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Lucubrate Magazine, Issue 43, October 19th, 2018
Think about this simple statement, is it better, from a marketability and fund-raising perspective, to have more high-quality assets being reported than less! Being a no-brainer I suspect the answer is intuitively obvious and thus why is IC not being embraced. Difficulties in measurement is not a response! Consider Skandia!
In 1991, Skandia AFS formally established an Intellectual Capital function headed by a Director of Intellectual Capital-the first ever in the world. Oh, if 1991 seems ‘dated’, consider the history of lease accounting:
1949: The Committee on Accounting Procedure determined that operating lease accounting shouldn’t be used for long-term leases. They issued the bulletin, Disclosure of Long-Term Leases in Financial Statements of Lessors, which required finance leases to be recorded as a leased asset and long-term liability. However, since capitalization was not required by GAAP, most lessees still used off-balance lease reporting. (https://explore.leaseaccelerator.com/history-lease-accounting/ )
Buy a Company
“WHEN YOU BUY A COMPANY, what do you buy? The fixed assets? Or do you look for some more sustainable assets? What do you measure? The number of customers? The number of nodes in the network of the virtual corporation? What do you value? The number of working hours? The number of good ideas? The reason why Skandia started to focus on intellectual capital was, among other things, a need for a new logic regarding the development of knowledge-intensive services. This is based on the very simple metaphor of a tree with fruit as well as roots. For the long-term sustainability of an organization, it is much more important to focus on nurturing the roots than harvesting the fruit. The long-term idea might even be to get a new balance with a leadership focus on how the tree is flourishing. A focus on intellectual capital provides an effective instrument to manage and develop the company. It will also serve as a useful indicator when benchmarking the company against other companies. It will stimulate renewal and development. It is also a better tool for evaluating the soft assets of the organization. Therefore, in the final analysis, intellectual capital becomes at least as important as financial capital in providing truly sustainable earnings.” End quote. Long Range Planning, Vol. 30, No. 3, pp. 366 to 373,1997 (Leif Edvinsson)
Now consider these ‘Google’ definitions relative to Skandia and the concept of IC.
- Differentiation ~ businesses must differentiate themselves from the competition to stand out to potential customers.
- Commoditized ~ it is the movement of a market from differentiated to undifferentiated price competition.
- Holistic ~ characterized by the belief that the parts of something are intimately interconnected and explicable only by reference to the whole.
Competitive advantage ~ in business, a competitive advantage is an attribute that allows an organization to outperform its competitors. A competitive advantage may include access to highly skilled labor, geographic location, high entry barriers, and access to new technology.
Buy an Employee
Number one reason why managers fail: inability or ineptitude in retaining top talent. Many bosses have this attitude that anyone is replaceable easily like gloves, that they can hire someone even better. They are fooling themselves, and do the disservice to their company. A good employee has knowledge of systems, products, and processes. They have trust relationships with clients and co-workers that takes years to build. When you lose a good employee, you lose part of your culture. You lose part of your company and they may lose their own future.
Thus with IC, we’re looking at:
- Human Capital
- Customer Capital
- Structural Capital (Organizational Capital)
Last week we said, accounting for IC does, in fact, create a supplementary balance sheet also based on the debit and credit system in the same way as financial accounting standards.
Buy an Organization
Now, let’s try and put this into perspective. Let’s say we have two small entities one on the East Coast and one on the West. Both entities start off with the same capital, rent an office, purchase furniture and equipment and hire employees. Let us also assume that both businesses are attempting to find a cure for the common cold, certainly most desirable. Based on this information, the financial statements i.e. particularly the balance sheet would pretty much look identical. We’ll also make an assumption that the costs of setting up business were also very similar.
Having dropped a hint above, the founder, on the East Coast, is both a researcher and a doctor and has hired other doctors, researchers, to assist in the work. The entity however on the West Coast has a founder both a doctor and researcher but also a Ph.D. On the West Coast as well, the founder has hired a similar number of employees to assist in the work but besides being researchers and doctors, they are all Ph.D.’s as well.
Understand though that this additional information is still not disclosed in the financial statements, and at the surface level their financial statements are still very similar. It would be reasonable to assume that the providers of capital would consider that these entities have an equal opportunity to succeed. Let’s add a caveat that in both entities irrespective of qualifications the payroll is quite similar. At this juncture, all the expertise and knowledge can be classified as tacit.
Now let’s start mixing things up a bit. On the East Coast, the founder though very well-qualified and experienced has a certain disdain and indifference towards accountants and infrastructures. His/her time they believe is better spent focused on the mission of the entity, that is to produce a cure for the common cold. This attitude effectively creates the corporate, politically orientated culture such that the accounting (bean-counter) personnel are pretty much isolated to do their work and instructed not to interfere nor disturb the researching function.
On the contrary, the West Coast founder believes in a very participative style of management with all functions cooperating to help each other. (continued)
IC and knowledge management is accounting absent IFRS accounting standards. Such contrasting internal information is critically valuable.
Lucubrate Magazine, Issue 43, October 19th, 2018