Invisible ink

"Regulation requiring companies to report on intangible assets is coming soon to the UK and other countries. Yet, argues Kim Warren ...

"Regulation requiring companies to report on intangible assets is coming soon to the UK and other countries.
Invisible inkYet, argues Kim Warren, unless investors understand how such ‘soft’ factors actually work through the business system to drive performance, they stand little chance of estimating the strength of a firms' strategy, or understanding likely performance prospects and value."

There has been considerable interest in recent years in the role that intangible factors, such as reputation, staff skills, and business relationships, play in the strategy and performance of commercial organisations. Executives fully understand the importance of sustaining these vital factors, and academics have devoted much effort to understanding how they operate. Lately, though, investors have also taken an increasing interest in intangibles, and regulators in both Europe and the US have also turned their attention to the issue. Underlying this interest is a concern that management, in an effort to deliver shareholder expectations, may inadvertently damage commercial fundamentals on which future prospects of the business rely.

The EU has published guidelines on the subject. And, in the UK, regulation is seemingly imminent after a consultation period.Us reporting requirements are heading in a similar direction.

The consultation document on the Operating and Financial Review and Directors’ Report (OFR), published by the UK’s Department of Trade and Industry, observes: “Company accounting and reporting remains essentially backward looking and based on financial indicators. There are few statutory requirements to report on the main qualitative factors which underlie past and future performance (or for future performance, even financial factors) – in particular on strategy, prospects, opportunities and risks; on intangible, and so-called ‘soft’, assets (which may contribute significantly to success but are not well captured in traditional financial statements); and on key business and wider relationships. As a result, the information provided is defective and directors do not have the discipline of accounting for stewardship on some key responsibilities.”

Moves to regulate the reporting of intangibles raise a fundamental question – would investors know what to make of information about intangible factors if it were provided? Managers with considerable experience of actually running a business find it hard enough to understand how intangibles impact on future performance. It is difficult to see how outsiders will be able to make sense of them. It is perhaps not surprising, then, that responses to the draft UK regulations suggest that boards and their advisors are uncertain as to how exactly to comply with the requirements.

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