What are the accountants up to now? BD Feb 2001

It is now one year since the South African accounting profession introduced new standards dealing with intangible assets and goodwill. Accounting standards guide auditors in how they should treat aspects of company affairs in the financial statements and they fall under the umbrella of Generally Accepted Accounting Principles (GAAP). The introduction, in January 2000, of accounting standards A.C. 129 dealing with Intangible Assets; A.C. 131 dealing with Business Combinations and Goodwill; and, A.C. 129 which introduces the related topic of Impairment Reviews, has started a process which ultimately will see accountants auditing the full value of companies including those company owned resources which they have historically ignored or swept under the carpet.

This year financial statements should be published featuring some of these new standards. But the auditors who prepared them will have encountered some difficult and confusing provisions. For example if a company bought another and paid a premium over the net asset value for the brands it was acquiring, how did it establish what proportion of the goodwill was represented by the brands and what was the value of each? The standard gives about three lines of guidance on this, and yet it is of crucial importance to the readers of the financial report. If the accountant managed to work that out and place the newly acquired intangible assets on the balance sheet, investors could well ask about the others the company owns. What others?

Well, if the brands that the company has just bought are recognised as assets on the balance sheet what about the brands the company already owns and which it has developed over many years? You guessed it; these are not assets in terms of the new standards because they do not conform to all the criteria resources are required to meet if they are to be recognised as assets.

Goodwill is another anomaly. We all know that goodwill is the part of a company’s value that the auditors cannot explain. It is the difference between what they say is the value of the firm’s assets and what the market (or a third party) says the firm is worth. While the one standard makes it clear that a brand that a firm has developed itself is not an asset, another states emphatically that the arithmetic difference that results in goodwill is an asset. What’s more it must be amortised over a period of twenty years and depreciated over that period. This strange piece of logic implies that the value the market places on the company now, will be systematically lost over time like a decaying building or aging motor vehicle.

A few years ago two American academics, Irene Herremans and John Ryans, examined the financial statements put out by a number of listed companies. They noted that all financial statements comprise two parts: the first is the report by the chairman and CEO and the review of operations. This is the publicity part in which all the good things the company has done or plans to do are set out in glowing prose. The second part contains the director’s report and analysis together with the financial statements. The authors conducted a content analysis on over twenty major brand-owning companies. They found that more than 70% of their sample talked in the first part about the leading position of their brands, how these brands create growth and of their marketing efforts to ensure this continues. Fewer than 30% carried this information forward to the second part. In other words the financial statements recorded the cause of much of the bottom line reported by the numbers, but the numbers did not follow through by showing the effect these vital strategies and actions had on shareholder wealth.

The new standards go part of the way to overcoming this dichotomy. But we are still some way distant from being presented with sets of accounts that tell the full story.

The good news is that the accounting profession is aware of this and is actively searching for new ways of disclosing company value. The newly structured, London based International Accounting Standards Committee (IASC) which has the task of harmonising global accounting standards and of researching and developing new ones, has it on its agenda. Work groups around the world, including South Africa, are studying the problem. But in the meantime auditors have to struggle with new standards which are by no means clear, and which will cause a few sleepless nights while they try to understand exactly what it is they are reporting.