It’s what makes a company worth more than the sum of its countable parts. Yet when intellectual capital has been accounted for at all in the past, it has usually been described (quite inadequately) as goodwill. As a result, companies today significantly understate both their earnings and book capitals (all in accordance with generally accepted accounting standards). They do this by expensing the huge sums they spend on intangible assets such as brands, software, patents and employee training — which are often the sources of a company’s competitive advantage.

Defining Intellectual Capital

Before you can measure something, you have to know what you’re counting. So how should intellectual capital be defined? A universally accepted definition is the first step toward standardization. Some people mistake intellectual capital for nerds in a think-tank. Others confuse it with intellectual property (such as copyrights, patents and the like), which is actually merely a subset of intellectual capital. The truth is, we are still working toward a universal definition of intellectual capital. SEC Commissioner Wallman describes intellectual capital as assets currently valued at zero on the balance sheet, including items such as the following:

Human brainpower
Brand names
Trademarks
Assets booked at historical costs that have appreciated over time into something of much greater value.

Other experts define intellectual capital as the “combined intangible assets which enable the company to function” or “the sum of human capital and structural capital” (i.e., customer relationships, information technology networks and management.)

Intangible Assets

However it is valued, the gap between a company’s market value and the value of all its tangible assets has widened significantly over the last two decades. Market-to-book ratios are rising demonstrably, and so are price/earnings ratios. Simultaneously, corporate investments in tangible capital stock have been declining. As a result, traditional accounting measures can no longer adequately determine the real value of companies.

Evaluating intellectual capital can help make a company more efficient, more profitable, and more competitive. By identifying and measuring intellectual capital, executives are better prepared to:

Confirm the company’s ability to achieve its goals.
Plan and fund research and development.
Make decisions for reengineering programs.
Focus organizational education and training programs.
Assess the value of the enterprise for better comparisons and for benchmarking.
Expand the organization’s memory by identifying key resources and avoiding reinvention.

Why the Accounting Profession Should Care

Intellectual capital holds far-reaching implications for the accounting profession, which should seize the opportunity to help measure and audit what makes companies valuable. Rather than the historical and (supposedly) objective approach that has characterized financial reporting to date, valuation of intellectual capital will require immediate and imprecise measures. Can the accounting profession adapt?

Valuing intellectual capital is undoubtedly fraught with risk (though not valuing it may prove even more risky if it means that accounting will increasingly lose relevance). Placing a monetary value on intangible assets creates the potential for abuse. Even well-intentioned, honorable companies are vulnerable to lawsuits for misrepresentation should their honest projections prove wrong.

Moreover, intellectual capital cries out for standardization, including a new auditing process and certified measurement. Helping companies measure intellectual capital thus represents an important opportunity for accountants to shape their future. If accountants fail to take the initiative, management consultants and other professional service-providers will likely fill the gap.

So where to from here? In intellectual capital, the accounting profession has an exciting opportunity to bring its talent and experience to bear on an issue that will affect business fundamentally from now on. It is, moreover, a job not only for auditors, but for CPAs in business and industry, accounting educators, consultants and regulators, all of whom must work together to establish criteria for recognizing and measuring intellectual capital, implementing appropriate controls, and developing information systems.

View the complete article from which this is excerpted.