INTANGIBLE ASSET ACCOUNTING AND ACCOUNTING POLICY SELECTION IN THE FOOTBALL INDUSTRY by NICHOLAS ROWBOTTOM A thesis submitted to the Faculty of Commerce and Social Science of The University of Birmingham for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Finance School of Business Faculty of Commerce and Social Science The University of Birmingham July 1998 University of Birmingham Research Archive e-theses repository This unpublished thesis/dissertation is copyright of the author and/or third parties.
The intellectual property rights of the author or third parties in respect of this work are as defined by The Copyright Designs and Patents Act 1988 or as modified by any successor legislation. Any use made of information contained in this thesis/dissertation must be in accordance with that legislation and must be properly acknowledged. Further distribution or reproduction in any format is prohibited without the permission of the copyright holder. ABSTRACT
The main aim of this thesis is to evaluate the feasibility of intangible asset accounting in financial reporting with particular reference to the football industry. It also examines related accounting policies. Lack of reliable measurement is the major obstacle to the recognition of intangible assets. The measurement of intangible assets is problematic due to a lack of verification through reference to an active market. However, drawing on Human Resource Accounting, the thesis argues that identifying and measuring human resource assets may be possible in the football industry.
The human resource asset, the player registration, is subject to sufficient control through unique industry structures to justify recognition as an intangible asset. The existence of an active market for player registrations facilitates reliable measurement. In the football industry, a wide variety of accounting policies are employed in accounting for player registrations and other material transactions. Hypotheses regarding the reasons for selecting particular accounting policies are developed and tested.
Findings suggest that institutional pressure which influences perceptions of legitimacy and credibility can affect the selection of accounting policies. The thesis also develops and tests a model to value player registrations as intangible assets where they are not subject to market transactions. The ability to reliably measure intangible assets is regarded as crucial to their recognition in financial reporting. In addition, it will lead to the acceptance of intangible asset policies as legitimate and credible, despite the market orientated bias of traditional financial reporting.
ACKNOWLEDGEMENTS May I thank and acknowledge the following in producing this thesis; Andrew Thomas for supervision; the Professional Footballers Association, The Football Trust, the Deloitte & Touche Football Industry Team and the football clubs themselves for the provision of information; Timothy Isherwood for data collection, James Cessford, Douglas Leonard, Stephen Thorpe, Alexander Burfitt, Matthew Brough, Ms Blurton, and my family for support, help and inspiration. CONTENTS Chapter Introduction 1 The Nature and Treatment of Intangible Assets 1. 1 1. 2 1. 3 1. The Nature of Intangible Assets The Importance of Intangible Assets Development of Accounting Standards for Intangible Assets in the UK International Accounting Standards for Intangible Assets Page 1 5 2 The Measurement of Intangible Assets 2. 1 2. 2 2. 3 Financial Reporting Requirements Valuation Models The Amortisation of Intangible Assets 26 3 Human Resource Accounting 3. 1 3. 2 3. 3 3. 4 3. 5 The Human Resource as an Asset The Relevance of Human Resource Accounting The Measurement of Human Resources The Development of Human Resource Accounting Consequences of Human Resource Accounting 44 4 The Football Industry . 1 The Nature and Structure of the Football Industry 4. 2 Finance in the Football Industry 4. 3 Transfer Fees 4. 4 Signing-on Fees 4. 5 Stadium Redevelopment 71 5 Accounting Policies in the Football Industry 5. 1 Accounting for Player Registrations and Transfer Fees 5. 2 Accounting for Signing-on Fees 5. 3 Capital Grants 5. 4 Depreciation of Stadia 106 6 Theoretical Framework for Studying the Selection of Accounting Policy Choice 6. 1 Theories of Accounting Policy Choice 6. 2 Explanatory Variables 6. 3 Statement of Hypothesis 138 7 Methods of Data Collection and Analysis 7. 1 Sampling 7. 2 Bank Questionnaire 7. Football Club Questionnaire 7. 4 Variable Construction 7. 5 Model Specification 7. 6 Parameter Estimation 7. 7 Sensitivity Analysis 168 8 Test Results and Interpretation 8. 1 Underwriter Pressure Hypothesis 8. 2 Debt Contracting Cost Hypothesis 8. 3 Youth Development Hypothesis 8. 4 Ownership Structure Hypothesis 8. 5 Normative Influence Hypothesis 8. 6 Political Cost Hypothesis 222 9 The Feasibility of Intangible Asset Accounting in the Football Industry 253 9. 1 Transfer Fee Accounting 9. 2 The Measurement of Player Registrations 9. 3 Valuation Model for Player Registrations 9. 4 Conclusions Conclusions Appendix 1
A1. 1 Bank Questionnaire Cover Letter A1. 2 Bank Questionnaire 292 300 Appendix 2 A2. 1 Club Questionnaire Cover Letter A2. 2 Football Club Questionnaire 305 Appendix 3 Appendix 4 Appendix 5 Appendix 6 Appendix 7 A7. 1 Multicollinearity A7. 2 Model Assumptions 312 321 322 323 328 Bibliography 332 INTRODUCTION One of the main aims of this thesis is to evaluate the feasibility of intangible asset accounting in financial reporting with particular reference to the football industry. It therefore focuses on Human Resource Accounting which is concerned with the process of identifying and measuring human resource assets.
The football industry provides a unique case where reliable recognition and measurement of human resource assets may be possible. The other main aim of this thesis is to examine related accounting policy-making issues in the football industry. This includes an empirical study designed to identify the factors that influence accounting policy choice. In addition, the thesis contains further empirical work aimed at providing a model for valuing internally generated human resource assets in a manner acceptable for financial reporting purposes.
Much of the recent debate over intangible asset accounting has focused on accounting for brands. The main points of contention concern the identification of a single brand asset and the measurement of internally generated brand assets. Similar issues are prevalent in the football industry. Some football clubs have recently begun to apply Human Resource Accounting techniques in accounting for transfer fees. This results in player registrations being recognised as intangible fixed assets. Thus, debate over intangible asset accounting is also particularly relevant in this industry.
The football industry has experienced a period of rapid growth in the last decade. Several clubs have recently been listed on the London Stock Exchange, and thus their finances are coming under greater scrutiny. There has been little financial research in the football industry, particularly in the light of industry changes. The thesis also aims to contribute to current knowledge on the relationship between economic and organisational variables, and accounting policy choice. Previous empirical research has tended to focus on particular types of organisation; the largest firms listed on a stock exchange.
The universal applicability of existing theories can be explored given the unique setting of the football industry. Existing theories of accounting policy choice can be argued to be entrenched in paradigms. For example, positive accounting theory is dependent upon the values of ‘Chicago School Economics’. This thesis explores common elements of existing theories. Furthermore, it seeks to develop new social and organisational variables which may influence accounting policy choice. This includes investigating indirect influences of accounting policies (and standards) upon cash flows.
Thus, this work aims to provide a possible contribution to the practical considerations relating to the regulatory framework of accounting as well as other broader socio-economic and political issues. Chapter 1 examines the nature and treatment of intangible assets. It first considers the definition of intangible assets. This is followed by a review of the growth and development of intangible asset accounting, including its relationship with changing economic structures and the current system of financial reporting. It then describes the development of financial reporting standards on intangible assets.
The final section explores the current generally accepted accounting principles for intangible asset accounting in the UK and internationally. Chapter 2 examines various methods of measuring intangible assets. It starts by describing the current measurement criteria for financial reporting purposes. Various methods of measuring intangible assets are then evaluated. These include acquisition costs, current costs, estimates of economic value, exit prices, market values, opportunity costs and qualitative measures. The aim is to assess which types of measure may be suitable for financial reporting purposes.
Finally, it describes the amortisation of intangible assets. The relevance of Human Resource Accounting is explained in Chapter 3. HRA is intended to measure the contribution of labour to an accounting entity. This chapter evaluates the existence of a human resource asset and explores the applicability of Human Resource Accounting in financial reporting. The intangible benefits of labour and their relevance in organisational decision-making and regulation are outlined. Various measurement approaches designed specifically for human resource assets such as wage based valuation models, are explored.
Finally, the potential uses of human resource accounting information are evaluated. Chapter 4 describes recent developments and special issues in the football industry. This industry has unique structures and transactions to which Human Resource Accounting is particularly applicable. It is also an object of study in its own right. The structure, funding and financing of the industry are examined in the light of its recent growth and commercialisation. The first section describes labour market restrictions and income sharing agreements.
The second considers sources of funding, income streams and the main items of expenditure in the football industry. The final parts of the chapter focus on the special characteristics of transfer fees, signing-on fees and stadium redevelopment. Chapter 5 reports the results of a survey into the accounting policies used by football clubs. This is generated from the 1995 financial statements of 102 English and Scottish football clubs. It examines the accounting policies used for four material types of transactions. Namely, transfer fees, signing-on fees, capital grants and stadium depreciation.
Chapter 6 explains the theoretical framework used to generate the hypotheses relating to the selection of accounting policies in the football industry. It examines the different explanations put forward in the existing literature relating to the associations between economic variables and accounting policy choice. The thesis then seeks to combine some of these theories, which it is argued, are not mutually exclusive. Finally, six hypotheses are generated relating to underwriter pressure, debt contracting costs, youth development, ownership structure, normative accounting influences and political contracting costs.
Chapter 7 describes the methods of data collection and analysis. It starts by explaining the methodology for studying the selection of accounting choices. The sampling and data collection techniques, including the responses to two postal questionnaires, are then outlined. Finally, it also describes the construction of variable measures and the statistical tests used. The results of the accounting choice study are analysed in Chapter 8. Statistical test results and qualitative analysis are used to assess the validity of the proposed hypotheses.
Chapter 9 considers, in detail, the legitimacy of identifying and recognising football player registrations as intangible assets in financial reporting. It evaluates the possibility of reliably measuring intangible assets in the absence of a market transaction. In doing so, it presents a valuation model for internally generated football player registrations. Finally, conclusions are drawn relating to the future of financial reporting in the football industry, factors influencing the selection of accounting policies and the feasibility of intangible asset accounting.
This chapter also highlights areas for future research and suggests implications for accounting policy making. CHAPTER ONE THE NATURE AND TREATMENT OF INTANGIBLE ASSETS Introduction This chapter reviews the current and possible future accounting treatment of intangible fixed assets in financial reporting. It starts by examining the nature of intangible assets. It then goes on to explain the importance of intangible assets in the modern economy. The relationship between the nature of intangible assets and the present method of financial reporting is explored.
The bulk of the chapter then reviews the development of standards in accounting for intangible assets in the UK and other developed countries. 1. 1 The Nature of Intangible Assets Intangible assets are defined as fixed assets of an intangible nature. To meet the definition of an asset, access to the future economic benefits it represents are controlled by the reporting entity, either through legal protection or physical custody. They are intangible in that they have no physical substance and are non-financial. The asset must be identifiable in that it is capable of being isposed of or settled separately, without disposing of a business of the entity [ASB, 1997]. Intangible assets entail expectations of economic benefits that carry no legal rights, or legal rights in relation only to persons at large rather than to specific persons. Common examples of intangible assets include licences, quotas, patents, copyrights, franchises and trade marks. For the purposes of this thesis, the definition of intangible assets excludes goodwill, leases or development expenditure. These items are, where appropriate, dealt with separately due to their differing nature.
Separate financial reporting standards exist for development expenditure and leases. Goodwill is assumed to differ from intangible assets in that it is not separately identifiable; it cannot be disposed of separately without disposing of a business of the entity 1 . 1. 2 The Importance of Intangible Assets At present there is little consensus over the treatment of intangible assets in financial reporting. The increasing significance of intangible assets has fuelled discussion over their nature and treatment.
The lack of consensus over their treatment leaves scope for manipulation and results in a lack of comparability. Generally accepted accounting principles were established under a predominantly manufacturing-based, economic structure. Hence, emphasis has been placed on the tangible assets of an entity and intangible assets have been largely ignored. It can be argued that due to changing technology, this type of economic structure and the accounting rules that are derived from it are outdated. These rules ignore many of the flows of the modern, knowledge-based economy.
In the latter half of the twentieth century, there has been a qualitative transformation to technology intensive industry where different blends of resources are used. In this environment, value is principally comprised of intangible rather than tangible factors. For example, a feature of the modern economy is the creation of added value through product differentiation. However, such flows are, at present, ignored by accounting standard setters. It is argued that the gap between book values and market values of organisations in the UK is growing.
A 1990 study by Higson found the amount paid for goodwill as a 1 This distinction is not universally held. Goodwill and intangible assets are often grouped together for the percentage of an acquirers net worth rose from 1% in 1976 to 44% in 1987 [ASB, 1993b]. This represents an increasing number of factors which are valuable to a buying organisation but are not recognised in financial reporting. Under current accounting practice, it is difficult to assess rates of return on intangible assets or evaluate shifts in their characteristics [Lev, 1997].
It is argued that a historical cost framework cannot accommodate the recognition of intangible assets. Attempts have been made to reflect the changing economic structure. For example, the principle of substance over form requires that the economic substance of a transaction rather than its legal form be accounted for. It was developed to ensure that certain types of liability did not escape recognition [Power, 1990]. The substance of a transaction is represented as it more accurately reflects the economic activities of an organisation.
This has been acknowledged in FRS 5, Reporting the Substance of Transactions. It seeks to represent the commercial effect of a transaction with respect to assets and liabilities. The debate over the recognition of intangible assets is said to stem from a lack of consensus on the objectives of financial reporting [Pizzey, 1991]. A matching, historical cost approach recognises realised gains and is grounded in past events and actual transactions of a reporting entity. It is compatible with the function of stewardship and accountability.
A current valuation approach deals with the current opportunities of the entity and recognises all gains. Such an approach aims to provide predictive and market-orientated information. The balance sheet shows the current value of the entity whereas a historical cost balance sheet is purposes of financial reporting. See below. said to be a depository for the unexpired costs and revenues derived from the transactions of the entity [Davies et al, 1997]. The objectives of financial reporting are laid down in chapter 1 of the Accounting Standards Board’s Statement of Principles for Financial Reporting.
They are the provision of information about the financial position, performance and financial adaptability of an enterprise that is useful to a wide range of users for assessing the stewardship of management and for making economic decisions [ASB, 1995b]. It is conceded that financial statements do not provide all information that may be needed to make economic decisions. The objective encompasses both a decision-usefulness function and a stewardship function. An assessment of management is assumed to aid in making economic decisions. Thus, it is inferred that decision usefulness is the primary objective of financial statements.
By meeting the needs of investors, financial reports will also meet the needs of other users. Intangible assets are mostly rejected from inclusion in financial reporting under a historical cost perspective because their existence is not verifiable and they cannot be measured with the same degree of reliability as tangible assets. However, intangible assets have an impact on the financial position, performance and adaptability of an enterprise. They influence an organisation’s ability to generate cash. Therefore, if intangible assets influence economic decisions, then their inclusion in financial reports will improve decision usefulness.
In addition, management should be held accountable for all the assets/liabilities to which they are entrusted to satisfy the stewardship function. Such assets may be of a tangible or intangible nature. The inclusion of intangible assets in financial reports is dependent upon a trade off between relevance and reliability. Information on the intangible assets of the entity is relevant to economic decision making. However, the reliability of that information is subject to difficulties in ensuring the existence of intangible assets and measuring their value.
This trade off reflects the dichotomy in financial reporting objectives; to provide reliable information for stewardship purposes or to provide relevant information for decision making. The current objective in the Statement of Principles for Financial Reporting appears to be a hybrid of these paradigms. This has led to much disagreement in setting accounting standards for intangible assets. 1. 3 Development of Accounting Standards for Intangible Assets in the UK a) Company Law Financial reporting in the UK is subject to company law. However, little guidance is given regarding intangible assets.
The main body of law relevant to financial reporting is found in the Companies Act 1985. Schedule 4 of the Companies Act 1985 requires separate disclosure of intangible assets but is silent on their treatment. It lists ‘concessions, patents, licences, trademarks and similar rights and assets’ as intangible assets in its balance sheet formats. It also prohibits the costs of research to be recognised as assets. Amounts shall only be included in the balance sheet if the assets were created by the company or acquired for valuable consideration and are not required to be shown under goodwill.
Schedule 4A of the act requires that identifiable assets be recognised in the balance sheet of the accounting entity. Identifiable assets are defined as assets that are capable of being disposed of or discharged separately, without disposing of a business of the undertaking [Goldenberg, 1991]. b) Statement of Standard Accounting Practice 22; Accounting for Goodwill Until December 1997, the treatment of intangible assets in the UK was officially governed by SSAP 22, Accounting for Goodwill, issued in 1984 [ASC, 1989].
It states that assets of an intangible nature can be recognised in financial statements provided they are separable. Separable net assets are defined by SSAP 22 as assets that can be identified and sold separately without necessarily disposing of the business as a whole. This definition was superseded by FRS 7, Fair Values in Acquisition Accounting. The term, ‘separable net assets’ was replaced by ‘identifiable assets’. An intangible asset was identifiable where it was capable of being disposed of or settled separately, without disposing of a business of the entity [ASB, 1994b].
Identifiable assets are to be disclosed on the balance sheet. The recognition of intangible assets in financial statements is based on their identity being separable from other assets, particularly goodwill. The test of separability is whether an asset is capable of independent sale, without disposing of the business as a whole. Legal rights such as publishing titles, concessions, patents, trademarks, licences, customer lists and franchise rights are listed as examples of recognisable intangible assets.
Intangible assets that meet recognition criteria are to be capitalised at their fair value and depreciated over their useful economic life. Accounting standard setters have traditionally followed an apparently logical approach of identification, recognition and measurement in assessing whether an item should appear in the financial reports of an entity [Napier and Power, 1992]. However, under SSAP 22, this process is inter-related as recognition is based on identification. Recognition of an asset is dependent on the ability of the asset to be disposed of separately from the business.
Identification or separability can be said to be dependent on the choice of measurement technique used. For example, if an asset is measured by its market value, this implies it is separable in that it can be sold without disposing of the business as a whole. If an item is separable, it can be recognised as an asset. Thus, recognition is entwined with measurement. SSAP 22 states that recognisable intangible assets must be carried on the balance sheet at their fair value. In the UK, the fair value of an asset is derived from its acquisition cost.
Thus, if recognition is dependent upon identification, and identification is dependent upon measurement, there will be a preference for recognising only items to which an acquisition cost can be attributed [Napier and Power, 1992]. Many intangible assets do not arise from a single market transaction and there is usually uncertainty over the costs of creation. Fair values for such assets are more difficult to estimate. This explains why accounting standard setters more readily recognise purchased intangibles rather than nonpurchased intangibles. No explicit distinction is ade in SSAP 22 between the treatment of purchased and non-purchased intangible assets. However, the recognition of purchased intangible assets in the balance sheet is less stringent because their fair value can be established with greater reliability. Under such treatment, organisations that grow organically will suffer whilst companies who grow by acquisition will recognise intangible assets because their fair value can be determined upon acquisition. SSAP 22 was issued primarily as a standard on goodwill. The close relationship between intangible assets and goodwill has led to difficulties over the treatment of intangible ssets. Goodwill can be defined as a bundle of unidentifiable intangible assets. Purchased goodwill is the difference between the consideration expended in an acquisition and the fair value of the separable net assets acquired. Purchased goodwill can be viewed as a payment made in the anticipation of future income. The accounting treatment of purchased goodwill is an anomaly in that it is inconsistent with other aspects of financial reporting whichever method is used. If it is recognised as an asset, it is inconsistent with the treatment of internally generated goodwill but consistent with the treatment of other fixed assets.
If it is written off immediately to reserves, it is inconsistent with the treatment of other elements of a purchase transaction. It has been said that what is an intangible asset to some is goodwill to others. This permits arbitrage. SSAP 22 prefers purchased goodwill to be immediately written off to reserves. It also allows goodwill to be capitalised and written off through the profit and loss account over its useful life. Thus, after SSAP 22 was issued, an organisation could decide whether to capitalise or write off purchased goodwill. A majority of organisations follow the preferred treatment outlined in SSAP 22.
A 1993 investigation by the Financial Times found that 96% of companies wrote off goodwill upon acquisition [ASB, 1993b]. However, heavily acquisitive companies began to experience an erosion of their reserves after writing off purchased goodwill. The alternative treatment of capitalising purchased goodwill meant that companies suffered amortisation charges in the profit and loss account. However, it was possible to reduce the amount of purchased goodwill written off to reserves by identifying intangible assets. Purchased goodwill could be converted into purchased intangible assets.
Companies became inventive in the recognition of identifiable intangible assets, particularly acquired brands. It was subsequently claimed that such assets would remain unamortised as their value had been maintained or enhanced. Such a policy avoided any amortisation charge to the profit and loss account. Therefore under SSAP 22, organisations can reduce the level of purchased goodwill written off to the profit and loss account by ‘compartmentalising’ purchased goodwill into intangible assets. Thus, organisations have an incentive and the ability to recognise and capitalise intangible assets after an acquisition.
The recognition of intangible assets after an acquisition can improve the reported results of an organisation. This is consistent with positive accounting theory on the selection of accounting policies proposed by Watts and Zimmerman . They assert that corporate management will take any discretionary action they have over the financial reporting process to present themselves and/or their organisation in a desired manner. Standard setters have responded to the possible arbitration between purchased goodwill and purchased intangible assets with attempts to introduce a new standard.
However, it is claimed that SSAP 22 allowed companies to spend heavily on wasting assets without having to write the costs off against profit. Therefore, standard setters found it difficult to withdraw this privilege [Fisher, 1995]. Since being issued in 1984, little consensus had been reached on an acceptable alternative to SSAP 22. During this time, it can be said that SSAP 22 had become largely defunct. c) Exposure Draft 52, Accounting for Intangible Fixed Assets The Accounting Standards Committee (ASC) attempted to align the treatment of purchased intangible assets and purchased goodwill.
ED 52, Accounting for Intangible Fixed Assets and ED 47, Accounting for Goodwill were released in 1990. In ED 52, the criteria for the recognition of intangible assets were threefold; 1) the historical costs of creation of the item were to be known or readily ascertainable, 2) its characteristics were to be clearly distinguishable from goodwill and other assets, and 3) its cost was to be measurable independently of goodwill, other assets and earnings of the relevant business segment [ASC, 1990]. For non-purchased intangible assets, ED 52 required an active market, independent of the purchase and sale of business segments.
Items that passed the recognition criteria were to be capitalised and amortised. The useful economic life of an intangible asset was not to exceed twenty years or forty years in exceptional cases. ED 52 (and ED 47) met with widespread disagreement and disapproval from the business community [Kennedy, 1995]. It specifically addressed an increase in the popularity of recognising brands as intangible assets. It stated that brands were not distinguishable from goodwill and should not be subject to separate recognition. Criticism was also made of the mandatory amortisation charge which was applicable to all intangible assets. 2% of respondents to ED 52 opposed fixed life amortisation proposals [ASB, 1993b]. Companies felt that they had spent heavily to maintain and enhance the value of intangible assets and felt it inappropriate to suffer an annual amortisation charge where their value had not decreased. Due to extensive opposition, ED 52 was withdrawn. d) Discussion Paper; Goodwill and Intangible Assets A discussion paper, Goodwill and Intangible Assets, was released by the ASB in December 1993. Again, the discussion paper proposed that intangible assets were so similar in nature to goodwill that they should be subsumed within goodwill.
An exception was made to purchased legal rights, presumably patents and trademarks, which could be capitalised at their acquisition cost and amortised over their useful life. Internally created intangible assets were not to be recognised in the balance sheet. Purchased intangible assets were to be treated as purchased goodwill. Six treatments of purchased goodwill were suggested. Two approaches were recommended. The first recommendation suggested writing off goodwill immediately on acquisition to a separate write off reserve. The second ecommended option stated that goodwill should be capitalised and written off over its useful economic life. If its useful life could not be estimated, the book value of goodwill would be subject to annual review [ASB, 1993b]. Respondents to the discussion paper criticised the alignment of intangible assets and goodwill. It was stated that they were critical to business and should be accounted for separately [ASB, 1995a]. Only 35% of respondents to the discussion paper supported the recommended treatments [Accountancy, 1995b]. Hence, no exposure draft was formulated due to the lack of consensus. Instead, further consultation was sought. ) Working Paper; Goodwill and Intangible Assets In June 1995, the ASB released Goodwill and Intangible Assets: Working Paper for Discussion at Public Hearing. The paper sought to set out proposals for public discussion that could be further developed for exposure. It stated that an item was subject to identification by meeting the definition of an intangible asset. An asset was defined as an item having rights or other access to future economic benefits controlled by the entity as a result of past transactions or events. An intangible asset was identified where control over future economic benefits was apparent hrough legal protection or physical custody. Emphasis was placed on the ability to obtain and enjoy benefits (or restrict the access of others to benefits) rather than ownership. To be included in financial statements, an item must have passed recognition criteria. There must be sufficient evidence of a change in the asset and that a future inflow will occur. An item must be measurable at a monetary amount with sufficient reliability. Sufficient reliability was dependent upon the variability of future economic benefits; both the spread of possible benefits and the probability of obtaining a benefit.
Transactions that were negotiated at arms length for monetary consideration were considered strong evidence of reliability. For intangible assets that have arisen from a transaction, it was proposed that recognition would occur where the reliable fair value of the asset could be measured. The least disputable measure of fair value was attained where a reliable market value existed. A reliable market value was obtainable from frequent transactions in a homogeneous population of identical assets. Replacement cost was permitted as a reliable fair value where there was a continuing market for the initial issue of an asset.
For internally generated intangible assets (those not arising from a single transaction), recognition in financial statements would only occur where a reliable market value existed or where there was a natural ceiling on the value of the asset. Those intangible assets that met the recognition criteria were to be capitalised and written off over the useful life of the asset if less than twenty years. Intangible assets with useful lives greater than twenty years were subject to annual impairment tests. Intangible ssets were to be shown separately in the balance sheet with opening and closing balances and movements during the year displayed in the notes. The Working Paper was discussed at a public hearing in October 1995. The ASB announced that their proposals were supported by approximately 60% of respondents [Accountancy, 1995b]. Hence, a Financial Reporting Exposure Draft was based on this approach. f) Financial Reporting Exposure Draft 12; Goodwill and Intangible Assets FRED 12, Goodwill and Intangible Assets, was released in June 1996 and supersedes SSAP 22. It was based on the Working Paper and subsequent responses.
The identification criteria for intangible assets remained the same. Recognition was undertaken where a fair value could be measured reliably. Purchased intangible assets were to be recognised at their cost. Internally generated intangible assets were to be recognised only if they have a readily ascertainable market value. FRED 12 differed from the Working Paper in limiting the economic life of intangible assets. There was a rebuttable assumption that the useful economic life of an intangible asset was not to exceed 20 years from the date of acquisition. Any departure from this assumption must be based on valid grounds and be disclosed .
Assets with lives under 20 years were subject to systematic amortisation. Assets with lives over 20 years were subject to annual impairment reviews [ASB, 1996]. Where identification is based upon securing or preventing access to economic benefits by legal protection, the Working Paper proposed that the useful economic life of the asset may not exceed the period of legal protection. This was altered to allow asset lives to exceed legal protection where renewal is assured. This change was made to mirror commercial practice with respect to contracts, licences and patents.
Responses to the exposure draft were received by October 1996. The ASB finally decided to issue a Financial Reporting Standard based on FRED 12 with no material changes. Hence, FRS 10, Goodwill and Intangible Assets, was released in December. g) Summary The difficulty in obtaining support for a standard on intangible assets over the last decade is due to divided opinion amongst the users and preparers of financial reports. Accounting standards must gain the support of the whole business community due to the lack of full legal backing for standard setters in the UK.
The formulation of accounting standards is a political process. For example, the intangible assets standard has been subject to considerable lobbying by those with a financial interest in the outcome. Auditors, brand valuation and trademark specialists are said to support the recognition of goodwill and intangible assets as they will benefit financially [Fisher, 1995]. The policy that gains the support of the business community may not necessarily be theoretically consistent and logical. Identification of intangible assets is based on control over the future economic benefits through legal protection or physical custody.
Identified intangible assets should be recognised where a reliable estimate of the asset’s fair value can be made 2 . 2 The measurement of intangible assets is discussed in Chapter 2. The wisdom of allowing intangible assets (and goodwill) to be capitalised without fixed life amortisation is disputed. It is argued that intangible assets are transitory; that one intangible asset is not being maintained but is continually substituted by a new asset. Thus, a purchased intangible asset will depreciate over time but will be succeeded by a new internally generated asset.
This view is inconsistent with the latest ASB proposals. The scope for the recognition of intangible assets on the balance sheet has been widened. From its Working Paper to FRS 12, the ASB has become more explicit about the treatment of intangible assets. Whilst intangible assets and goodwill are treated similarly, standard setters have acknowledged the role of intangible assets in financial reporting. 1. 4 International Accounting Standards for Intangible Assets a) International Accounting Standards Committee Disagreement over intangible asset accounting is not confined to the UK.
The international standard setting body, the IASC have found difficulty in reaching a consensus over the treatment of intangible assets. IAS 22, Accounting for Business Combinations, released in 1983, provides similar guidance to SSAP 22. IAS 22, subject to the provisions of the EC fourth directive, stated that purchased goodwill was to be capitalised and amortised or written off immediately to reserves. If capitalised, the useful economic life of goodwill was to be no greater than five years. No explicit statement is made regarding the treatment of intangible assets.
Thus, intangible assets could be recognised if separable from goodwill. Items that were not capable of separate disposal were treated as purchased goodwill. Revision was made to IAS 22 by E 32, released in 1989. It limited the treatment of purchased goodwill to capitalisation and amortisation. Further revisions were made in 1993. However, the treatment of intangible assets was not materially affected. The role of international standards became more influential in 1995 when the IASC agreed a programme to create a set of core international standards with the International Organisation of Securities Commissions.
These standards would be used in all the major international capital markets. It also appeared that these standards would be adopted by the European Union. Thus, work began on standards that would be consistent and internationally acceptable. E 50, Intangible Assets, was released in June 1995. It dealt solely with intangible assets and was designed to align their treatment with tangible assets. It proposed that items meeting three criteria should be recognised on the balance sheet and amortised over a maximum period of 20 years. 1) an item meets the definition of an intangible asset.
That is, an item must be non-monetary, without physical substance and identifiable in that it is subject to legal rights or is separable from the business to which it relates. 2) it must be probable that future economic benefits associated with the item will flow to the entity. Thus, the role that an item will play in enhancing expected benefits must be demonstrated alongside an asset’s ability to perform that role and the entity’s intention to use the item in that role. 3) the cost of an item must be capable of reliable measurement.
It was claimed that the requirements of E 50 would permit few intangible assets to be recognised [Cairns, 1995]. It restricted the recognition of brands as their value could not be measured with reliability. Comments were received by November 1995. Respondents claimed that the 20 year ceiling on the useful life of assets did not reflect economic reality. In addition, lack of consensus between the major national standard setters limited the development of E 50 into an International Accounting Standard. E 60, Intangible Assets, was released in August 1997.
It applied to all intangible assets: this included the costs of research and development which had previously been dealt with separately by the major standard setters. Hence, the exposure draft proposed the withdrawal of IAS 9, Research and Development Costs. Similar to E 50, items would be identified as intangible assets if they met 3 criteria. The item must be identifiable and distinguishable from goodwill. An item would be identifiable if separable. However, separability is not a necessary condition for identification. The second criterion was that the item must be controlled by the entity as a result of past events.
Control would be aided if legally enforceable but is not required for sufficient control to exist. Finally, identification could only occur where future economic benefits are expected to flow to the enterprise [IASC, 1997]. Recognition of identified intangible assets in the financial reports of the entity is subject to two criteria. 1) It must be probable that the future economic benefits identified will flow to the entity. This has to be demonstrated in light of the fact that intangible assets rarely have alternative uses or high resale value. The IASC hint that this may be achieved through feasibility studies. ) the cost of the asset can be measured reliably. The recognition of internally generated intangible assets is restricted in E 60. Recognition is phrased in terms of ‘research and development costs’. Hence, only items that have reached the development stage are expected to be recognised. That is, the item must be commercially viable and have the ability to generate specifically attributable future economic benefits. The item must also be capable of reliable measurement. E 60 specifically rules out the recognition of internally generated mastheads and brands.
Similar to FRS 12, E 60 contains ‘a rebuttable presumption’ that the useful economic life of an intangible asset is no more than 20 years. Annual impairment tests must be undertaken for internally generated intangible assets with a useful life over 5 years. Impairment tests must also be undertaken on purchased intangible assets with lives over 20 years and for those assets which are not yet available for use. Impairment tests were to be undertaken in line with E 55, Impairment of Assets. The IASC approach is similar to the ASB in basing recognition upon measurement.
The alignment in E 60 of research and development costs with goodwill and intangible assets is thought to standardise the treatment of similar items. Hence, reporting entities will be restricted to one accounting treatment whether an item is classified as goodwill, intangible assets or research and development. b) Financial Accounting Standards Board In the United States, the treatment of intangible assets is still enforced by Accounting Practices Board Opinion 17, Intangible Assets, released in 1970. It recommends that intangible assets be recognised on the balance sheet if they are separable and have a determinate useful life.
Separability is based on whether an item is saleable. Items that are recognised are capitalised on the balance sheet and amortised through the income statement. The useful economic life of an intangible asset is limited to forty years. The scope for recognising internally generated intangible assets is limited as recognition is again based upon measurement. The Jenkins Committee studied the needs of investors and creditors. It found that users generally opposed recognising internally generated intangible assets because it didn’t help them value companies or assess credit risk.
It concluded that users would be aided by improved disclosures about the identity, source and life of intangible assets [Cairns, 1995]. However, a 1996 symposium organised by the Securities and Exchange Commission expressed the view that the enhanced disclosure of intangible assets was desirable but no clear solution was available in achieving this objective [Lev, 1997]. c) Australian Accounting Research Foundation In Australian financial reporting, intangible assets were first specifically addressed in AAS 18, Accounting for Goodwill.
Identifiable intangible assets were permitted to be recognised on the balance sheet: no mandatory amortisation was specified. However, it was noted that companies sought to recognise intangible assets, particularly brands, without amortisation. This enabled companies to avoid amortisation charges with respect to goodwill [Wines and Ferguson, 1993]. The AARF responded by issuing Accounting Guidance Release 5. This drew attention to AAS 4 which required amortisation for all non-current assets. The AARF attempted to formulate a standard on intangible assets with Exposure Draft 49 in August 1989.
It required the capitalisation and mandatory amortisation of intangible assets. Their useful economic life was limited to twenty years unless justification could be provided. The exposure draft also provided the opportunity to value and recognise internally generated intangible assets. Opinions on ED 49 were divided and no agreement was reached. It was withdrawn by the AARF ‘in view of the lack of consensus on the subject at national and international level’ [Wines and Ferguson, 1993]. Summary The growing importance of intangible assets in the modern economic environment promotes their recognition in financial reporting.
This has influenced the evolution of accounting standard setting and has led to increasing scope for the identification and recognition of intangible assets in financial statements. Identification is based upon control over future benefits. Recognition is based upon reliable measurement which is subject to separability. This enables purchased intangible assets to be more easily recognised than internally generated assets. This is due to the nature of intangible assets being incompatible with a historical cost framework of measurement in financial reporting.
Hence, the future of intangible asset accounting will depend upon the ability to provide reliable measurement procedures. CHAPTER TWO THE MEASUREMENT OF INTANGIBLE ASSETS Introduction This chapter describes the financial reporting regulations for measuring intangible assets. It then evaluates valuation bases offered for intangible asset accounting. This evaluation includes methods which may be currently unacceptable for financial reporting purposes. Finally, a description is given of the amortisation requirements for intangible assets. 2. Financial Reporting Requirements The recognition of intangible assets in UK financial reporting is dependent on measurement. This assertion is represented in SSAP 22 by the term, ‘separable net assets’ and in FRS 7 by the term ‘identifiable assets’. Hence, recognition is dependent on the ability of the asset to be disposed of separately from the business. Separability is dependent on the choice of measurement technique used. FRED 12 is less subtle in referring to the dependency of recognition on measurement. Its criteria for recognition includes the clause that an item must be measurable at a monetary amount with sufficient reliability.
Hence, under current and proposed intangible asset requirements, recognition is entwined with measurement. Therefore, the reliable measurement of intangible assets would facilitate their recognition in financial reporting. a) Company Law Schedule 4 of the Companies Act 1985 requires that fixed assets be measured in reports at their purchase price or production cost. The carrying amount must be reduced by a provision for depreciation or diminution in value in order to write down the asset to its residual value over its useful economic life.
However, under ‘alternative accounting rules’, the act explicitly allows intangible fixed assets, other than goodwill, to be included at their current cost. The basis of valuation must be disclosed. The accounts must also disclose either comparable amounts determined using historical cost accounting rules, or the difference between the historical figure and the amount carried in the accounts on an alternative basis [Goldenberg, 1990]. b) Accounting Standards The requirements for the measurement of assets are found in chapter 5 of the Statement of Principles for Financial Reporting [ASB, 1995b].
In conjunction with company law, the ASB normally require initial measurement at historical (or acquisition) cost. However, situations are identified where acquisition costs cannot be ascertained: assets bought by barter or assets bought in groups. In addition, any subsequent remeasurement of assets may use alternative valuation bases. Current values can be used as an alternative to acquisition costs. They will only coincide with acquisition costs at the initial stage of recognition. Several distinct current values are identified; entry value, exit value and the value in use.
The entry value is replacement cost; the cost of acquiring the asset under current market conditions. Exit values are based upon the current selling price of the asset. The value in use is the present value of the net future cash flows that can be obtaining by retaining the asset in its most profitable use. The ASB use each of the above current value bases to derive an eclectic valuation concept known as the ‘value to the business’ or ‘deprival value’ [ASB, 1995b]. It aims to measure the minimum amount that the entity would lose if deprived of the asset.
Hence, it is claimed to be relevant to the economic opportunities facing the reporting entity. Under the model, an asset is not to be measured above its recoverable amount. If an asset is worth replacing, it is measured at replacement cost. If it is not worth replacing but is worth keeping, it is measured at ‘value in use’. If an asset is not worth replacing or worth keeping, it is measured at net realisable value. The ASB warn that the ‘value in use’ is a highly subjective measurement technique which may not pass the reliability test for inclusion in financial reporting.
In such cases, the replacement cost or net realisable value should be used [ASB, 1995b]. Further measurement guidance is provided by FRS 7, Fair Values in Acquisition Accounting. This standard aims to estimate the value of individual assets which are purchased as a whole. Hence, individual purchase prices are not assigned to each identifiable asset. It requires assets to be measured at their fair value. Fair value is defined as the amount at which the asset could be exchanged in an arms length transaction. This must not exceed the recoverable amount of the asset.
Here FRS 7 aligns itself with the ‘value to the business’ model. The standard also explicitly makes reference to intangible assets. It states that their fair value should be based upon replacement cost which is normally the estimated market value of the asset. Where quoted prices are not available, market prices can be estimated either by independent valuation or valuation techniques such as discounting future estimated cash flows [ASB, 1994b]. Under E 60, the initial measurement base for purchased intangible assets is acquisition cost. Assets bought as part of a business combination are to be recognised at their fair value.
Fair values can be derived from quoted prices in an active market (current bid price). If no market exists, the cost is (based on the best information available) the amount that the enterprise would have paid at the date of acquisition for the asset in an arms length transaction between willing and knowledgeable partners. This clause allows fair value to be derived from discounting estimated future net cash flows. This is available only if cash flows can be identified that are specifically attributable to the asset and independent of cash flows from other assets used in the same revenue generating activity.
In valuing internally generated intangible assets, the costs of creation can be estimated. These costs must be distinguishable from the cost of enhancing or maintaining goodwill and separate from costs of running day-to-day operations. The costs of creation can include the employment costs of those personnel engaged in generating the asset and allocated overhead costs [IASC, 1997]. It can therefore be seen that under both IASC and ASB guidelines, assets can be measured on different bases; acquisition cost, out of date revaluation’s and current valuation’s.
Thus, the residual figure, capital, is argued to be a hybrid figure whose significance is unclear [ASB, 1993a]. The ASB has acknowledged the shortcomings of the current modified historical cost basis of measurement and supports a move towards alternative accounting measures. It states that movement to the ‘value to the business’ model will be gradual, thereby retaining consistency with the ASB’s aim of evolution rather than revolution in the development of financial reporting. The model is similar to the current cost system which was introduced unsuccessfully in SSAP 16 by the ASC.
Critics of this model argue that it measures the deprival value rather than the future economic benefits associated with an asset [Davies et al, 1997]. Valuations are dependent upon management strategy with regard to holding and replacing assets: this is subject to change [Baxter, 1996]. There has also been criticism of the valuation bases, particularly value in use and replacement cost. In sum, current financial reporting requirements allow replacement cost, value in use and net realisable value measurements in addition to acquisition costs.
The dominant valuation bases for intangible asset accounting are acquisition costs, replacement costs and market values. Each of these measurement bases requires the existence of a market. This is argued to be the main obstacle to the widespread recognition of intangible assets in financial reporting. Recognition is dependent upon measurement. Measurement is dependent upon the existence of a market. There is some departure from this principle in allowing valuations based upon market estimates to be used for the measurement of intangible assets. Several bases can be used to estimate fair value or value to the business.
The freedom in measuring intangible assets leads to the development of several different valuation techniques. The future of intangible asset accounting can be said to rely on the development of such measures. 2. 2 Valuation Models This section describes and evaluates those valuation models which are capable of measuring intangible assets. Both the established methods which are acceptable to financial reporting and developing methods are assessed. There are several methods which attempt to estimate economic value directly. Alternatively, many measures use entry and exit values as a surrogate for economic value.
Here, economic value is defined as the present value of all cash flows flowing to the entity resulting from control of the asset. Cost based models measure the sacrifice incurred to obtain an anticipated future benefit. They use the sacrifice incurred to gain benefits as a surrogate for the benefit itself. Hence, such models rest on the assumption that the sacrifice paid to access benefits equates to the benefits flowing from the resource. a) Evaluation Criteria In evaluating methods of measurement, it is useful to establish a set of criteria.
Valuation methods will be judged by their levels of objectivity and reliability, and their relevance for decision making. Such criteria are selected so as to be concordant with the objectives of financial reporting. This is defined by the ASB as the provision of financial information to aid the informed investor in decision making [Tweedie, 1996]. The level of objectivity refers to the extent to which the measurement exists outside the mind of the measurer. The results of an objective method will be reliable and can be replicated by external sources.
An objective measure is reliable in that it is free from material error and bias. Relevance is said to refer to the extent that the method measures the economic value of the measurement object. Economic value can be said to be the most useful measure for economic decision making. It is defined as the present value of the future benefits that will flow from the resource. Several methods attempt to directly estimate economic value. The usefulness of the information for decision making will be dependent upon the economic decision being undertaken.
It may be noted that the valuation models described are not mutually exclusive and that different models can serve different purposes [Tsay, 1977]. Thus, models may have an internal emphasis, concentrating upon future expectations data, or an external emphasis, based upon performance measurement. In evaluating decision making usefulness, the irrelevance of a measure may be considered. If irrelevant information is used when expanding the measurement system to include intangible assets, then the quality of existing information may decrease as the additional information can overload the decision maker [Sydenham, 1979]. ) Acquisition Cost Acquisition or historical cost measures the sacrifice incurred to purchase, produce or create intangible assets. Those expenditures that are expected to provide benefits beyond the current accounting period are capitalised and amortised over the period in which the benefits are expected to occur. If the asset arising from the cost is liquidated prematurely, a loss is recorded. If the useful life of the asset is longer than expected, the amortisation schedule is altered. Acquisition costs have a high level of objectivity as the data is verifiable and dependable, being traced to actual transactions.
They are said to be irrelevant as these measures may only represent the economic value of the resource at the date of acquisition. Thus, they are unlikely to fulfil the role of a predictor and are of limited use for decision making. However, they may be directly relevant to some input decisions. Assets valued at their acquisition cost will not be comparable within and between entities unless purchased at the same date. This is due to instability in the monetary unit. As a result, the older the asset, the less relevant the valuation. Acquisition cost measures are simple, feasible and cheap to prepare.
The value of the information can be said to exceed the cost of providing that information. They are used in the current, established basis of measurement in financial reporting and are familiar to users. However, it is argued that intangible fixed assets are incompatible with the modified historical cost system. Acquisition costs are based upon actual transactions which can be verified, and actual cash flows that have been generated. Intangible assets are, by their nature, more difficult to verify or trace to a single transaction. Intangible assets are not normally saleable and there is no independent check on valuation.
In addition, they are often bought as part of a group necessitating an allocation of the total consideration between individual assets. Thus, it is unlikely that acquisition costs will be of use in the valuation of intangible fixed assets. (c) Current Cost Current cost is the sacrifice that would have to be made to replace intangible assets presently employed. Current cost can be split into replacement cost and reproduction cost. Replacement cost is the cost of acquiring an asset offering identical services as the intangible asset held. Reproduction cost is the cost of acquiring an asset identical to the one held.
The level of objectivity of this measure is dependent upon the availability of obtaining current cost data. This is dependent upon the existence of an active market for the asset. Reproduction cost valuations require a continuing market for the asset. Replacement cost valuations require a market for a similar asset. If a market exists, then current cost can be ascertained reliably. Current costs measure the market’s current assessment of an assets economic value. Thus, they can be very useful for economic decision making. Replacement costs are part of the ASB’s ‘value to the business’ measurement system.
Thus, this basis is considered suitable for financial reporting purposes. The existence of a market for identical intangible assets is uncommon. Many intangible assets are heterogeneous in nature. Thus, market prices are rare. There may be no current cost for assets which are custom made or which become technologically obsolescent. As such data are not typically available, then subjective assessments need to be made. For example, an estimate of the effect of technical progress is frequently required in valuing an asset at its replacement cost [Whittington, 1996].
An exception may be the buying and selling of player registrations between professional sports teams. Player registrations are heterogeneous but have ascertainable market values. The major form of current cost valuations is replacement cost. This is due to its pragmatism. However, this method fails to give a value to assets that will not be replaced. It may also exert bias towards inefficient firms as their costs of replacement will be greater. (d) Estimates of Economic Value Economic value is defined as the present value of the sum of future cash flows flowing from the asset in question.
It is a theoretical construct and can only be estimated in practice. Models have been developed that seek to directly estimate economic value. Value can be separated into exchange value and use value. Exchange value measures the purchasing power that possession of the resource will allow. Use value measures the usefulness of the resource. The benefits derived from intangible assets are usually measured in terms of exchange value rather than on use value, due to the difficulty of measuring use value [Dawson, 1989].
Economic value estimates are acceptable in financial reporting under the guise of ‘value in use’ as part of the ASB’s ‘value to the business’ rules. However, the reliability of any estimate must be proven. In addition, economic value estimates may be permitted by FRS 7 to measure fair values where quoted market prices are unavailable. They are used as a surrogate for market values in order to estimate replacement cost. Valuation methods attempt to measure economic value through the application of capital budgeting techniques. Estimates are made of future cash flows and the rate at which such flows are discounted.
The discount rate will normally be the entity’s weighted average cost of capital adjusted for specific risk factors. Several forms of estimate have been offered for valuing intangible assets. One form of estimate is known as royalty relief. This estimates the premium that would be payable for the use of an asset under a hypothetical licensing agreement [Napier and Power, 1992]. The notional royalty income earned from licensing out the right to exploit the asset is quantified and discounted to estimate the assets economic value [Mullen, 1993].
This method can also be used in financial reporting as a surrogate for market value, and used for estimating replacement cost. Another form of estimate is premium profits. This compares the reporting entity with and without the intangible asset. It is assumed that the entity will be valued more highly with the asset. The difference can be estimated using different criteria. For example, the actual operating margin can be compared with the operating margin arising if the business did not have the asset. The value can also be estimated by comparing the Return on Capital/Asset or Price Earnings ratios.
The increment in the ratio is attributed to the asset and added to an estimate of maintainable earnings to derive an asset valuation [Napier and Power, 1992]. Another method of estimating the premium is by using the selling price of a product. This method is advocated for brand valuations. Brands can be valued by comparing the price of the branded product with the price of an unbranded generic equivalent [Murphy, 1991]. However, many elements of value are said to relate to the future demand and stability of the brand rather than any price premium.
In addition, the price premium may be influenced by other factors such as distribution networks [Mullen, 1993]. Another economic value estimate can be provided by the earnings multiple. The asset is valued at a multiple of its estimated earnings. The return on the investment will be more than the return from a risk free investment. Hence, the risk free return provides a ceiling for the earnings multiple. It will vary between businesses and industries but can be signalled by industry Price Earnings ratios. This method is used in the valuation of brands.
Factors such as market share, stability, international exposure, support and protection determine the earnings multiple of the brand [Murphy, 1990]. The perfect brand is said to have a earnings multiple of 20. Brand earnings are estimated from historical profits. They are adjusted by a medium term tax rate for the company and compounded to present day values [Power, 1990]. Despite its use in practice, this method lacks reliability and objectivity. The choices available over many influential parts of the measurement process make it susceptible to manipulation.
In summary, it can be argued that economic value estimates are often conceptually attractive but difficult to apply. In practice, these methods can be severely limited by their volatility and subjective nature. Expectations are continually revised and cannot be confirmed [Egginton, 1993]. All estimates involve a high degree of speculation. The difficulty of estimating future values and determining a basis for allocation reduce the level of reliability and objectivity. (e) Exit Price The exit price represents the amount that could be gained from the selling or disposing of an intangible asset. It is also known as the net realisable value.
It is acceptable in financial reporting, being used as part of the ‘value to the business’ measurement rules. Exit prices, where available, are highly relevant to current economic decision making, assuming an asset can be sold immediately. The objectivity and reliability of exit prices rests on the proximity to perfect competition of the market from which prices are drawn. Here, an active market with arms length transactions between knowledgeable and willing partners provides sufficient reliability for financial reporting purposes. (f) Market Value The use of market values for measuring assets is limited by company legislation.
Under the Companies Act 1985, intangible assets are permitted to be measured in financial reports at current cost but not at market value [ASB, 1993b]. However, current market value is used to estimate replacement cost. In this case, the market value must be derived from an ‘active market’. An active market is defined as one where willing buyers and sellers can be found at any time to trade homogeneous items. The prices, derived from arms length transactions, must be publicly available. Market values are highly relevant due to their proximity to economic value.
Their reliability and objectivity are dependent upon the market from which they are drawn. Due to company law, market values are only used as estimates of other measures. In their own right, market values could be used in financial reporting. It has been suggested that market value estimates of intangible assets could be undertaken by a professional body similar to property valuations. This strategy has been undertaken by brand valuation specialists who set up the Institute of Brand Valuation [Accountancy, 1997]. It is assumed that the aim of this strategy is to provide more credence and objectivity to their valuations. g) Opportunity Cost Opportunity cost is the value of an asset in its next most profitable alternative use. Valuation is possible only in limited circumstances. Such circumstances are only likely to arise in large organisations with separate investment centres and scarce resources. Each investment centre manager will bid for the asset; the highest bidding price represents the opportunity cost of the asset. Opportunity costs are not recognised in financial reporting. This method can be said to have a low level of reliability. However, they may be used to estimate market value which in turn is used to estimate replacement cost.
The logic of the method is questionable on the grounds of circularity. A surrogate measure of value is needed to make an initial bid. This bid is used to derive a surrogate measure of value. It is also subject to shifts in supply and demand and may bear no relation to value except at the date of acquisition. (h) Qualitative Measurement In response to the difficulties of quantifying intangible assets, non-monetary measures have been suggested. Inventory lists and descriptions of intangible assets can be used as a surrogate for monetary measures.
The relevance for decision making is likely to be poor but the objectivity of such measures can be high. (i) Summary and Conclusions In appraising intangible asset valuation methods, it is suggested that the most acceptable measures are those which are linked to a market. Acquisition costs, current costs, market values and exit prices are all linked to a market through the past or current purchase price of an asset. Reference to the market provides an objective benchmark which gives the measure reliability. The linkage of valuation methods to a market enables the entity to avoid the ‘aggregation problem’.
This occurs where the value of individual assets added together does not equal the value of the same assets valued in aggregate [Baxter, 1996]. The valuation of an asset cannot be considered an independent event. The difference is attributable to synergy. Synergy may be described as that part of value arising from an assets interdependence with other organisational assets. For example, the value of one glove is dependent upon whether it is valued in aggregation with a matching glove. One glove has little value unless it is part of a matching set.
The existence of synergy results in a different value being ascribed to the same asset under the same valuation technique depending upon the level of aggregation. This leads to the problem of what level of aggregation should be used to value assets [Whittington, 1996]. The jointness of intangible assets is also characterised by the use of the term ‘separable’ or ‘identifiable’ in the recognition of intangible assets. The solution to these problems is to reference valuation techniques to a market. Hence, the market defines the level of aggregation at which an asset can be measured.
The market also defines what is separable or identifiable. Therefore, the recognition and measurement of intangible assets can be argued to be based around the existence of a market. 2. 3 The Amortisation of Intangible Assets For cost based measures such as acquisition and current costs, asset values may require amortisation. Such a policy should aim to match the consumption of the asset’s services with the benefits derived. An estimate is required of the expected useful life of the asset. The amortisation of intangible assets is contested. It is argued that charges are already made to the profit and loss ccount to maintain such assets. Hence, any amortisation would result in double counting. For example, marketing and advertising costs are said to represent depreciation charges for a brand asset. Thus, it is argued that such assets should be written down only if there is a diminution in value. Assessments of diminution in value, relevant to goodwill and intangible assets, have been codified by the ASB. FRED 15, Impairment of Fixed Assets and Goodwill, was released in June 1997. It is expected to be issued as a Financial Reporting Standard in the second quarter of 1998 [Accountancy, 1998].
Impairment tests seek to ensure that assets valued under ‘value to the business’ rules or in a fair value exercise are not held at above their recoverable amount. Impairment tests judge whether carrying values are supported by their net present value. If an asset is to be depreciated over less than a twenty year period, then an assessment is made after the first year. Consideration is taken of: a) the existence of negative cash flows associated with the asset; b) adverse changes in legal, market or regulatory environments; and c) whether the method adopted for assigning value would now give rise to a lower value.
If there is indication of impairment, or the asset is to be depreciated over twenty years or more, carrying values are to be compared with net present values. Assets are grouped into their major income streams. Cash flows are estimated and discounted at the entity’s weighted average cost of capital adjusting for specific risk factors. Assets held above their net present value are written down to their recoverable amount. Alternatively, the useful economic life of the asset may be adjusted. FRED 15 is based upon the US standard, FAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.
Similar treatment is also proposed in an IASC exposure draft, E 55, Impairment of Assets, issued in May 1997. A degree of speculation is inherent in impairment testing due to the estimation of future cash flows. The acceptance of an indefinite useful life is criticised in that it provides scope for manipulation. It is argued that impairment tests allow treatments which are inconsistent with Companies Act 1985. It states that identifiable assets must be written down to a residual value over a finite useful period. Impairment tests recognise that an assets ife may be indefinite if not infinite [Accountancy, 1995a]. Thus, the accounting treatment is justified by resorting to the overriding principle of a ‘true and fair view’. In this case, it is assumed that relevance precedes reliability. This is in recognition of commercial practice where asset lives, particularly intangible assets, are increasingly uncertain. Summary Measurement is critical in intangible asset accounting because it provides the basis for recognition. Financial reporting standards in this area are developmental. Hence, opportunity exists for several bases of valuation to be used.
It may be suggested that cost measures are generally more objective, reliable and more acceptable for external reporting. However, whilst value measures may be more subjective, the information generated may be more relevant and of greater use for decision making. Economic value measures are feasible but are intrinsically unreliable. The most widely used and accepted methods of measurement are linked to a market for intangible assets. The existence of a market aids measurement and hence, enables recognition. CHAPTER THREE HUMAN RESOURCE ACCOUNTING Introduction This chapter focuses on a particular type of intangible asset, the human resource.
Accounting research first addressed intangible asset accounting in its attempts to measure and recognise the contribution of labour to the activities of an organisation. The process of recognising and measuring intangible assets associated with labour became known as Human Resource Accounting. Labour represents the largest source of unaccounted intangible benefit. Human Resource Accounting (HRA) is defined as “the process of identifying and measuring data about human resources and communicating this information to interested parties” [AAA Committee On HRA, 1973: p169].
The purpose of HRA is said to be the improvement of decision-making, both internal and external to the organisation. HRA (or human asset accounting) may be distinguished from human capital. HRA measures value to the organisation whereas human capital measures value to the employee. This chapter starts by examining whether human resources are assets and whether they are relevant in financial reporting. It then outlines various measurement approaches specifically designed for valuing human resources. The fourth section describes the development and uses of HRA. Finally, consideration is given to the consequences of HRA. 3. The Human Resource as an Asset The existence of a human resource asset is questionable. This section highlights the points of debate, particularly with regard to financial reporting requirements. Human resources are assessed using the criteria for the identification and recognition of intangible assets outlined in Chapter 1. The existence of a human resource asset is also assessed from an economic perspective. HRA is concerned with the performance and value of employee services to the accounting entity. Hence, it is the services that employees are expected to provide that are said to comprise a human resource asset.
Activities undertaken to enhance the economic generating abilities of the labour force such as training and recruitment are expected to provide economic benefits in future accounting periods. The human resource asset is comprised of employee services, in terms of skills and knowledge. These services are intangible in that they have no physical substance and are non-monetary in nature. a) Identification An intangible fixed asset can be identified for financial reporting purposes where rights or other access to future economic benefits are controlled by the entity as a result of past transactions or events.
Control over economic benefits must be maintained through legal protection or physical custody [ASB, 1997]. Future economic benefits associated with human resource assets derive from the ability of labour to generate cash flows. The services of employees create economic benefits for the organisation. Evidence of the future service potential of human resources is said to occur as no investments such as training would be undertaken if benefits didn’t accrue beyond the current accounting period [Lev and Schwartz, 1971]. It is debatable whether a right to exploit future economic benefits exists.
Humans cannot be owned unless they exist in a slave society. However, the services people are expected to provide may be subject to some form of ownership or control. It is argued that an organisation does constructively own a labour force that is constantly associated with the firm [Lev and Schwartz, 1971]. This labour force can be bought and sold in acquisition or merger. Alternatively, it can be said that there is no exclusive right to the services of employees as they are free to leave. Employee services are highly perishable through loss to other organisations or technological obsolescence.
Any benefits from human resource investments such as training aren’t necessarily retained within the firm. An organisation does not own a human resource asset. However, some control is said to exist in the form of an employment contract. The enforceability of employment contracts from the organisation’s perspective is argued to be so tenuous that they allow no exclusive right to the services of an individual [Jauch and Skigen, 1974]. However, the rights to services given by employment contracts are more enforceable in industries where the supply of labour is small.
Employment on fixed term contracts has become more popular over the last decade. Organisations are increasingly prone to adding compensation clauses to contracts should their employees take up similar work with other organisations whilst under contract. Proponents of HRA argue that some form of control is sufficient for the recognition of human resources as an asset. Money is spent on developing human resources to enhance the future economic prosperity of the organisation. Accounting is said to be concerned with events of economic significance.
In debating the existence of a human resource asset, a HRA paradigm is evident. This is summed up by Marques [1976: p178]. “Are people a resource for the enterprise or is the enterprise a resource for the people? “. It can be argued that human resources do provide economic benefits. However, the use of those benefits is dependent upon the employee being able to perform future services, and the employee’s association with the firm [Jaggi, 1976]. Thus, the identification of human resources as assets is dependent on the degree of control exercised over human resource services. ) Recognition For recognition as an intangible asset, there must be sufficient evidence of a change in the assets of the organisation, and that a future inflow will occur. The item must be also capable of reliable measurement in monetary terms. The absence of a single transaction leading to the creation of a human resource asset impairs evidence of its existence. This is in common with many intangible assets. However, some outlays on training and development may lead directly to an expansion of services an individual is able to offer.
For example, the technical qualifications gained by employees may allow the organisation to generate additional revenues. It is debatable whether human resource assets can be measured accurately due to the interdependent nature of their value. Their contribution cannot be disentangled from other factors of production [Parker, Ferris and Otley, 1989]. The existence of a market is central for reliable measurement. Human resource assets that cannot be linked to a market will be incapable of reliable measurement under ASB guidelines.
It will be difficult to assign fair values to human resource assets as part of an acquisition due to their inseparability caused by the lack of a continuing market. Thus, human resource assets may be indistinguishable from goodwill. In financial reporting, the recognition of intangible assets is dependent upon measurement. The measurement of intangible assets is dependent upon the existence of a market. However, in cases where the rights to the services of a human resource have been purchased, a reliable measurement may be possible. Human resource assets which are urchased as in the case of professional sports industries may provide evidence of a change in the assets of an organisation. Where no market exists, an imperfect measure of human resource assets may provide some utility. For example, the allocation of depreciation may be imperfect but is of some information value to users [Edmonds and Rogow, 1986]. However, this may not be acceptable for financial reporting. Volatility over the timing and existence of future economic benefits may prevent recognition. The possibility of any benefit and the timing of such benefits are subject to a high degree of variability. ) Economic Perspective The existence of a human resource asset is questioned under economic analysis. HRA states that benefits are created from training. However, economics suggests that wages tend to equal marginal revenue product (MRP) even in imperfect markets. Thus, cost is equal to benefit and no value is created. Under general industry training, human resource value to the organisation is increased but so is human capital value. General industry training adds skills that are not specific to the organisation.
An individual will contribute more to the organisation but will possess greater skills and there will be greater demand in the labour market for his/her services. General industry training causes MRP to increase. Therefore, an employer will have to increase wages in response to the increased MRP of an individual to prevent movement to another organisation. With organisation specific training, human resource value is increased and there is no change in human capital value. An individual will contribute more to the organisation but will be unable to confer similar services to other organisations due to the nature of the training.
The marketability of the individual is not increased and so wages need not be increased to prevent movement to another firm. Thus, value may exist where wages are less than MRP. The presence of a human resource asset is questioned because training is rarely organisation specific. Where an individual whose MRP to the organisation is greater than wages, a human resource asset may exist. However, attempts to maintain this asset may lead to its eventual elimination [Dittman, Juris and Revsine, 1976]. For example, a manager may delay the layoff of an employee who is no longer required but who has undertaken organisation specific training.
However, this argument assumes the perfect mobility of labour. Under conditions of imperfect mobility, marketability cannot be exploited as easily and wages need not be increased to ensure an individual does not move to another organisation. Thus, wages may be less than MRP, indicating the possible existence of human resource value. The existence of a human resource asset centres around the degree of control an organisation can exert over the skills gained by the employee. If the organisation can exert control, it will enjoy the benefits of general industry training alone.
It can prevent any increase in marketability leading to a diminution in the value of the human resource by restricting movement to other organisations. If no control can be exerted, the organisation is unlikely to enjoy the benefits of general industry training. The increased marketability that general industry training provides will cause the employee to leave the organisation or have remuneration increased. Human resource accounting is argued to have parallels with accounting treatment of finance leases [Brummans and Langendijk, 1996]. The organisation is effectively renting the ervices of human capital, rather than physical capital. It is argued that their treatment should be aligned. Thus, leased human assets could be recognised on the asset side of the balance sheet with the organisations liability to pay salaries on the liabilities side [Lev and Schwartz, 1971]. d) Summary Under present financial reporting guidelines, the existence and timing of future economic benefits from human resources may be too unreliable to allow recognition as an asset to occur. The reliable measurement of the majority of human resource assets is impaired by the lack of an associated market.
However, in some circumstances, human resource assets may exist where control and accessibility to future economic benefits are more certain. Specific human resource assets are subject to transactions. In such cases, HRA may be acceptable in financial reporting. 3. 2 The Relevance of Human Resource Accounting The relevance of HRA is said to derive from the users of financial reports (both internal and external) receiving information on an additional dimension of the organisation. Management are held accountable for all the resources under their control; this includes human resources.
HRA is said to facilitate the utilisation of human resources more effectively than conventional accounting information because it recognises that human resource expenditures are often made with the aim of providing benefits beyond the current accounting period [Flamholtz, 1985]. Conventional accounting only recognises human resources in the current accounting period. HRA attempts to measure the benefits of expenditures on human resources. Conventional accounting does not attempt to quantify these benefits. It can only recognise the value of human resources as a part of goodwill.
It treats them as an expense of the period and charges them against the current period’s revenue which can lead to a distortion of income measurement. Expenses are overstated and current profit is understated. By omitting human resource assets, it can be said that the investment base will be undervalued. This distorts Return on Investment and Rate of Return measures. Under conventional accounting systems, changes in the capabilities of the human organisation may not be reflected until long after the event [Alexander, 1971]. The measurement of HRA is said to aid external and internal decision making.
The addition of this information adds a new variable to decision making. Without it, human resources are only considered from a qualitative rather than a quantitative viewpoint. Flamholtz  sought to test whether HRA data made any difference to the allocation decision. Individuals were to be assigned to jobs within an organisation on the basis of three criterion; job productivity, human resource development and individual satisfaction. The results indicated that decisions were made differently when using nonmonetary HRA data compared to conventional accounting data.
HRA is said to provide a framework for optimising the value of human resources. It can be used to evaluate the allocation of resources among profit opportunities to maximise the return on all resources [Das-Gupta, 1974]. HRA can be said to allow the human organisation to be assessed on a cost benefit basis allowing the whole organisation to be managed with greater economic rationality. Decisions concerning the acquisition of human resources can be made by choosing the person who possesses the greatest future value to the firm. HRA is said to aid personnel layoff decisions.
Laying off workers can increase short run profit. Conventional accounting doesn’t quantify the costs of recruiting and training new workers if a business subsequently expands. HRA is said to quantify the costs of personnel turnover. The costs of separation can be compared to the costs of continuation. A study by Ogan  found that HRA data made a difference to personnel layoff decisions and led to an increase in confidence regarding those decisions. In their survey, Spiceland and Zaunbrecher  found that HRA influenced personnel decisions, and that respondents found potential utility in the data.
However, Elias  questioned the relevance of HRA data in assessing the costs of personnel layoff. He argued that any amortisation charges or book losses are sunk costs once they have occurred. However, it can be argued that HRA may still be of use in assessing the benefits of continuing employment. Development policy decisions about whether to recruit at entry level and train or to recruit from experienced personnel outside the organisation may be aided by HRA data. External decision making may also be improved by HRA.
By taking account of human resources, investors should be able to assess a firm’s performance and its future prospects with greater confidence. Identifying the respective contributions from the organisation’s inputs and assessing the ratio of human assets to total assets can be said to provide useful predictors of a firm’s performance. The stewardship function may be aided by providing more accurate measures of management performance. For example, short run profits can be made by diminishing the workforce, and this decline in the asset base (operating capacity) of the organisation will not be reflected in the financial statements.
By the time such a liquidation of assets has been identified in the conventional accounting system, the ‘successful’ management are likely to have moved on [Alexander, 1971]. This argument is applicable both to investor decision making and divisional performance evaluation. It is claimed by several authors that the lack of information about human resources leads to uncertainty about the value of the firm, particularly in labour intensive industries. Schwan  tested the usefulness of HRA data for the investment decision of bankers who frequently used published accounts.
It was found that HRA data resulted in a significant change in decisions. However, a similar study by Elias  using accountants, financial analysts and students, found no statistically significant difference in decisions. A study by Hendricks  concluded that the addition of HRA information to conventional accounting information affected stock investment decisions. Hansson  found that specific information on the amount invested in human resources would improve investor decisionmaking. Campbell  incorporates human resource value into an asset pricing model in order to give more accurate predictions of stock prices.
However, any changes in decision making found in the above tests may be attributable to the ‘novelty effect’ of HRA data. In sum, it is suggested that HRA is relevant in terms of economic decision making. It is said to be relevant to allocation decisions, internal personnel decisions and external investment decisions. Empirical evidence for the relevance of HRA is available, but it is inconclusive due to methodological difficulties associated with assessing the use of intangible assets. It may be argued that HRA is relevant in the stewardship role, a traditional aim of financial reporting.
That management is held accountable for an extra dimension of resources under its control, is said to be the foremost benefit of HRA. It can be said that debate over whether human resources are assets has led to the creation of a ‘HRA paradigm’. The above arguments are ideologically very strong, but are based on the assumption that human resources behave and exist as assets. Hence, arguments advocating their relevance often assume that human resources can be measured reliably and the social consequences of HRA are ignored. These issues are explored in the next two sections. . 3 The Measurement of Human Resources The development of intangible asset measurement began with methods of measuring the contribution of human resources to an organisation. Many early human resource accounting measures form the basis of several modern intangible asset measurement techniques. This section describes valuation techniques developed specifically for measuring human resource value. These consist of acquisition costs, current costs, estimates of economic value, opportunity costs, qualitative measurements and wage based valuation models.
Techniques, where appropriate, are appraised using the same criteria as those applied in Chapter 2 to the valuation of intangible assets. a) Acquisition Cost The acquisition cost of a human resource asset can be split into outlay and development costs. Outlay costs include those relating to recruitment, selection, hiring and placement. Development costs include formal training and orientation, on-the-job training and the lost productivity of others during training. Such a system would have to be operated for several years before it can be expected to represent an organisation’s total investment in human resources.
In addition, the costs spent on development and training may bear no relevance to the employee’s ability to contribute to the organisation. b) Current Cost The current cost of a human resource asset is the cost of recruiting and developing replacements to the level of proficiency and familiarity with the organisation experienced by existing employees [AAA Committee On HRA, 1973]. Replacement costs can be personal or positional. Personal replacement cost is the cost associated with acquiring someone capable of providing equivalent services in all the positions the former employee might have occupied.
Personal replacement costs may provide operational estimates of economic values. Positional replacement cost is the cost of acquiring someone who is capable of providing an equivalent set of services in a given position [Flamholtz, 1985]. A further distinction can be made between marginal and full replacement costs. Marginal costs are those associated only with the replacement (selecting and recruiting one individual) whereas full costs include the effect on others in the organisation (development costs to ensure that all layers of the organisation possess the same skills and abilities). ) Estimates of Economic Value Economic value is defined as the present value of the sum of future cash flows arising from the human resource. The economic value of human resource assets has been estimated both individually and in aggregate. One early measure is discounted excess earnings, as reported by Hermanson [AAA Committee On HRA, 1973]. Here, any supranormal earnings are attributable to unidentifiable assets, which include human resources. Thus human resource value can be estimated by the level of differential earnings.
This measure can be said to have a high level of objectivity as data required can be obtained directly from accounting records. It is also cheap and provides a close association with financial statements. However, reliability is low as all assets of an intangible nature are subsumed. Also, the method relies upon previous earnings as a surrogate for future earnings. There is no evidence to support this relationship. Furthermore, there is no recognition of the human resource base required to undertake normal operations and earnings. Thus, this measure can be said to have little predictive value.
A similar measure of human resource value suggested by Brummet, Flamholtz and Pyle [AAA Committee On HRA, 1973] discounts the future earnings of the organisation to obtain its total net present value. A portion of the net present value will be allocated to human resources depending on their relative contribution. The difficulty of estimating future earnings and determining a basis for allocation reduces reliability and objectivity. A model developed by Likert identified variables that could estimate changes in the effectiveness of the human organisation [Likert and Pyle, 1971].
Periodic measurement of causal and intervening variables such as loyalty, structure and leadership style may reveal changes in the productive capacity of the organisation. After a time lag, these present changes can be translated into expected future changes in terms of end result variables such as productivity or profits. Thus, such changes can be expressed in money terms. It was suggested that these variables be measured using a questionnaire. This means of measurement can be said to have a low level of objectivity and reliability, and may also be expensive.
However, it may be a sound predictor in decision making. A model of individual valuation has been proposed by Flamholtz [1972:1985]. It assumes that human resources are valuable in relation to the roles the individual is expected to occupy. The model measures an individual’s expected realisable value. This is the amount actually expected to be derived by the organisation. It is equal to an individual’s conditional value multiplied by the probability that the individual will stay with the organisation.
Conditional value is the amount that could potentially be realised if an individual stays with the organisation for the duration of his/her productive service life. The conditional value is based upon the services the individual will provide in various roles through the organisation. The level of these services will be dependent upon individual attributes such as cognitive abilities, personality traits, skills and activation level. It will also be dependent on how these individual attributes combine with organisational attributes such as structure and management style. This measure lacks objectivity and reliability.
However, it was intended as a basis for developing a theory of human resource value rather than be used as a method of measurement [Flamholtz, 1972]. Other measures of human resource value that have been suggested incorporate the mobility of employees. An individual’s movement through different roles in an organisation is described as a stochastic process. A stochastic process is defined as a natural system that operates in accordance with probabilistic laws [Flamholtz, 1985]. Stochastic models estimate the mobility of an employee through an organisation by the use of Markov chains.
A Markov chain is a stochastic system where the occurrence of a future state depends only upon the immediately preceding state [Sydenham, 1979]. Using this technique, the probability of occupying each organisational role can be established. The roles may be groups of jobs the person is expected to occupy while they work for the organisation. Flamholtz [1985;1987], applied this Markovian process to his individual valuation model. The net profit contribution provided by each organisational role or service state can be measured.
Therefore, by calculating the probability that the individual will occupy each state at specified future times, the level of future cash flows contributed by the individual can be derived. Discounting the level of expected future cash flows will provide a present value measure of the human resource. However, it is argued that assigning probabilities on an individual basis will be costly and large variances will undermine the reliability of the method. Thus, Jaggi and Lau  propose a stochastic model based upon homogeneous groups.
This method can be said to be objective in so far as the information needed can be derived from historical personnel records. However, quantifying the net profit contribution of each service state may be problematic in some industries due to the difficulty in allocating overheads. The reliability of this method is further decreased by the assumption of stability in the organisation. It is argued that individual valuation models are flawed because value is treated as an independent event [Edmonds and Rogow, 1986]. That is, the models ignore synergy.
However, this problem is common to all asset measurement techniques 3 . Synergy, in this context, may be described as that part of value arising from an individual’s interdependence with the organisation and other employees. Synergy is said to occur because an organisation will employ up to a point where marginal revenue product 3 Refer to Chapter 2; 2. 2(i) equals the marginal cost of employment (wages). Before that point, marginal revenue product is greater than wages; this creates synergy [Morse, 1975]. d) Opportunity Cost Opportunity cost is another method of measuring human resource assets.
It has been suggested that human resources can be measured by the amount bid between investment centre managers for a scarce employee [Hekiman and Jones, 1968]. The bid price should then be included in the investment base. This type of measurement will only be feasible in large organisations with a sufficient number of investment centres and managers to ensure fair bidding. Furthermore, if employees can be readily recruited from outside the organisation, then there is no opportunity cost as the resource is not scarce [Brummans and Langendijk, 1996].
It is also questionable whether frequent transfers and bidding have a healthy impact on employee morale. e) Qualitative Measurement A human resource inventory has been suggested as a non-monetary alternative to the quantitative measurement of human resource assets. It lists the skills and capabilities of people within the organisation. It may include academic and professional qualifications as well as personal credentials. This method can aid external and internal users by representing the potential skills to be rendered, particularly in smaller organisations.
However, it is not a method of valuation. f) Wage Based Valuation Models Several human resource accounting measures are based upon the level of remuneration received by an individual. The human resource will add wealth to the organisation in the future. The payment offered for the services of the human resource is assumed to be equal to the level of wealth generated by those services. Thus, the present worth of the remaining earnings from employment should represent the organisation’s assessment of the value of the resource.
The method of discounting future salaries embodies these principles. Expected wage payments over a specified future time period are discounted at the most recent rate of return and modified by an efficiency factor [AAA Committee On HRA, 1973]. The time period is the number of years a person is expected to provide services to the organisation. The efficiency factor should reflect the effectiveness of performance of the resource. Lev and Schwartz  proposed a similar model measuring human resource value as the present value of the remaining future earnings from employment.
Census data and actuarial calculations are offered as methods for obtaining average earnings, and average ages for retirement. Friedman and Lev suggest an approach to valuation based upon wage differentials [Sydenham, 1979]. The wage differentials between the market and the firm are said to reflect the organisation’s personnel policy. Otherwise, these differences would be eliminated by employee mobility. This wage differential is said to represent the return on the organisation’s investment in human resources. If this return is known, then the value of the investment in human resources can be