The Importance of Intangible Assets

The Importance of Intangible Assets

Evaluation of Transitional Issues from a Canadian Standpoint

Contents

Topic Page

1. Executive Summary 3

2. Report

I. The Trade-off Between Relevance and Reliability 4

II. "Nothings" are Something to Consider 5

III. Current Practice in Canada 5

IV. The Challenge of Valuation 6

V. Analysis of Potential Improvements to Canadian Standards 7

• Issue One - Valuation

? Valuation and Business Combinations

? Solution to Valuation Issues

• Issue Two - Improved Transparency

? Recommendation for Improved Transparency

VI. Comparison of Canada, USA, and International Standards 9

? Goodwill and Initial Measurement

? Impairment Testing

? Intangible Assets Recognition

? Impairment Rules

? Amortization of Finite Lives Intangible Assets

? Impairment Testing of Indefinite Lives Intangible Assets

? Business Combination

3. Bibliography 14

Executive Summary

While intangible assets are proving to become more significant in their role in business today, the policies and practices used in accounting for them seems to fall short when it comes to representing the needs of users of the financial statements. Many significant intangible assets go unrecognized on financial statements due to the current accounting standards. Due to the importance of these intangibles to many companies, the identification of them would better satisfy the needs of financial statement users. However, a trade off between reliability and relevance exists when trying to account for certain intangible assets. Traditional accounting standards stressing reliable information may be too conservative when considering intangible assets. Conversely, recognizing intangible assets may provide relevant information to users, but prove to be unreliable when more information is available. However, given the less than perfect nature of valuation itself, companies should identify and recognize intangible assets when they play a significant role in the respective firms’ business.

Current accounting policies also inhibit a lack of transparency with regards to the disclosure of information relating to recognizable intangible assets. Items such as asset value fluctuations can go hidden to the financial statement users, thus affecting their decision making abilities. Creating an allowance accounting against the balances of the intangibles would provide users with a more reliable representation of the asset as a whole.

Comparison of current Canadian standards with current U.S. and international standards on the accounting of intangible assets indicates the overall policies are very similar. Therefore the harmonizing of Canadian accounting standards with U.S. and international policies will still leave room for improvement with regards to recognition, valuation and disclosure of intangible assets.

Report

The Trade-off between Relevance and Reliability

In order for financial information to be useful it should possess two qualitative characteristics—relevance and reliability. Financial statements that are relevant provide users with information about a company’s future economic prospects, such us future cash flows, dividends and short/long-term earnings feasibility. Reliable financial information is defined as information that is precise and free from bias. In pursuit of relevance the accounting profession has attempted to move toward fair value accounting or a "measurement perspective" to report for items such as pensions, debt and equity securities, and intangible assets. In order to maintain relevance and shift toward "fair value accounting" a company must use a great deal of estimates in arriving at an accurate picture of a firm’s market value. These