Sunday, July 21, 2024

The Intangible Assets Debate

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In the first episode of the Disney+ Beatles documentary, Get Back, there is a short interlude in which the lads from Liverpool meet with a British music executive, Dick James. James is there to discuss the Northern Songs purchase of a large song catalogue, which he says has the potential to bring in massive revenue to the company which is co-owned by John and Paul.

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In the world of music, owning the long-term publishing rights to songs is a major source of revenue. In fact, companies such as Royalty Exchange now offer the opportunity to purchase song rights to anyone with the capital to invest. Song catalogues are an example of what’s known in the accounting profession as an intangible asset—an asset that is not physical in nature, but has some type of value.

Intangible assets, such as data, algorithms, software, and copyrights, are driving the explosive growth of the digital economy. Seven of the world’s 10 largest companies were built on a data-first business model and it has been estimated that 70 percent of the value of companies listed on the TSX consists of intangible assets.

However, despite the growing importance of intangibles in our economy, accounting rules and financial reporting for these assets have not kept pace.

Current accounting practice treats intangibles as expenses to be written off rather than investments to be managed. As a result, many of the companies that rely on intangible assets—especially software-as-a-service (SaaS) and other technology businesses—have taken to developing their own internal metrics such as annual recurring revenue or customer churn to report their value. Though such measures can be useful, they lack the auditing and reporting rigor of other accounting standards.

CPA Ontario’s new report titled You Can’t Touch This: The intangible assets debate provides an overview of the importance of intangibles within our economy and lays out the ongoing debate in the accounting profession about whether to account for intangible value drivers in organizations and if so, how.

Proponents of maintaining the existing system contend that there are inherent risks in valuing intangible assets and that the profession shouldn’t lend credibility to potentially problematic valuations. Those advocating for new approaches argue that accounting for intangibles may help better articulate the contributions that intangibles make to business and to the broader economy.

A compromise may be found in a third position that advocates enhancing other forms of disclosure about internally generated intangible assets so that investors gain important information without pushing CPAs and auditors outside their professional expertise.

Whatever the ultimate solution, it’s important that the accounting profession work through this issue now. Business and policy leaders are already engaged in a conversation about valuing and reporting intangibles—CPAs need to make their voices heard on the matter.

As the potential of the digital economy continues to grow, the debate surrounding the valuation of intangibles will only intensify.  In publishing this report, CPA Ontario hopes to advance this critical discussion and ensure that CPAs are able to help build Canada’s forward-looking digital economy. Special guest blog by CPAO.

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