Jarett Decker discusses Singapore’s new Intangibles Disclosure Framework, developed in just 12 months to tackle a complex problem that “languishes elsewhere”.
This week in Paris, the International Accounting Standards Board (IASB) –the global rule-maker for corporate accounts–will convene its 2023 Research Forum on the seemingly sleepy topic of improving accounting for “intangible assets,” non-physical items of value in business such as intellectual property, brands, commercial data, and ongoing research and development (R&D).
But this initiative is critical to support growth in the knowledge economy. And the London-based IASB has some catching up to do. While the IASB is exploring research, one of its constituents in Asia—Singapore—is already implementing a unique solution to a growing global problem.
A long-building consensus among academics, investors, and other experts holds that the accounting rules issued by the IASB and its American cousin, the Financial Accounting Standards Board (FASB), are out of touch with modern business.
These rules were shaped for an earlier era when heavy physical assets—the property, plant, and equipment of railroads and industrial enterprises—were the cornerstone of the economy. Despite many revisions since then, accounting rules still don’t properly address intangible assets, which are today’s key drivers of value.
Here’s the issue: If a company undertakes a multi-year effort to construct a new factory, it does not have to treat its costs as a current expense that would reduce profits. It can store these costs as an asset on its balance sheet—a procedure called capitalisation—and then charge them as expenses over time once the factory starts operating and generating revenue.
But if the same company undertakes a multi-year effort to develop intangibles—by creating a new drug, transforming its use of data to solicit new customers, or building brand recognition in a new market—most or all of the costs must be treated as current expenses. This year’s profits are weighed down by expenditures that are actually investments in the future. And the costs of investing in the future are often mingled and hidden in the financial statements with current operating expenses.
The unequal treatment of investments in physical and intangible assets distorts accounting and financing, particularly in high-tech industries. As US researchers Baruch Lev and Feng Gu have shown, companies investing heavily in their own R&D often look like losers when gauged by their reported profits, because most R&D expenditures are deducted from current-year income under international accounting rules (and all are deducted under US rules). Many would be obvious winners if more R&D costs were capitalised.
Early-stage tech companies may have difficulty obtaining access to finance because they are invested heavily in intangibles, which do not show up as assets on their balance sheets.
Current rules also skew incentives for corporate managers. If a manager needs to show a bump in net income—perhaps to meet analysts’ expectations or earn a bonus tied to performance—she can simply reduce this year’s spending on R&D. That’s like burning the furniture to stay warm. But it looks like a spike in profitability.
Managers are also less accountable for poor investment choices if their investments are mingled with current costs and so hidden from view.
Not surprisingly, the IASB’s constituents are seeking change. In an April report, the EU-funded European Financial Reporting Advisory Group (EFRAG) asked the IASB to consider allowing increased capitalisation of the costs of developing intangibles as well as unbundling of expenses to distinguish the costs of investing in the future.
And in March, the UK Endorsement Board—the British counterpart of EFRAG—published similar calls from its stakeholders for updating and upgrading the rules, although one commenter lamented that reforms may not be worth the effort because a new accounting standard is “likely to take 20 years.”
Meanwhile, Singapore has moved forward on its own. In September, Singapore’s accounting and intellectual property authorities published their Intangibles Disclosure Framework, the first of its kind in the world.
The Singapore framework includes guidance on identifying, measuring, and managing intangibles. Disclosures will be voluntary. Singapore anticipates that its larger listed companies will serve as “champions,” developing approaches to implementation that others can follow.
The product of a public-private partnership with key stakeholders, the framework was developed with signature Singapore efficiency in 12 months, with another 9 months to finalise through public comment, revision, and public launch. The initiative is part of Singapore’s IP Strategy 2030, the country’s drive to become a global leader and Asia node in intellectual property development and investment.
Singapore launched the framework through announcements in local media, without much international fanfare. But the country has once again exploited its strengths of expertise, collaborative relationships between the public and private sector, and a “culture of continuous improvement and future orientation” to tackle a complex problem that languishes elsewhere.
Let’s hope it doesn’t take 20 years for the rest of the world to follow Singapore’s lead.
Jarett Decker, former Head of the World Bank’s Centre for Financial Reporting Reform in Vienna, is the Jacobs Chair of Excellence in Accounting at Middle Tennessee State University.