Two communities, one challenge – Intangibles
By Josh Martin
Just as national accounting has rules and guidelines set out in international documents like the System of National Accounts (SNA), so company financial reporting has similar rules in similar documents for that purpose. Both national accounting and company financial reporting are grappling with questions of how to measure the modern economy. This includes how to account for intangible assets (non-physical resources that provide value for their owners over time, such as software, knowledge, and intellectual property).
I recently had the opportunity to attend a meeting of the UK Endorsement Board’s (UKEB) Academic Advisory Group (AAG) which focused on intangible assets. The UKEB, an arm’s length body, is the UK National Standard Setter for international accounting standards. Its Board is responsible for deciding on the adoption of international accounting standards for use in the UK, but a lot of its work focuses on influencing standards which are under development by the International Accounting Standards Board (IASB) and shaping the international debate on financial reporting developments. The UKEB is undertaking research on intangible assets, while the IASB is considering how the international accounting standards on intangibles might need to be updated.
During the discussions, I was struck by the similarity of issues that the financial reporting and national accounting communities are grappling with – which intangibles to include, how to define them, how to measure and value them, how long they last and how quickly they depreciate, and what difference they make to our understanding of the economy. Since both communities can likely learn from each other, I wanted to try to bridge the gap with this blog.
National accounts include research and development (R&D), software and databases (both purchased and on own-account), artistic originals, and mineral exploration, as intangible assets. Digitalised data will be added as a produced intangible asset following the new guidance in the 2025 System of National Accounts (SNA).
By contrast, company financial accounting is more limited about internally generated intangibles that can be capitalised. At present, most financial accounting rules allow companies to include some things on their balance sheet as intangible assets that are generated internally – a process known as “capitalisation” – in much the same way as in national accounting. The alternative is to “expense” the same costs – i.e. treat them as current rather than capital expenditures. However, there is more scope for capitalisation of purchased intangibles, whether they are bought separately (e.g. purchased software) or as part of acquiring another business (the key references in IFRS are IAS 38 Intangible Assetsand IFRS 3 Business Combinations).
Financial reporting is arguably a little narrower than national accounting when it comes to intangible assets – a fact which might surprise some economists who think that the national accounts are very restrictive in this case. Neither measurement domain includes the broader set of intangible assets considered by economists, such as organisational capital, firm-specific training and human capital, branding, and design. There are also other differences, such as the approach to deprecation. Something both domains have in common is that it takes a long time to make changes to the rules.
Unlike the national accounts, however, there is a softer alternative in financial reporting to the strict identification of additional intangibles. Annual reports of companies typically consist of two components: a front “narrative” portion, which is unaudited, and a back “quantitative” portion containing the financial statements. This “second half” is audited and prepared adhering to requirements set out in accounting standards (either IFRS or local reporting frameworks).
The front part can describe intangible investments and assets via narrative descriptions and extra information, a process known as “voluntary disclosure”, without those things being necessarily included in the financial statements in the back half. Examples include assessments of project feasibility and likely success, future R&D plans, and even the share of revenues attributed to innovation. This provides information to potential investors and interested parties, without requiring the application of the accounting standards. Given the narrative and more qualitative nature the first half of the reports, it can provide information that serves a different purpose to the financial statements. However, this does mean the reader needs to do more work to find and interpret the information, including connecting the narrative with the financial statement information, or identifying disconnects between them.
A parallel here might be the use of experimental statistics to complement the core national accounts. The ONS publish “statistics in development” on intangible investment, which provide estimates on a different measurement basis to that in the core national accounts – imagining that more types of intangibles were treated as produced intangible assets. This sort of additional information provides a richer set of data for users and so improves understanding of the economy, without compromising the adherence to the rules for the national accounts.
Like the economic measurement community, accounting academics are studying the effect of accounting for intangibles. A first set of questions is whether firms are capitalising intangibles at all, what influences the probability of capitalisation, and what gets included. Despite increases over time, only about half of relevant firms capitalise R&D, and rates of capitalisation vary systematically by company characteristics. Economists using company financial accounts data on intangible assets should bear in mind this mixed approach to capitalisation – a challenge which has long been known.
Another focus is on company outcomes – for instance, do companies which put intangibles on their balance sheet do better, or is it important to also explain about intangibles via voluntary disclosure? In fact, the recent literature suggests that while capitalisation is useful, voluntary disclosure is the most important source of information for potential investors. Capturing this more qualitative information in a systematic way is difficult in economic analysis, so relying on only the capitalised elements of intangibles may miss important information.
Beyond the question of whether to capitalise intangibles, is the question of how to measure them. The use of “historic cost” (i.e. costs of investment) is easier but understood to give less relevant information at a company-level; meanwhile in the national accounts, this approach is often used, on the assumption that company-level inaccuracy is roughly balanced out at the aggregate level. An alternative is an assessment of the “fair value” (current market value if sold) or “future benefits” (discounted value of future income stream), which are both conceptually more appropriate but difficult in practice. National accountants have come to similar conclusions (discussed in detail in Martin et al., 2024).
I was inspired by the common challenges and efforts of the financial reporting and national accounting communities to better measure intangible assets. It was somewhat reassuring to me that, while the national accounts move slowly, we are not falling behind international financial reporting. There are no easy answers here, and the approach adopted by both fields seems to be continued research, case studies, analysis of measurement approaches, and discussion. Both communities might benefit from learning more from each other. I am grateful to the UKEB for inviting me to the meeting to learn from them and help to foster those inter-disciplinary discussions.
ESCoE blogs are published to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of ESCoE, its partner institutions, the Office for National Statistics, or the UK Endorsement Board.
