Who regulates the regulators? Newsletter January 2008

I turned down an invitation in early January to appear on a morning television business programme. They wanted me to talk about brand trends in 2008. I gave the reason that my field of brand valuation is so narrow that I could not imagine what I could say that would be of interest to their viewers.

Mulling over the prospect, I have since realised that there is a very clear trend emerging. It is quite esoteric, but has far-reaching consequences and is therefore the subject of this first newsletter for 2008.

Last August a friend, who is a board member of the International Accounting Standards Board (IASB), drew my attention to the International Valuation Standard Committee (IVSC). This London based body had historically represented property valuators. What sparked my friend’s interest was the discussion paper (DP) IVSC had issued and made available for public comment. The DP announces the decision of the IVSC to expand its area of interest beyond property. The new accounting standards (SFAS 141 in the United States and IFRS 3 elsewhere in the world) require measurement guidelines and as valuators of assets who better than an established body to issue them. This of course would require a restructuring of the IVSC to include subjects of measurement other than property, but this was a step they had decided was in their interests to take.

The DP serves a dual purpose: 1) it signals the expansionary intentions of the IVSC; 2) it is the initial phase necessary to developing a universally acceptable set of standards that will guide its expanded membership when valuing intangible assets. It is a bold step, because it gives notice to those who work in the field that the IVSC plans to broaden its coverage to include valuations far removed from property. That would draw in the valuation departments of the banks, accounting firms, management consultants, actuaries and many others who could well see this as a threat to their independence.

Unsurprisingly, my friend thought this would appeal to me. Of course it did.

The DP is very comprehensive and sets out a variety of issues related to the measurement of intangibles. In the process it recapitulates guidelines issued by the accounting bodies; reviews various valuation methodologies and goes into some detail about the principles of valuation. The IVSC called for comments on its draft by the end of October 2007.

For reasons that will be clear to all readers of this newsletter, I decided to respond and recruited a powerful ally to add credence and gravitas and to help me prepare a quality submission. Globally renowned brand academic, Professor Kevin Lane Keller, agreed to be my collaborator. Our joint submission arrived with the IVSC by due date at the end of October. You can see it at the IVSC website www.ivsc.org along with the other twenty that were submitted to the IVSC.

What the trend is

In 1990, based on a report by a group led by London Business School professor Patrick Barwise, the British Chartered Accountants of England and Wales decided that nothing would be gained if acquired brands were to be valued and admitted as balance sheet assets. Brands would, they suggested, fail to meet the accounting recognition criteria for an asset and in any event, they would not provide any information that analysts were not already in possession of. Nothing would be gained. As a result, the extant accounting standards would not be modified to recognise brands as assets.

It took just over a decade for this position to be reversed. First by the American Financial Accounting Standards Board (FASB) in 2001 when it finessed a few incremental changes it had brought about with the new SFAS 141. Then a few years later in 2005, the rest of the world followed suit by adopting the first International Financial Reporting Standards (IFRS) which included IFRS 3 Business Combinations.

The trend that is now established and which affects brands is that when companies are acquired in mergers and acquisitions, brands that are owned by the target firm are recognised as assets. Auditors have to measure them at their fair value. As I have written before, there are no guidelines as to how this should be done. At least not in most jurisdictions. Our local SA Institute of Chartered Accountants (SAICA) was ahead of the game eighteen months ago in preparing a statement and distributing it to members. But elsewhere industry is waiting for the various bodies to finalise their drafts and formalise valuation guidelines.

Enter IVSC. It has clearly spotted a gap which it plans to fill. In one stroke it could expand its membership and valuation coverage, and take ownership of a vital and growing area.

What the trend might be

It remains to be seen if the IVSC will succeed in this ambition. A cursory reading of the twenty responses (excluding ours) indicates that there is resistance. It is generally couched in gentle tones, but the message is that IVSC should not “go it alone” and that the timing is bad because other guidelines are quite far advanced.

Reading between the lines it seems that the big players would not appreciate another body getting in on the act. So time will tell how this plays out.

What has been revealing are the views expressed in the responses because these indicate the way the guideline – whoever issues them – will go.

• It will be principle based. This is one of those bureaucratic “slip off the tongue” phrases that have to be interpreted. It probably means that the guideline should not be prescriptive. It must state a set of principles that should be followed and not be emphatic as to how these should be applied. For example, as a matter of principle, valuations should be based on the “time value of money”.

• Theory should be left to the text books. Rather cynically I read this to mean that no one must interfere with the way different organisations go about the valuation of intangible assets. Not that I mind that one, but it was not a proposal that we promoted.

• Do not interpret the standards. There was a feeling that if this occurred the standards would become immutable. They must be allowed to evolve over time. I don’t quite see this connection: of course the standards must evolve over time and I don’t see why a 2008 interpretation of the 2008 standards would prevent this.

What we would like the trend to be

The one thing that is certain is that the recognition of intangibles (which includes brands) as assets is irreversible. Less certain at this stage, but quite probable, is that internally generated intangibles will become balance sheet assets in due course. It does however seem untenable that the brand of an acquiring company is not an asset while the brand it acquires is. This will have to be resolved and there are working groups around the world giving consideration to it.

For what it is worth, our view is as follows:

• It is essential that a global body (we don’t really mind if this is the IVSC, FASB, IASB or another) issues guidelines and helps auditors to assess if a valuation conforms to international norms or not.

• The guidelines must not prescribe the approach to be used, but should set out a set of principles that any methodology should follow. These are largely contained in the drafts issued by FASB and to some extent reviewed in the IVSC document.

• The principles should encompass the special characteristics that brands possess and which call for methodologies somewhat different to those currently in use by most valuation professionals. The differences are set out in our IVSC submission.

• The different approaches to acquired and internally generated intangible assets must be resolved as a matter of urgency.

I still don’t think this is a topic of much interest to an early morning, pre-breakfast television audience, but it is a trend nevertheless, and one that will eventually touch every business and every owner of a brand.