WP4: Accounting, Audit, and Financial Analysis in the New Economy
University of Ferrara

First Report (April 02)

Accounting, Intangibles and Intellectual Capital:
an overview of the issues and some considerations

S. Zambon

Table of contents

1. INTRODUCTION…………………………………………………………………………......................…………………………… 3

2. TRADITIONAL ACCOUNTING FOR INTANGIBLE ASSETS ..........…………………………………………………………… 5
2.1. Why are traditional financial measures becoming less relevant?…………………………....…………………….…... 5
2.2. Problems with conventional accounting treatment of intangible assets………………………………………………… 6
2.3. Consequences of inadequate accounting for intangibles...............................................................................………….. 7
2.4. Accounting for intangible assets - general approaches....................................…………………………………...…....... 8
2.5. A short note on company goodwill …………………...................................................................…………………….… 8
2.6. Some dichotomies relating to traditional accounting and intangibles…………………………………………….……. 9
2.7. Some concluding remarks of Section 2………………………………………………………………………………..… 10

3. INTELLECTUAL CAPITAL: DEFINITION, CLASSIFICATION AND VALUATION...............................……………………... 12
3.1. Components of Intellectual Capital.........................................................…………………………………………….… 12
3.2. Knowledge Companies …………............................................…………………………………………………………. 14
3.3. Why do companies want to measure intellectual capital…………………………. ………………………………….... 14
3.4. The valuation of Intellectual Capital……………………………………………………………………………………. 15
3.4.1. Market-to-book values…………………………………………………………………………………..… 15
3.4.2. Tobin’s Q…………………………………………………………………………………………………. 18
3.4.3. Calculated Intangible Value (CIV)……………………………………….. ……………………………... 18
3.4.4. Real Options-Based Approach……………………………………………………………………………. 19
3.5. Some concluding remarks of Section 3………………………………………………………………………………….. 22

4.1.Economic Value Added (EVA
)………...………………………………………………………………………………. 24
4.2. Human Resource Accounting…………………..……………………….………………………………………………. 25
4.3. Intangible Asset Monitor……………………………...………………………………………………………………… 26
4.4. The Skandia Navigator……………………………………...…………………………………………………………... 28
4.5. The Balanced Scorecard…………………………………………...……………………………………………………. 30
4.6. Other Intellectual Capital measurement tools…………………………...……………………………………………… 32
4.7. Some examples of firms that seem to have benefited from reporting IC………...….. …………………………………. 32
4.8. Some emerging problems with the "new accounting and reporting"…………………...………………………………. 33


6. CONCLUSIONS……………………………………………………………………………………………………………………... 37


The aim of this first report is to provide a preliminary overview of the various issues and
approaches regarding the subject area of accounting for intangibles. In particular, the concept
of intellectual capital will be thoroughly analysed, as well as some of the innovative methods
which have been put forward to deal with such problematic area. Some considerations on the
accounting dichotomies and the problematic aspects with which accounting has to grapple
when addressing intangible resources will also be proposed.

1. Introduction

It is now commonly accepted that we are in the midst of a new phase of evolution in the major
global economies, which is characterised by new performance and value drivers that are mainly
intangible in nature. Accordingly, the so called intangible or knowledge economy is the new
environment that companies have to learn to cope with.
This new phase is having profound implications also for corporate accounting and reporting. It
is well known that there is a huge gap between the accounting book value and the market value
of many internationally-listed companies. There is also widespread concern about the difficulty
of valuing and assessing the performance of 'new economy' companies. Some companies have
recognised this new phase and started to produce reports which are largely different from the
traditional, financially-oriented ones. These reports may take different names (intellectual
capital report, auxiliary balance sheet, report on intangibles etc), but they have a common goal
of penetrating beyond the financial dimension in order to identify and track the new value
drivers - mainly of an intangible nature - which permit long-term, sustainable growth of the
This new economic order poses challenges and offers innovative opportunities also to the audit
profession and financial analysts. In particular the so-called intellectual capital supplements -
pose a clear problem of verification of the data and information which are disclosed to
institutional investors and the general public. The procedures for verification and assessment of
this new information set are immature and need to be standardised and agreed at an
international level.
In the light of the above new economic framework, the general objective of WP 4 is to carry
out a critical assessment of the various innovative conceptual approaches and practices in the
area of accounting and reporting, financial analysis and audit that are emerging as a response to
the intangible economy. Working closely with the IASB and EFFAS, the research will
eventually aim to provide an authoritative policy agenda for auditors, professional accountants
and financial analysts, and will analyse and point out areas where existing accounting standards
and market regulatory systems may need special attention with regard to intangible resources.
Our research aims to identify and analyse leading edge conceptual approaches and practices in
the area of accounting and reporting (recognition, measurement and disclosure), financial
analysis, and audit for the intangible economy.
After the first period of analysis, the detailed objectives of the contractual commitment can be
more meaningfully re-expressed as follows:
• To investigate from a preparers', users' and regulators' perspective the new developments in
the traditional corporate reporting domain with regard to intangibles.
• To explore the innovative forms of company reporting on intangibles from a preparers,
user, regulator and management perspective by analysing the proposals put forward in the
literature and those emerging from practice in order to respond to the challenges posed by
the new economic framework, without disregarding the implications of these innovations in
the reporting and management of non-profit organisations.
• To provide a blueprint for auditors, professional accountants and financial analysts
regarding the new corporate information disclosures required by the intangible economy. It
will also set out to identify areas in the intangibles realm where the existing accounting
standards and market regulatory systems may need to be sharpened.

As pointed out in the 'proof of concepts' statement, the aim of this first report is to provide a
preliminary overview of the complex issues and approaches regarding the subject area of
accounting for intangibles. In particular, the analysis deals with the issues linked to the
recognition, measurement, and disclosure within and outside the tradition financial statements,
which are posed by the intangible economy to private and public organisations. The concept of
intellectual capital will also be thoroughly examined, as well as some of the innovative
methods and forms of reporting which have been put forward to deal with such problematic
area (cf. the 'proof of concepts' statement). Further, this first report of the WP4 unit sets out a
rationale and work plan for the remainder of the project.

2. Traditional accounting for intangible assets

Financial accounting and reporting practices have traditionally provided a basis for evaluating
a company’s business performance. The fundamental objective of financial accounting is to
provide users of financial statements with useful information for the purpose of efficient and
effective decision making
. Outside of the firm, financial reporting should provide information
that is useful to present and potential investors and creditors in making rational investment and
credit decisions. Within the firm, accounting information is essential for the purposes of
efficient managerial decision making - as managers need timely and accurate information in
order to carry out the budgeting process and implement effective control mechanisms.
Consequently, any event that is likely to affect a firm’s current financial position or its future
performance should be reflected in its annual accounts. Unfortunately, conventional financial
statements appear to be rapidly becoming less useful within today’s dynamic business

2.1. Why are traditional financial measures becoming less relevant?

Conventional accounting systems, as well as the system of national accounts used in all
industrialised countries, were developed for manufacturing economies where most wealth was
in the form of property, plant and equipment
. These systems were designed to provide
accurate and reliable cost-based information about the value of assets used in production, and
about the net value (adjusted for depreciation) of the output produced by these assets.
Unfortunately, in recent years, cost-based accounting information has become increasingly less
A principal factor behind this growing irrelevance of conventional financial statements has
been the global transition towards a knowledge driven economy. During the last two decades
most industrialised economies have progressively moved towards a knowledge-based rapidly
changing economy where investments in human resources, information technology, R&D and
advertising have become essential in order to strengthen a firm’s competitive position and
ensure its future viability
Intangible factors play a predominant role in the ability of companies to innovate and their
subsequent competitiveness within a knowledge-based economy. Such assets enable
knowledge intensive economies to maintain their competitive position compared to resource or
labour intensive economies. This dematerialisation of the economy involves greater investment
in intangibles. There is a growing awareness in OECD Member countries that an increasing
part of total investment in the business enterprise sector is directed towards intangible
“investment products” such as R&D, marketing, training, software. Nevertheless OECD data
on intangible investment is still relatively scarce
, as it is in the national statistics.
With the transition to a knowledge-based economy, the principal source of economic value and
wealth is no longer the production of material (tangible) goods but the creation and
manipulation of intangible assets. In other words, economic growth is not as much influenced
by investments in physical capital (ie. land, machinery), as by knowledge which is a critical

Horngren, Harrison, Fraser and Izan, H (1997).
Blair and Wallman (1997).
Cost-based is a managerial accounting activity designed to help managers identify, measure, and control operating costs.
Good cost accounting statements guide managers in pricing their products to achieve greater profits, and determine when a
product is not profitable and should be dropped.
The Economist (1999, pp. 69-70).
Vickery (1999).
determinant for the productive application and exploitation of physical capital
. Consequently,
companies depend on being able to measure, manage and develop their knowledge.
Unfortunately conventional accounting systems still largely to concentrate on and to measure
only the value of financial and physical assets - plant, equipment, inventories, land and natural
resources. In other words, conventional accounting principles simply do not account for many
drivers of corporate success in the knowledge-based economy, eg. investments in intangible
assets such as know-how, brands, patents and customer loyalty. There presently exists no
adequate accounting techniques for determining and reporting the value of intangible assets
such as the skills of workers, IP, business infrastructure, brand names, databases and
relationships with customers and suppliers

2.2. Problems with conventional accounting treatment of intangible assets

Research has shown that traditional financial accounting performed reasonably well when a
company’s investment in intangibles was high and stable. Traditional accounting does not
perform so well, however, when companies increase their investment in innovation, for
example to open up a new market. It is hard for investors and accountants to value this
additional investment, particularly because the future earnings it might generate are so
. Traditional accounting finds it particularly difficult to cope with fast moving
industries, with rapid innovation which is driven by investment in intangibles.
The greatest challenge to conventional accounting is not quantifying the level of investment in
intangibles but accounting for the rate of change
. Changes to investment in intangibles are
difficult to track. Those investments can lead to a marked and unpredictable change in business
performance. Traditional accounting measures have been undermined by this faster, less
predictable rate of change because accountants find it increasingly difficult to match costs and
investments in one period with earnings and revenues in another. Earnings in one period are an
increasingly poor guide to earnings in a subsequent period. This faster rate of change is in part
due to deregulation and technological change - which has exposed companies to new
competition and opened up new markets that are difficult to value. However, intangible
investment - R&D to create new products for example - also plays a significant role in driving
Conventional accounting performs particularly poorly with internally generated intangibles
such as R&D, brands and human capital - the very items considered the engines of modern
economic growth. Accountants generally agree that any internally generated intangibles should
not be treated as an asset. On the other hand, if intangibles are separable from the operations of
a business, and acquired at an arm’s length transaction, they may be classed as an asset, and
valued at market price (such as purchased licensing agreements or franchises)
. For example,
today’s generally accepted accounting principles call for the immediate expensing of R&D
costs. But, unlike rent and interest payments, intangibles investments can often produce rich
future rewards (why else would firms invest in them?). Expensing them now produces serious
distortions in reported earnings and detracts from the relevance of financial reports. Studies
have shown that investors implicitly recognize R&D expenditures as assets rather than
expenses. For example, Lev et al (1996) found that net annual R&D investment (i.e., R&D
expenditure minus the amortization of the R&D capital) is positively and significantly
associated with stock prices - despite the fact that this amount is expensed in the income

Bishop (1999).
Lev (1997).
Leadbeater (1999).
Jan-Enk Gröjer and Ulf Johanson, Voluntary guidelines on the disclosure of intangibles: A bridge over troubled water?,
Workshop "To Manage And Account for Intangibles", February 15—16, 1999, Brussels.
ibid., p. 42.
. Another study, Kothari et al (1998), found that earnings volatility associated with
R&D is three times larger than that associated with tangible investment in plant, property and
Nakamura (1999) explains how investment, profit, and savings are understated in corporate and
national accounts, particularly since the mid-1970s, because of the accounting treatment of
intangible assets. Nakamura (1999) shows that if investment in R&D was treated similarly to
investment in tangible assets, profits (and hence retained earnings) would be higher and
reported business savings would increase enough to raise reported gross national savings (U.S.)
during the 1990s from 15.9 percent to 17.1 percent of GDP. This percentage would be even
higher if investment in R&D was extended to include investments in intangibles.
The immediate expensing of practically all intangible investments, while obviously
inappropriate given the consistent evidence about the substantial future benefits associated with
such investments, is often justified by the conservatism principle
. Conservative accounting
procedures, like the immediate write-off of intangibles, goes the argument, counter a company
management’s general inclination to paint a rosy picture of the firm - its performance and
potential (to beat analysts’ forecasts of earnings, to enhance compensation etc). A conservative
treatment of intangibles, it is further argued, is appropriate given the generally high level of
uncertainty associated with such investment.
However, others see immediate expensing as being both biased and inaccurate
. For example,
expensing is only conservative when outlays on intangible investments exceed their revenues -
which usually occur early in a company’s life. Later on, as investment in intangibles subsides
whilst revenues from intangibles increase - reported profitability is often overstated.
Frequently, even internally generated corporate data is insufficient to support appropriate
analysis and evaluation of the firm’s intangible investment activities. Thus both internal, and
external performance evaluation and monitoring of investment in intangibles are hampered by
the absence of adequate accounting information.
Traditional accounting techniques do an unacceptable job of measuring the value of the
principle activities of a knowledge-intensive business. According to conventional accounting
practices, tangible acquisitions such as computers, land and equipment are treated as company
assets. Investment expenditure on knowledge-building activities such as training and R&D are,
however, still largely treated as costs. This is despite such activities being a primary source of
organisational wealth in the new economy.

2.3. Consequences of inadequate accounting for intangibles

Interest in accounting for intangibles is based on the assumption that the present non-
accounting of intangibles is causing harmful effects. Supporters for the inclusion of human
capital and structural capital into the balance sheet argue that such capitals may largely explain
the gap between book value and market value, namely intellectual capital. Opponents argue
that balance sheet are not designed to be speculative and that determining precise
figures/numbers are highly subjective and difficult to measure. The main argument for
accountability and accounting regulation is (capital) market failures, eg. appropriate accounting
regulation would reduce the amount of market failures
. If intangibles are not reflected in the
balance sheet, and intangible investments are fully expensed as they are undertaken, both
earnings and the book value of equity are argued to be understated by the conventional

Lev and Sougiannis (1996, pp. 107-138).
Kothari, Laguerre, and Leone (1998).
Lev, Sarath and Sougiannis (1999).
Lev (1997).
Jan-Enk Gröjer and Ulf Johanson, Voluntary guidelines on the disclosure of intangibles: A bridge over troubled water?,
Workshop "To Manage And Account for Intangibles", February 15—16, 1999, Brussels.
accounting model. This makes it practically impossible for investors and company managers
- assess the rate or return (productivity) of investment in intangibles, and changes over time
in the efficiency of the firm’s investment activity;
- evaluate shifts in the characteristics of intangible investments, such as from long-term
research to short-term development, or from product development to “process (cost
reducing) R&D”; and
- determine the value of a firm’s intangible capital, and the expected lives (benefit duration)
of such assets
There is considerable evidence that this lack of information about asset and true sources of
value in corporations is already an urgent problem for corporate investors and managers
However, because valuation and disclosure issues related to intangibles are complex and little
understood, accounting standard-setters around the world encounter great difficulties in
attempting to improve disclosures about intangible assets.

2.4. Accounting for intangible assets - general approaches

The increased importance of intellectual capital to business competitiveness has driven change
in the accounting treatment of intangibles. So far there are two broad streams of development.
One approach is to improve information about intangibles by making it easier to treat them as
assets in financial statements, thereby increasing their visibility in financial accounting and
reporting. The International Accounting Standards Committee (IASC) took a step in this
direction with the 1998 approval of International Accounting Standard (lAS) 38 - a standard on
intangibles, including advertising, training, start-up and R&D activities
. For intangibles to be
recognised as assets, they are required to meet definitions spelled out in the standard, generate
a flow of benefits that are likely to accrue to the company, and are able to be measured reliably.
Although this places businesses under the obligation of recognising intangible assets on the
balance sheet, it does impose certain strict conditions on the capitalisation of such assets in
order to get greater certainty on their future realisability
. This fact, to a certain extent, limits
its applicability in measuring and valuing a number of intangible assets.
Another approach is to increase the availability of non-financial information about investment
in and management of intangibles. This strategy is most evident in Europe, where some
countries require companies to report certain information about human resources, for example,
and where many companies have voluntarily disclosed non-financial information about
everything from training efforts to customer networks and in-process R&D (e.g., Skandia,
Ramboll and Ericson). This second approach is promising, as it does not run afoul of
objections by accountants and accounting standards. In contrast to reporting requirements
linked to accounting standards, though, the disclosure of non-financial information about
intangibles has been far less transparent
. There is little clarity concerning definitions,
measurement and verifiability of information; the consistency over time and the comparability
of information across companies is not ensured.

Blair & Wallman (1997).
Nakamura (1999, pp. 3-16).
International Accounting Standards Committee (1998).
Wurzburg (1999).
2.5. A short note on company goodwill

Goodwill is often described as the corporate reputation of the acquired party; it might also
flagship value, customer relationships, and a range of equally difficult to describe, much less
quantify, business intangibles. Goodwill is often thought of as the value of the company’s trade
. An accountant would describe goodwill as the market price of the business as a
whole less fair value of other assets acquired
. An economist would define goodwill as the
consequence of a firm’s above-normal ability to generate future earnings, or as a set of assets
controlled by an acquired company.
Historically, the accounting treatment of goodwill has served as a convenient category in which
to allocate intellectual assets. However, goodwill is only valued when a business is sold
(acquired) and is therefore not valued for firms that have not been acquired. This does not, of
course, imply that such firms do own any intellectual assets. From July 2001, the Financial
Accounting Standard Board (FASB) will no longer allow the accounting consolidation method
called "pooling of interests" as this does not reflect the creation of goodwill on
purchase/acquisition (SFAS 141). The FASB is concerned that pooling obscures the true cost
of acquisitions. Companies will also have to break down goodwill into its component elements
(i.e., intangibles), which will be no more amortised, but subject annually to an impairment test
aimed to verify whether the value of these intangibles has decreased (SFAS 142).
In addition, the emerging interest in IC reporting means the relevance and appropriate use of
goodwill will be subjected to greater scrutiny. While the accounting profession is still tackling
with the problems of goodwill, the rise of IC reporting has added another dimension (and
perhaps, a new perspective) to the way goodwill is accounted for.
Furthermore, conventional accounting only recognizes intangibles on a company’s balance
sheet when that company is acquired by another company
. As already pointed out, in the
accounts the line item ‘goodwill’ represents the difference between the revalued net assets of a
company and what is actually paid. It represents value in the eye of the buyer – not in the
company value. The buyer might perceive value in trademarks, brand names and other
intangibles not recorded in the books of the company being taken over. Under conventional
accounting practices, ‘goodwill’ is only assigned a value when a company is sold.

2.6. Some dichotomies relating to traditional accounting and intangibles

The conceptual challenges which are posed by intangibles to the traditional accounting can be
summarised as follows:
- role and nature of accounting: intangibles are most often internally generated, while
traditional accounting is transaction-based (cf. double entry principle);
- relevance vs. reliability: the knowledge of the value of company intangibles is certainly
relevant owing to the today's business conditions and environment. However, this value is
generally less reliable, verifiable and stable than that of a tangible asset: therefore, to switch
the pendulum towards relevance of data may produce problems with their reliability;
- recognition vs. disclosure: should the intangibles be recognised as a value within the
traditional financial statements, or simply be accounted for in the disclosure section of the
annual report (Management Discussion and Analysis)? In the former case, we clearly face a
measurement issue, while in the latter case we lend towards a more qualitative recognition.
- internal vs. external reporting: should the intangibles be reported upon only in the internal
accounts and statements of a company (e.g., internal managerial reports) or also in the

Sullivan (1998, p. 287).
International Federation of Accountants (1998).
Skyrme (1998).
external, publicly-available reports?
- voluntary vs. mandatory: should the production and diffusion of information relating to
intangibles be left voluntary, or somehow be made mandatory through ad hoc regulations
(e.g. Denmark regulation in 2001)?
- audit and litigation: who and how can audit this new information on intangibles, and how
companies can avoid litigation consequences potentially linked to this type of information?
- traditional accounting vs. "new accounting": can traditional accounting - which is financial
capital based - face all the above challenges, or will these challenges necessarily require a
new form of accounting and reporting - which we could define as "intellectual capital (IC)

2.7. Some concluding remarks to Section 2

With the transition to a knowledge-based economy, the competitive position of a firm is being
increasingly determined by its investments in intangible assets such as human resources,
information technology, R&D and advertising. As such investments are largely not tangible,
most expenditures on intangibles are not being recognised as investments in either companies’
financial accounts or national income and product accounts. This practice may have seemed
reasonable when intangible investments constituted a negligible portion of total corporate
investment - but this is no longer the case. Within the knowledge-based economy, economic
growth is largely driven by intangibles such as knowledge, brand names and relationships.
Therefore, it is highly desirable that companies can provide a reliable and accurate insight into
their “intangible strength” to both investors and managers. Unfortunately, conventional
financial statements and internal management reports presently provide insufficient
information on the factors that really contribute to a company’s success
Intangible assets are present in every business enterprise, yet only tangible assets and
intangible assets purchased in an acquisition appear on a company’s balance sheet. As a
consequence, the conventional book value of a company is often far removed from its true
Accountants have long argued that there are sound reasons for not treating intangibles as assets
on a company’s balance sheet
. Problems of definition and measurement hamper the degree to
which data on intangibles is robust and comparable. This complicates valuation on the basis of
historic costs - and valuation on the basis of expected future economic benefits is not
appropriate for the balance sheet, which is backward-looking. So too does the fact that it is
virtually impossible to impute a value for intangibles such as customer or supplier networks,
which are difficult to separate from other aspects of the business. Furthermore, human capital
cannot be easily treated as a financial asset because - as mentioned above - companies do not
own their employees. Finally, tax policies encourage the immediate expensing of investment in
intangibles as a way of reducing tax liability. There is also strong opposition, among
accountants, to recognizing internally generated intangible assets, particularly research and
development costs. Many accountants believe that this would allow management the flexibility
to capitalise virtually every expenditure as an asset in an attempt to increase book value and
defer expenses. This means that companies will be able to manipulate earnings both in the
short term by determining economic feasibility, and in the long term by the judicious use of
amortisation and impairment tests
However, in the knowledge-driven economy where the key factors are complexity,
intangibility and dynamics - managers clearly need new management tools and stakeholders

Lev (1997).
Wurzburg (1999).
Association for Investment Management and Research (1997).
need other measuring methods to form a clear view of a company’s true economic potential.
Such tools should provide transparency about the quality and value of a company’s intangible
assets and their potential value in the future.
Unfortunately, accounting for intangible assets is more easily described than implemented. It is
a new discipline, as yet largely undeveloped. There are clearly difficulties in quantifying
immaterial attributes such as openness to change or even degrees of competence. As a result of
the numerous problems associated with traditional financial measures of intangible assets -
there is general agreement that new types of measurement systems are needed that will help
investors, managers and policy-makers alike manage more effectively in the knowledge
economy. The problem is recognised internationally, and a number of countries are working on
developing a workable system of accounting for intangible assets

Neilson (1999).
3. Intellectual Capital: Definition, Classification and Valuation

Intellectual capital can be described simply as knowledge that can be converted into profits
There is, however, a multitude of other IC definitions and experts have yet to reach a consensus
on a commonly accepted definition. Researchers and other large accounting/consulting firms
have played an important role in the search for suitable classification of intangibles. Other
definitions of intellectual capital/assets include:

‘The sum of everything everybody in a company knows that gives it the
competitive edge.’

‘Intellectual capital is intellectual material – knowledge, information,
intellectual property, experience that can be put to use to create
wealth.’ (Stewart 1998)

‘Knowledge that can be converted into value.’
(1996; Leif Edvinsson, Skandia, Pat Sullivan, European Management
Journal, vol. 14)

‘Intellectual material that has been formalised, captured and leveraged
to produce a higher valued asset.’
(Klein & Prusak 1994)

‘Intangible assets as non-monetary assets without physical substance
that are held for use in the production or supply of goods or services,
for rentals to others, or for administrative purposes: (a) that are
identifiable; (b) that are controlled by an enterprise as a result of past
events; and (c) from which future economic benefits are expected to
flow to the enterprise (IAS 38).’

3.1. Components of Intellectual Capital

In order to arrive at the objective of valuing and measuring IC, it is necessary to understand the
different components that make up intellectual capital. Intellectual capital
includes/encompasses inventions, ideas, general know-how, design approaches, computer
programs, processes and publications. Distinguishing between the different components of IC
will help to improve the understanding of what IC is, and will hopefully allow us to apply the
concept at a strategic and operational level. Some components of intellectual capital are
difficult to measure, and the costs and benefits are difficult to quantify. For example,
quantifying the value of customer relationships is highly subjective and determining a dollar
measure would be very difficult.
One of the most popular models for classifying IC is the Hubert Saint-Onge model which is
largely based on Sveiby’s (1988). The Saint-Onge model, developed in the early 1990
, divides
intellectual capital into 3 parts: human capital; structural capital; and customer capital. A
slight variant of this model, devised by Dr Nick Bontis, Director of the Institute for Intellectual
Capital Research, restates customer capital as relational capital to include relationship with

Intellectual Capital Management (ICM) Gathering developed this definition at its first meeting.
suppliers and other strategic partners and stakeholders. Adopting Bontis’s classifications,
intellectual capital can be divided into three categories:

Human Capital Structural Capital Relational Capital
• Knowledge, competence,
skills and experiences of
• Training;
• Networks.
• Organisational processes;
• Databases;
• Software;
• Manuals;
• Trademarks;
• Laboratories and market
• Assembled workforce –
the relationship between
the business and its
employees; training,
employee contracts;
• Leadership;
• Organisational capacity
for saleable innovation;
• Organisational learning
• Leaseholds;
• Franchises;
• Licenses;
• Patents;
• Mineral rights.
• Customer relationship;
• Customer loyalty and
• Distribution relationships
and agreements;
• Relationships with other
partners and other

Human capital is often recognised as one of the largest and most important intangible asset in
an organisation. It is the capital which ultimately provides the good or services which
customers require or the answers to their problems. Human capital includes the collective
knowledge, competency, experience, skills and talents of people within an organisation. It also
includes the creativity and innovativeness of the organisation. The predominant intangible in
any organisation is largely driven by and derived from the human side of the enterprise, that is,
its people and their collective intelligence
. Improving productivity through the provision of
employee training is not a new phenomenon, but the financial commitment and scale at which
companies are now investing in human capital is growing. The effects of human capital
formation is hard to determine, even how difficult they are to measure. Apart from the
measurement difficulties, many argue against the inclusion of human capital onto the balance
sheet because (1) human capital is not owned by the organisation: it is only for rent, and (2)
ethical reasons – placing a price on individuals runs the risk of making employees appear
substitutable for other form of capital
. However, in spite of this shortcomings, considerations
of human capital provides another approach on training and human resource management
policies, ultimately improving the management of an organisation.
Structural capital is often referred to as what is left when the employees go home at night and
is considered the “hard” assets of the firm. It consists of the supporting resources and
infrastructure of a firm and includes all of the assets found in the financial statements of a firm,

Sullivan (1998, p. 43).
Early 2000, the Australian Securities and Investment Commission forced One.Tel to change its policy of
treating a advertising and staff costs associated with customer acquisition as an asset. See Boyd (2000).
such a cash and equivalents, property, buildings, and equipment. It reflects the collective
capabilities of the organisation that enable it to function to meet market requirements. Unlike
human capital, structural capital is company property and can be traded, reproduced and shared
by within the firm.
Relational capital comprises not only customer relations but also the organisation’s external
relationships with its network of suppliers, as well as its network of strategic partners and
stakeholders. The value of such assets is primarily influenced by the firm’s reputation. In
measuring relational capital, the challenge remains in quantifying the strength and loyalty of
customer satisfaction, longevity, and price sensitivity.

3.2. Knowledge Companies

The term knowledge companies or knowledge intensive companies is increasingly being used
to describe companies that focus or leverage their intellectual capital
. Knowledge companies
are utilising their intellectual capital as a key source of competitive advantage. In a knowledge
company, profits are generated primarily though the commercialisation of new ideas and
innovations, that is through the interaction of the company’s human capital and structural
capital. Activities that create intangibles always lead to a seat of tangible outcomes, over a
period of time. It is the interaction between tangible and intangibles that determine the
corporate value. It is this entrepreneurial activity that generates the primary value of so many
businesses. The embedded 'know-how' or knowledge of an organisation is dynamic, complex,
heterogeneous and networked.

3.3. Why do companies want to measure intellectual capital?

Before going into the issues surrounding the measurement and reporting of intellectual capital,
we need to examine why firms want to measure IC. Young, knowledge-intensive organisations
encounter great difficulty in attracting external financiers, and as such need to develop a way to
quantify their intellectual capital to investors and financiers. There a number of reasons why
firms want to measure IC and the predominant reason has been for strategic or internal
management purposes. Specifically, reasons include:
• Alignment of IC resources with strategic vision. To support the implementation of a
specific strategy via a general upgrading of the work with the companies' human
resources (support and maintain a strategy concerning the composition of staff as
regards seniority, professional qualifications and age. Through the description of the
staff profile, measuring, discussion and adjustment become possible).
• To support or maintain various parties' awareness of the company.
• To help bridge the present and the past (stimulates the d3ecentralised development of
the need for constant development and attention towards change).
• To influence stock prices, by making several competencies visible to current and
potential customers.
• To make the company appear to the employees as a name providing an identity for the
employees and visualising the company in the public. Knowledge of employees and
customers will stimulate the development of a set of policies to increase customer
satisfaction and customer loyalty.

The OECD defines the knowledge-based industries as those which are relatively intensive in their inputs of
technology (high-tech and medium-high tech industries) and/or human capital and 3 service sectors –
communications; finance, insurance, real estate and business services; and community, social and personal
services. See OECD (1999b).
• Assessing effectiveness of a firm's IC utilisation - Allocate resources between various
business units. Extract full value from acquisition and joint ventures.
• Determine the most effective management incentive structures.

Attempt to measure IC has largely been driven by companies that rely heavily on knowledge as
a key input to production. Companies that are creating measurement and reporting
requirements are choosing to engage in benchmarking activities because they believe that such
activities create value for them. A firm makes an investment in intangibles when it undertakes
expenditure which has a long-term pay-off, but acquires no physical assets. To gauge the
relative profitability of such investments, firms need to be able to measure their IC. Firms
which develop a deep understanding of the role of knowledge in their business, treat it as an
asset, cultivate and exploit it, are gaining significant business benefits as a result.

3.4. The valuation of Intellectual Capital

The growing interest in benchmarking intellectual capital stock between firms has led to the
development of three broad indicators - market-to-book ratios, Tobin’s Q and Calculated
Intangible Value (CIV). The value of intellectual capital is both time and context dependent.
As a result, these measures of intellectual capital should be interpreted as a stock valuation,
not a flow.
This section examines the three major techniques used to value intellectual capital and outlines
the benefits from reporting intangibles. This section also considers the use of real options as a
way of valuing the anticipated/expected benefits from investments in intellectual capital. This
technique attempts to utilise the workings of the market to determine a price and value on
assets that are expected to yield future economic benefits. Unlike the static techniques, market-
to-book ratios, Tobin’s Q and CIV, real options provide a forward looking approach to the
valuation of IC.

3.4.1. Market-to-book values

The value of intellectual capital is commonly expressed as the difference between the market
value of the company and its book (equity) value
. People are recognising the growing
divergence occurring in the marketplace between the book value and the market capital of
various corporations. This divergence indicates that there is something not accounted for on
the balance sheet
. Recent acquisitions shows that the price paid for an acquired company is
almost invariably higher than its book value, and this difference has been incorporated under
conventional accounting practices as goodwill. In today’s increasingly fast-paced business
environment, where mergers and acquisitions are occurring more frequently, what has
changed, is increasingly the size of the value of goodwill that has been paid.
The growing disparity between market value (MV) and book value (BV) is largely based on
the intangibles of the business providing the foundation for future growth. The largest
disparity occurs in high-tech and knowledge-intensive industries, where investment is heavily
weighted in intangible assets such as R&D and brands. According to Skynne (1997), in June
1997, the ratio of market-to-book value for all Dow Jones Industrial companies was 5.3, while
for many knowledge-intensive companies (e.g. Microsoft, pharmaceutical companies) the ratio

Book value is also known as net tangible asset value.
There are many other explanations for the gap between market value and book value. One claims that it is due to knowledge
(Buckman Laboratories), while another attributes it to the brand (Coca-Cola) or the ownership of a standard (Microsoft). See
Ministry of Economic Affairs (1999).
was more than ten
. Between 1973 and 1993, the median ratio of MV to BV of American
public companies doubled; the difference has grown with the boom in high-tech shares and the
differences being the biggest for firms that have most rapidly boosted spending on R&D
From an internal perspective, differences between MV and BV are due primarily to assets that
are not currently included in the conventional balance sheet total, such as knowledge,
relationships, and image. The external perspective on the gap between MV and BV is due
primarily to the company’s future opportunities and these are currently not valued in the
conventional balance sheet
. Further empirical evidence of the growing gap between market
value and book value include:
• Netscape, which the market valued at the end of the first day of trading at US$3 billion but
Netscape’s book value was $US17 million, giving a market - to - book value of 176.4
• Merck, a pharmaceutical company with a market value of US$139.9 billion was valued at
11 times greater than its book value of US$12.6 billion
• Bristol-Myers Squibb, a leading diversified worldwide health and personal care company
had a market value 14.8 times greater than its book value of $7.2 billion.
• Johnson & Johnson, a manufacturer of health care products with a market value of
US$92.9 billion was valued at 7.5 times greater than its book value of $12.4 billion.
• DuPont, a science company with a market value 7.6 times greater than its book value of
$11.3 billion.
• Monsanto, had a market value 8 times greater than its book value of $4.1 billion
• Recruitment company Morgan & Banks had a capital asset base of around $11 million
(when it listed on the Australian Stock Exchange two years ago). However, the company
was soon valued at over $300 million - almost 30 times the book value of its assets
• Glaxo Wellcome - of its £40 billion plus market value, £1 billion is tangible, £10 billion
goodwill, and the rest intangible
• British Technology Group - turnover £40 million, losses £4 million, yet market value of
around £1,240 million. Their key assets are 3000 patents

These results imply that there are huge hidden value in such companies, which is not visible in
traditional accounting. Yet increasingly larger investments are being made in precisely these
hidden assets. Such investments concern customer relations, information technology, networks
and competence
Research undertaken by Margaret Blair, a Brooking Institute economist, has demonstrated that
the value of hard assets represented 62 per cent of the companies market value in 1982. In
1992, this figure had dropped to 38 per cent. In 1995, health care and personal care companies
had the highest market-to-book value in the world with almost 75 per cent of MV attributable
to intangible assets. Recent estimates suggest that 50-90 per cent of the value created by a firm
comes, not from management of traditional physical assets, but from the management of IC
In May 1997, for example, the market-to-book ratio for General Motors was 1.6 compared with
13.4 for Microsoft. Furthermore, analysis in Business Week (July 1997) found that Microsoft’s

David Skyrme Associates (1997).
The Economist (1999).
The internal value of IC can be proxied on replacement value or market value while the extemal perspective on the value of
IC can be proxied on economic value or future potential. See Ministry of Economic Affairs (1999, p. 7).
Roos. J., Roos. G., Dragonetti., and Edvinsson (1997, p. 3).
The Economist (1999).
ibid., p.
Sherry (1999).
David Skyrrme Associates (1998, p.15)
ibid., p. 15.
See Skandia Group Yearend Report Supplement (1996).
International Federation of Accountants (1998, p.4).
stock market value of $148.5 billion was worth the same as the combined value of Boeing ($3
7.9bn), McDonald’s ($34.7bn), Texaco ($28.7bn), Time-Warner ($26bn) and Anheuser-Busch
. Moreover, at the time, only about 7% of Microsoft’s stock market value was
accounted for by traditional tangible assets (land, buildings, machinery and equipment)
recorded on it’s balance sheet.
Intangible assets (e.g. brands, R&D and people) were seen as constituting the remaining 93%
of the company’s assets.

Ratio of Market Value to Book Value: As of August 19, 1998
Company Name Market-to-Book Value
Coca-Cola 24.3
Microsoft 19.8
Cisco 16.6
Intel 6.9
International Business Machines 6.7
Nike 3.4
Merrill Lynch 3.3
Citicorp 3.2
Southwest Airlines 3.1
General Motors 2.9
Source: http://www.adamscapital.com/volumel_issue4.htm

Limitations of market-to-book values

Market-to-book ratios have both theoretical and practical problems. First, the stock market is
volatile and responds, often strongly, to factors entirely outside the control of management.
Stock market price data are a highly volatile series, which can often be dominated by irregular,
seasonal and cyclical factors. Furthermore, market-to-book values ignore exogenous factors
that can influence MV, such as deregulation, supply conditions, general market nervousness, as
well as the various other types of information that determine investors’ perceptions of the
income-generating potential of the firm, such as industrial policies in foreign markets, media
and political influences.
Companies with large intangible values tend to have share prices that fluctuate more than other
companies. In a publicly traded company, the greater the ratio of intangible to book value, the
more uncertain the investment
, as witnessed by recent falls in technology stocks.
Second, there is evidence that both MV and BV are usually understated. To encourage
companies to invest in new equipment, Internal Revenue Services rules deliberately permit
companies to depreciate assets faster than the rate at which they actually wear out
Calculations of IC that use the difference between market and book values can also suffer from
inaccuracy because book values can be impacted if firms choose to, or are required to, adopt
tax depreciation rates for accounting purposes
. Other changes to the accounting standards
also impact on book value, such as FASB Statement 115 (Accounting for Certain Investments
in Debt and Equity Securities, in accordance with GAAP) which affect reported book value.
Under Statement 115, effective for fiscal years beginning after December 15, 1993, returns on
equity for a given company will fluctuate inversely with the book value and will be unusually

See Kaufman (1997, p. 5).
In addition, organisations that are not traded in public markets do not have a market value that is easily determined.
Presumably, this organisations still have IC which has value that to the organisation.
Stewart (1999, p. 225)
International Federation of Accountants (1998, p. 17).
high when the book value is depressed because of high interest rates
Third, adopting the market-to-book approach for valuing intangibles suffers from timing
inconsistencies because market value is determined and revised constantly whereas book
values are only updated periodically.
The reliability and usefulness of the difference between MV and BV can be enhanced by
looking at the ratio between the two, rather than at the raw number. You can then compare one
company with similar competitors or benchmarked against the industry average and also make
year-to-year comparisons of the ratios. While the market-to-book method of valuing IC is
subject to several problems, it has served to draw attention to the undeniable existence of IC,
and for that reason alone has been a constructive innovation.

3.4.2. Tobin’s Q

Traditionally, Tobin’s Q was used as a method for predicting investment behavior
. Tobin’s Q
compares the market value of a company with the replacement cost of its assets. It uses the
ratio (the “Q”) to predict the investment decisions of the firm, independent of macroeconomic
conditions such as interest rates. The replacement cost of fixed assets can be calculated as the
reported value of a company’s fixed assets plus the accumulated depreciation and adjusted for
inflation. According to Smither & Wright, in the year 2000, Wall Street’s Q was standing at
well over two
As with market-to-book ratios, Tobin’s Q is most revealing when like companies are compared
over a period of several years
. Use of both Tobin’s Q and the market-to-book ratio are best
suited to making comparisons of the value of intangible assets of firms within the same
industry, serving the same markets, that have similar types of hard assets. These ratios are
useful for comparing the changes in the value of IC over a number of years. When both the
“Q” and the market-to-book ratio of a company are falling over time, it is a good indicator that
the intangible assets of the firm are depreciating. This may provide a signal to investors that a
particular company is not managing its intangible assets effectively and may cause them to
adjust their investment portfolios towards companies with climbing, or stable “Q’s”. An
advantage of Tobin’s Q over the market-to-book ratios, is that the Tobin’s Q approach
neutralises the effects of different depreciation policies.
Technology and human capital assets are typically associated with high ‘Q’ values
. The
Department of Industry Science and Resources (2000) in their study using Tobin’s Q as an
indicator of company valuation, found that the market does value more highly those firms
which invest in R&D and patents. Indeed, there is a relationship at work between these
intangible assets, such that R&D is valued more highly if it is effective in leading to patent
Tobin’s Q can be a useful measure of intellectual capital because it can reflect the value
markets place on assets which are not typically reported in conventional balance sheet
. By
making intra-industry comparisons between a firm’s primary competitors, these indicators can
act as performance benchmarks that can be used to improve the internal management or
corporate strategy of the firm
. The information provided by these ratios facilitates internal

See Robertson (1995).
Nobel laureate, James Tobin proposed the idea of ”Q” in 1969.
The Economist (2000b).
Stewart (1998, p. 226).
International Federation of Accountants (1998, p. 18).
Markets value investment in these intangible assets five times greater than investment in physical assets. This is consistent
with US studies, which find that R&D spending is capitalised into a firm’s market value at a rate between 2.5 and 8 (with most
estimates centred between 5 and 6). See Department of Industry, Science and Resources (2000).
Jones & Sharma (1999, p. 9).
International Federation of Accountants (1998).
benchmarking; enabling the organisation to track its progress in the area that it has defined as
being integral to its success.

3.4.3. Calculated Intangible Value (CIV)

Developed by NCI Research, calculated intangible value allows us to place a monetary/dollar
value on intangible assets. This method allows us to calculate the fair value of the intangible
asset. CIV computes the value of intangible assets by comparing the firm’s performance with
an average competitor that has similar tangible assets. An advantage of the CIV approach is
that it allows firm-to-firm comparisons using audited financial data and, as such, CIV can be
used as a tool for benchmarking.

Determining CIV

1. Calculate average pre-tax earnings
2. Calculate average year-end tangible asset (from balance sheet)
3. Return on assets (ROA) = Average pre-tax earnings / Average year-end tangible assets
4. Benchmark/compare the ROA against the industry’s average ROA. If a company’s ROA>
Industry ROA proceed to step 5.
5. Excess return = Pre-tax earnings - [industry - average ROA * company’s average tangible
6. (l-t) * excess return = premium attributable to IA (where t = average income tax rate and
IA= intangible assets)
7. NPV
= premium / company’s cost of capital = CIV.

Limitations of CIV method

First, the CIV uses average industry ROA as a basis for determining excess returns. By nature,
average values suffer from outlier problems and could result in excessively high or low ROA.
Secondly, the NPV of intangible assets will depend on the company’s cost of capital. However
for comparability within and between industries, the industry average cost of capital should be
used as a proxy for the discount rate in the NPV calculation. Again the problem of averages
emerges and one must be careful in calculating an average that has been adjusted for outliers

3.4.4. Real Options-Based Approach

An emerging new market approach to the valuation of intangibles is now gaining currency.
Over the past twenty years, there has been a growing body of academic research that has taken
the theory and methodology of financial options and applied it to the valuation of intangible
assets. This is known as real option theory, an extension of financial option theory
. An option
is the right, but not the obligation to buy (or sell) an underlying asset at some fixed price for a
predetermined period of time. A real option is an option that is based on non-financial assets. It
applies the same techniques and variables as the Black-Scholes model on which financial
options are based, but uses non-financial inputs. Real options can be applied by using non-
numeric strategy options to determine the value to proceed, defer, expand or abandon
investment. By drawing on financial markets’ techniques, benchmarks, and information,
businesses can discipline their investment decisions and align them with the investment

ibid,p. 19
The item “real option” was coined in 1977 by Stewart C. Myers of Massachusetts Institute of Technology. Its earliest
applications were in oil, gas, copper, and gold, and companies in such commodity businesses remain some of the biggest users.
decisions of the market. They can close the gap between strategy and shareholder value
Reporting Intellectual Capital is often criticised by accounting professionals for the high
uncertainty associated with the returns on intellectual assets. Intellectual capital by its very
nature, derives its value from the opportunities it creates. Unlike the previous measures of IC -
market-to-book value, Tobin’s Q, and CIV - real options (option pricing models) provides an
approach which values the opportunities arising from IC
. Deciding how much to spend on
R&D, or the kind of R&D in which to invest, translates to the valuation of opportunities.
Companies with new technologies, product, development ideas, defensible positions in fast-
growing markets, or access to potential new markets own valuable opportunities. For some
companies, opportunities are the most valuable things they own and the question is how do we
map the opportunity to reality
. The analysis of real options is more than simply a valuation
tool. It is also a formal strategic tool, offering a proactive rather than just reactive flexibility.

Exploiting uncertainties

Executives readily see why investing today in R&D, or in a new marketing program, or even in
certain capital expenditures can generate the possibility of new products or new markets
tomorrow. A corporate investment opportunity is like a call option because the corporation has
the right, but not the obligation, to acquire something, like the operating assets of a new
business. If we could find a call option sufficiently similar to the investment opportunity, the
value of the option would tell us something about the value of the opportunity
The options approach is increasingly being used by companies acquiring research and
technology from universities in the US
. The option pricing model
largely borrowed from
the financial markets may assist companies and investors to overcome the problem of valuing
R&D in an environment of great uncertainty. R&D expenditure should be viewed as an
investment to create an asset - knowledge capital - which in turn can produce a flow of income.
Increasingly companies are using the options approach to acquire and fund research in stages.
At each stage of the research the company can either choose to renew the option, terminate it or
sell it to another bidder. Projects can be viewed as a sequence of options (for example, the case
of oil extraction includes stages such as licensing, exploration, appraisal and development) and,
importantly recognises that options themselves have value. As the research project progresses,
the company can potentially gather additional information about the prospects of the project.
The future of an organisation is related to their ability to respond to the organisation’s changing
conditions. By building an option pricing into a framework designed to evaluate not only
physical assets but also the opportunities, we can add financial insight earlier rather than later
to the creative work of strategy

Managers can then compare every incremental opportunity
arising from existing investments with the full range of opportunities open to them.

Applying the discipline: valuing the option

A project’s full value is the value of all the options it creates, not just the value if it is
successful. Spending money to exploit business opportunities is analogous to exercising an
option on, for example, a share of stock. The amount of money expended corresponds to the

Amram and Kulatilaka (1999, p. 96).
Rapid change has also exposed the weaknesses of these less flexible valuation tools.
Partanen (1988, p. 51).
Luehrman (1998, pp 51-2).
Ajvids A. Z. 1999, Inward Technology Transfer by Firms: The Case of University Technology Licenses, Working paper
presented to the 2
Intangibles Conference, New York University, May 27-28.
Options are commonly used in financial markets, for example in markets linked to trade in minerals and agricultural
commodities. Stock options are increasingly used by companies to reward staff.
Luehrman (1998, p. 99).
option’s exercise price. The length of time the company can defer the investment decision
without losing the opportunity corresponds to the option’s time to expiration

The possibility
of deferral gives rise to two additional sources of value. First, we would always prefer to pay
later than sooner, all else being equal, because we can earn the time value of money on the
deferred expenditure. Second, while we are waiting, the world can change. The more uncertain
and volatile the pay-offs from the project, the more it makes sense for a company to hold an
option. Hypothetical examples of the most common types of real options: timing options;
growth options; staging options; exit options; flexibility options; operating options; learning
Traditional net present value (NPV) analysis misses the extra value associated with deferral
because it assumes the decision cannot be delayed. In contrast, option pricing presumes the
ability to defer and provides a way to quantify the value of deferring. However, we must note
that value may be lost as well as gained by deferring, and the proper decision depends on
which effect dominates. Anytime there are predictable costs to deferring, the option to defer an
investment is less valuable, and we would be foolish to ignore those costs
Option valuation tools and models are constantly being improved, and additional types of risk
are constantly being securitized. Many risks that once had to be considered private risks have
turned into market-priced risks. For example, the establishment of a trading market for sulfur
dioxide emissions has enabled manufactures and energy companies to think systematically
about the most economic way to reduce pollution

Future Prospects

The real options approach is in its infancy. There are real limits to how far it can go.
Historically, R&D and other forms of knowledge capital are difficult to value because
knowledge is not actively traded. According to an OECD study by Charles Leadheater (1999),
a market for knowledge capital is emerging at least in the United States

The emergence of
markets where R&D and other intangibles are traded should be closely watched since prices
established as reliable in these markets could provide guidelines for changes in accounting
procedures. Natural resources companies have been the early keen experimenters in the use of
real option, largely as a result of their ability to link the future value of their assets to traded
commodities, for which market information is readily available. It is now gaining appeal to a
wider corporate audience.
Advocates of the real options approach believe that it provides greater substance or kudos to
management intuition. Real options analysis is a big step beyond static valuation measures
such as price-earnings and market-to-book-ratios. Because the options approach handles simple
contingencies better than standard Discounted-Cash-Flow (DCF) models, option-pricing theory
has been regarded as a promising approach to valuing business opportunities since the mid-i
970s. However, a combination of factors - large, active competitors, uncertainties that do not fit
neat probability distributions, and the sheer number of relevant variables - makes it impractical
to analyse real options formally. As a result, option pricing has not yet been widely used as a
tool for valuing opportunities

According to McKinsey, option pricing has not been much
used in the evaluation of corporate investments, for three reasons, the idea is relatively new, the
mathematics are complex, making the results hard to grasp intuitively, and the original
techniques required the source of uncertainty to be a traded world commodity such as oil,

ibid, p. 52.
ibid., p. 53.
Amran and Kulatilaka (1999, p. 104)
In particular, the growth of the Intemet have produced new online marketplaces which bring together potential buyers and
sellers of patents, licences and intellectual property on a global scale.
Partanen (1988, p.51).
natural gas, or gold
Although this new measure may seem attractive, there are significant drawbacks. Determining
the value of real options remains an inexact science. Substantial difficulties remain in valuing
non-financial assets accurately at a firm level. Unfortunately, most business opportunities are
unique, so the likelihood of finding a similar option is low. The only reliable way to find a
similar option is to construct one. Furthermore, real options is often too complex to be
worthwhile for minor decisions. The use of real options presents two fundamental problems:
first, quantifying real option value; and, second, persuading an organisation to change the way
they traditionally think about valuation and investment. There are a number of other limitations
such as model risk; imperfect proxies; lack of observable prices; lack of liquidity and private

3.5. Some concluding remarks to Section 3

The problem is fundamentally an economic issue of how to price intangible assets in the
absence of proper functioning markets. From an economic standpoint, the challenge is to create
an internal market for IC, where buyers and sellers can exchange intangible assets at fair
market prices

In practice, however, markets for knowledge and information depend critically
on reputation, on repeated interactions and on trust. Through the Internet, a variety of
companies such as yet2.com, pl-x.com, Patentauction.com, and Inventions for Sale are
providing a forum/marketplace for the trading of technology, patents, licenses, and intellectual
As a result of the complexity and involvement of many fields of study/research in the valuation
of intellectual capital, a multi-disciplinary and multi-institutional approach which engages
economists, accountants, regulators, investors and intellectual property specialists need to be
taken. Real options can be broadly applied in industries characterised by high levels of R&D,
manufacturing, and marketing investment. Research is now focusing on the extension of real
options beyond commodities - into biotechnology, pharmaceuticals, software, computer chips,
and similar fields. The frontier of the real-options approach continues to advance rapidly. The
models are becoming more sophisticated, and information from the markets is becoming more
The lack of visibility of investments in intellectual capital have several consequences. If IC or
human capital is not regularly accounted for, the result tends to be under-investment. If we can
develop a better way to account for such investments, we will achieve a more efficient
allocation of resources and benefits will accrue to the economy. The measurement and
accounting systems we use today actually depress intangible investments. In other words, the
poorer the information that investors have about the companies they invest in, the greater the
information asymmetry, the less efficiently the capital markets can allocate capital and the
higher the cost of capital.
Intellectual capital measurement can be approached from several viewpoints: internal versus
external; qualitative versus quantitative; and dollar-based versus non-dollar-based. The
valuation techniques discussed in this section are aggregate measures (with the exception of
real option pricing) that attempt to assign a value to a firm’s stock of intellectual capital. These
economic valuations measure the extent to which intangible assets comprise a firm’s total
value. For purposes of comparability between firms, the techniques outlined in this section
would be more useful.

Copeland and Keenan (1998, pp. 38-39).
David A. Klein. (1998), The Strategic Management of IC, p6. It is estimated that the uncommercialised technology lying
dormant in US companies is worth more than $179 billion (SUS 115 billion). (IT: Taking the intangibles off the shelf, David
M. Walker, 23 November 1999, www.it.fairfax.xom.au/industry.
In section 4, the intellectual capital models considered have more of an internal-analytical
measurement focus, such as budgeting, patent counts and staff turnover/levels, than those
discussed in this section. Such micro-level measures of IC are largely designed to support
management’s decision making process and for reporting purposes. Given the difficulties
associated with determining precise values for IC, most of the metrics considered in this
section do not attempt to put a dollar figure on the value of intangibles, but instead measure
processes or results that are dependent on it. Focusing on such aspects of IC, much of the
metrics considered are of a non-financial nature.

4. Intellectual Capital: Some Analytical Measures and Models

There is a general consensus among managers, investors, financiers and accountants that
intangibles are important factors in company performance. Businesses are discovering that
fostering growth in intellectual capital can improve profits and are attempting to quantify this
in their financial statements. Reporting such information has the potential to improve internal
management and improve the efficiency of the allocation of resources by providing more
explicit recognition of assets. Other benefits, include increased transparency, better information
for investors and lenders, and more effective and efficient allocation of investments in the
capital market. Firms that are actively measuring and reporting IC, obviously see value or
benefits in such activities, otherwise they would choose not to engage in such activities.
Reasons for reporting on intellectual capital can be broadly classified into internal and external
reasons. Companies who are starting to measure their intangible assets cite several reasons for
doing so.

Reasons for internal reporting

• Demands are growing for effective governance of intangibles, of which social and
environmental reporting are already evident.
• ‘What gets measured, gets managed’ - it therefore focuses on protecting and growing those
assets that reflect value.
• Managing the firm’s intellectual assets.
• Assessing the effectiveness of the firm’s IC utilisation/management.
• Reports of current and future income from IC
• Relating employee contributions to IC to profits
• Alignment of IC resources with strategic vision

Reasons for external reporting

• It more truly reflects the actual worth of the company.
• Improve stock prices, by providing a more accurate picture of a firm’s assets.
• It supports a corporate goal of enhancing shareholder value.
• It provides more useful information to existing and potential investors.
• Strategic positioning.
• Effect on the cost of capital.

There are several substantial difficulties associated with the valuation of intangibles - values
are subject to frequent changes, many intangible assets are produced internally, rather than
acquired in an arm’s length transactions. In addition, the value of an intangible asset often
depends on the value of other related intangible and/or tangible assets. According to an OECD
study undertaken by Mavrinac and Siesfeld (1998), empirical results collected using revealed
preference analysis suggest that non-financial measures of quality and strategic achievement
have a profound effect on investment and valuation.
In a world of increasing technological change and shortened product life cycles, and in a world
where “knowledge work” and intangible assets are of profound importance, future financial
performance is often better predicted by non-financial indicators than by financial indicators

The underlying principle of measuring intangible assets must be that it complements the
accounting system with a new language, not replace it with a new control system. A growing

Mavrinac & Siesfeld (1998, pp. 3-4).
number of measurement systems are appearing, and one of the challenges for their users is to
determine their relative merits and the scope and suitability of each. In this section five popular
approaches to intellectual capital measurement will be briefly discussed. These five models are
listed below.

1. EVA
(Economic Value Added).
2. Human Resource Accounting.
3. The Intangible Assets Monitor.
4. The Skandia Navigator
5. The Balanced Scorecard.

4.1. Economic Value Added (EVA

(economic value added) is a measure developed in the 1980s by New York
consultancy Stern Stewart & Co as an indicator of returns to shareholders
. EVA is common
in many large US companies, including AT&T and Coca Cola, though less used elsewhere. In
Australia, EVA is presently used by both Fletcher Challenge Ltd and James Hardie Industries.
EVA strips out many of the anomalies of the accounting system, and represents the difference
between profit and the cost of capital. It provides a measure directly linked to return on capital
employed. In simple terms:

Put most simply EVA is net operating profit minus an appropriate charge for the opportunity
cost of all capital invested in an enterprise. As such, EVA is an estimate of the amount by
which earnings exceed or fall short of the required minimum rate of return that shareholders
and lenders could get by investing in other securities of comparable risk. By taking all capital
costs into account, including the cost of equity, EVA shows the dollar amount of wealth a
business has created or destroyed in each reporting period. The related measure MVA (market
value added) compares total market value (less debts) with the money invested in the firm,
represented by share issues, borrowings and retained earnings.
According to Stern Stewart, when used as a management tool, EVA shift’s managers’ focus to
a balance sheet rather than an income focus:

“By assessing a charge for using capital, EVA makes managers care about managing assets as well as
incomes, and for properly assessing the trade-offs between them. All key management decisions and
actions are thus tied to just one measure, EVA”

According to Stern Stewart, conventional financial balance sheets often need restating to give
an accurate picture of the capital employed in the business, and often this involves adding in
intangibles. They have identified over 160 possible balance sheet adjustments, of which an
obvious one is to write back goodwill that has been written off. Other adjustments may include
adding back R&D costs, and appropriate parts of marketing expenditure as well. If this was not
done the EVA would show a short-term reduction even though the investment may ultimately
increase the MVA.
Despite its popularity, measures like EVA have numerous critics
. First, among analysts there

David Skyrme Associates (1998).
EVA = net operating profit after taxes – (capital x the cost of capital)
is a feeling that EVA relies too much on accounting profits and adjustments, whereas cash
flows might be a more reliable indicator. Analysts are beginning to recognise that EVA should
be complemented with measures that created stronger linkages between long-range plans,
financial and stock price goals. Critics also argue that EVA is still too historic a measure and
does not provide any sense of the linkages between a company’s investments in intangibles and
its financial performance
. Furthermore, EVA has also been criticised for it’s inability to
explain why firms can be successful one year and then a complete failure the next.
“EVA and the like is all well and good, but there is absolutely no evidence whatsoever that it is
a guide to whether companies can sustain good performance. What we are looking for are the
measures which really create shareholder value over the long term

4.2. Human Resource Accounting

Human Resource Accounting (HRA) is a set of accounting methods that seek to settle and
describe the management of a company’s staff. It focuses on the employees’ education,
competence and remuneration. I-IRA promotes the description of investments in staff, thus
enabling the design of human resource management systems to follow and evaluate the
consequences of various HR management principles
. There are 4 basic human resource
accounting models
• The anticipated financial value of the individual to the company. This value is
dependent on two factors - the person’s productivity, and his/her satisfaction with being in
the company.
• The financial value of groups, describing the connection between motivation and
organisation on one hand, and financial results on the other. This model does not measure
value, but concepts such as motivation and welfare. Under this model, measurements of
employee satisfaction are represented with great importance.
• Staff replacement costs describing the financial situation in connection with
recruitment, re-education and redeployment of employees. This model focuses on
replacement costs related to the expenses connected with staff acquisition, training and
separation. Acquisition covers expenses for recruitment, advertising etc. Training covers
education, on-the-job training etc. Separation covers lost production etc, when a person
leaves a job. This model can be used to describe the development of costs in connection
with replacements. In many firms, such replacement costs are included in accounts as an
expression of staff value to the company.

Leadbeater (1999).
Phillips (1997, p. 3, 26).
The Danish Trade and Industry Development Council (1999).
. Case Study: Coca-Cola

An early adopter of EVA was Coca-Cola. Through drawing attention to the cost of capital, EVA focused
managerial actions to more effective use of company assets. By charging managers for the cost of capital
employed in their business, Coca Cola achieved better inventory control and replaced expensive metal
containers with cardboard and plastic ones. The value of Eva to Coca-Cola is illustrated by the following
quote from Roberto Goizueta, CEO, the Coca-Cola Company:
“At the Coca-Cola Company, we are strong believers in the significance of the economic value added… The
shareowners of the Coca-Cola have witnessed the benefits of EVA in very personal terms as the market value
of our company has gone from just over $4 billion to approximately $89 billion (in 1996)”
• Human resource accounting and balancing as complete accounts for the human resource
area. This model concentrates on cost control, capitalisation and depreciation of the historic
expenses for human resources. One effect of such a system is the visualisation of the
impacts of human resource management - through revealing the consequences of
inexpedient human resource management routines.

The basic aims of HRA are several. First, HRA improves the management of human resources
from an organisational perspective - through increasing the transparency of human resource
costs, investments and outcomes in traditional financial statements. Second, HRA attempts to
improve the bases for investors company-valuation.
Unfortunately, for several reasons, the accuracy of HRA is often called into suspicion
. This
doubt stems from difficulties with several major human resource evaluation methods:
• Input Measurement. Inputs (such as training) are not necessarily effective, so cost is not
always a good proxy measure of output value. Trained personnel may also move to another
employer through higher labour mobility - thus inhibiting the returns from corporate
training investment.
• Output Measurement. Virtually no firm actively measures the output benefits from training.
• Replacement Values. Such values are rare, usually calculated to help product sales or the
sale of the company, and are often highly debatable.

Ernst & Young Centre for Business Innovation (1997).
Case Study: The Swedish Civil Aviation Administration (SCAA)

The SCAA is a government agency experiencing increased competition within several business
areas. The company’s business area are related to the operation of airports. SCAA aims at returning
the human resource area into a key resource for the development of the company.

SCAA’s intellectual capital accounts are a direct spin-off from the company’s human resource
management system for some time. Moreover, as decision authority has been delegated over past
years, consolidating and reporting of various human resource aspects has become necessary.

The SCAA’s intellectual capital accounts are structured around a financial representation of the
company’s staff expenses per division, and for the entire group. Moreover, they also include
information about the composition of the staff (eg. age, sex, breakdown by managers and non-
managers, absence of education). These intellectual accounts include non-financial information
about the composition and education of the staff. Also included are a financial description of the
staff which specifies the staff categories of the ordinary financial accounts.

SCAA’s accounts are an example of consolidated accounts within the staff area. They enable
management to consider question about education, employment and reshuffling of staff from a strict
financial position – as the profitability of staff-related activities can be calculated. SCAA’s
intellectual accounts have both internal and external consequences. Internally they help emphasise
the need for responsible management to work with human resource development – and they place
importance on this by comparing divisional results within this field. Non-conformance with
standards, the average of all divisions, is the object of much managerial discussion. Externally, such
accounts draw attention to SCAA as a business attentive to staff-related issues. This creates a good
reputation among potential SCAA recruits. In this way, intellectual capital accounts can contribute
to enhanced competence with job applicants.
4.3. Intangible Asset Monitor

The Intangible Assets Monitor (IAM) was developed by Karl-Erik Sveiby
as a management
tool for organisations that wish to track and value their intangible assets. Sveiby was one of the
first to develop a method for measuring intangible assets in the 1980s, in an attempt to
demonstrate how the intangible assets account for the difference between a company’s market
value and book value. The “Konrad Group”, to which Sveiby belonged, introduced the “family
of three” concept of intellectual capital -the division of IC into external structures, or customer
capital, internal structures, or organisational capital, and individual competence, or human
. This concept has become the basis for many IC measurement systems, including
Sveiby’s Intangible Asset Monitor.
The IAM is based on the fundamental premise of people being an organisation’s only profit
generators. According to Sveiby, people are the only true agents in business; all assets and
structures, whether tangible physical products or intangible relations, are the result of human
action and depend ultimately on people for their continued existence
. Therefore, according to
the IAM, human actions are converted into both tangible and intangible knowledge
“structures”. Such structures are either directed outwards (external structures) or inwards
(internal structures). These structures are assets, because they affect the organisation’s revenue
streams. According to the TAM, the profits generated from people’s actions are signs of that
success, but not the originators of it.
The IAM is a stock/flow theory. It assumes that some of the organisation’s assets are intangible
assets and the purpose of the IAM is to guide managers in how they utilise the intangible
assets, identify the flows that are increasing and renewing them and guard against the risk of
losing them
. According to the IAM the intangible part of a company’s balance sheet can be
said to consist of three parts: individual competence, internal structure and external structure.
• Individual competence. This is one’s ability to act in various situations. It includes skills
(including social skills), education, experience, and values. According to Sveiby, a key
determinant of a organisation’s success is the competence of it’s staff. This competence is
directed in two ways, externally and internally.
• Internal structure. These assets are organisational in nature - they include patents, processes,
systems, concepts, and computer and administrative systems. Such structures are generally
created by the employees and are thus generally ‘owned’ by the organisation, and adhered to.
A key feature of such structures, is that they largely remain intact even if people leave the
• External structure. This consists of relationships with customers and suppliers, brand names,
trademarks and organisational reputation or “image”.

See Kari-Erik Sveiby (www.sveiby.com.au)
The Konrad group (‘Konradgruppen”) consisted of members from several Swedish knowledge companies.

Intangible Assets
Our Customers
(External Structure)

Our Organization
(Internal Structure)

Our People

Revenue growth
Image-enhancing customers


Organization-enhancing customers
Revenues from new products
Intangible investments% value added

Average professional competence
Competence-enhancing customers
Growth in professional competence
Experts with post-secondary degree

Revenues per customer


Proportion of administrative staff
Revenues per administrative staff

Value added per expert
Value added per employee


Repeat orders
Five largest customers


Administrative staff turnover
Administrative staff seniority
Rookie ratio


Expert turnover
Expert seniority
Median age all employees


Source: Celemi, 1997

Figure 1 – Celemi intangible asset monitor

4.4. The Skandia Navigator

The world’s first annual intellectual capital report was prepared by the Swedish financial
services firm, Skandia. Skandia’s 1994 IC report, Visualising Intellectual Capital, represented
a coherent first attempt to report the value of intellectual capital in an organisation. The
Skandia “Navigator” is perhaps the best known business model developed to identify the
intangible assets that are key to company performance
. A feature of the Skandia Navigator is
its definition of the intellectual capital as not just the skills and expertise of its workforce, but
also the systems and processes that it has put in place to capture and exploit all the knowledge
it can. The Navigator is based upon the same broad conceptual framework as the IAM.
The Navigator is designed to provide a balanced picture of the financial and intellectual capital.

David Skyrme Associates (1998).
. Case Study: South Gippsland Shire Services, Q4C Community Services

South Gippsland Shire Council’s business unit, Q4C Community Services, recognise the integral
role of their staff and their knowledge. The IAM has provided a framework that has helped Q4C
explicitly manage and exploit it’s key resources, it’s intangible assets. Developing the IAM has
resulted in dynamic understandings about Q4C and the key factors that drive its success.

Through using the IAM model of intangible assets, Q4C focused on the following key business
factors. First, key indicators of financial success (traditional financial measures such as profit etc).
Second, measures of Q4C’s customer relationship, and how they impact upon revenue, growth,
competence and image. Third, measures of Q4C’s internal systems an structures tat support effective
and efficient service delivery. Finally, indicators of human capital that provided a picture of the
combined expertise and experience of Q4C staff.

By understanding and articulating these key drivers, the IAM has provided Q4C with the
opportunity to recognise that a customer project brings more than just financial benefits. Indeed,
when managed correctly, such projects will educate staff, create new solutions and processes and
develop new knowledge and revenue.
Consequently, it incorporates measures in categories similar to those of the balanced scorecard.
The focus on financial results, capital, and monetary flows, is complemented by a description
of intellectual capital and its development. The Navigator framework, as expected, has at its
top end a series of measures relating to the financial focus. But it also has “below the line”
measures of intellectual capital. These involve 4 areas and 2 dimensions. The 4 areas are:
• Customer Focus -- which quantifies how the organisation is to look to its customer
• Process Focus -- which quantifies key aspects of the organisation’s process
• Renewal and Development Focus -- which quantifies what is being done to renewal and
develop the intellectual asset base.
• Human Focus -- the “virtual” binding force of customer, process, renewal and
development and finance.





Source : Intellectual Capital Report, Skandia 1998

Figure 2 – Skandia Business Navigator

The Navigator incorporates a total of about 30 key indicators in the various areas, which are
monitored internally on a yearly basis. The key indicators for customer focus include number
of accounts, number of brokers and number of lost customers. The key indicators for process
focus include number of accounts per employee and administrative costs per employee. The
key indicators for human focus include personnel turnover, proportion of managers, proportion
of female managers and training and/or education costs per employee. The key indicators for
development/renewal focus include satisfied employee index, marketing expense/customer,
share of training hours. Almost more importantly, the Navigator includes 2 dimensions. The
measures in each focus area specified in terms of today’s performance and tomorrow’s
performance - a clear view of articulating “targets” for the Navigator.
The Skandia Navigator is used to identify, the important areas of know-how in the organisation
which need to be developed and shared. Each of Skandia’s strategic business units have used
the Navigator framework to develop their own specific measures of intellectual capital. By
identifying important assets like its customer and innovation capital more systematically,
Skandia says the Navigator has improved its management of these assets, benefited overall
performance and increased its share value
. Skandia says that its ability to identify and draw
upon the relevant know-how easily has enabled it to set up foreign offices much more quickly
than in the past. The Skandia Navigator model has been applied by the Swedish Government
and also developed by other companies.

Criticisms of the Intangible Assets Monitor and Skandia Navigator

The Skandia Navigator and Intangible Assets Monitor are two popular methods for calculating
and visualising the value of the intangible capital. Despite this widespread popularity both
approaches are not without their critics. Both approaches share the presupposition that IC
represents the difference between market and book value of a company. Some authors,
however, have expressed concerns that two other important aspects of evaluation and value
creation remain unresolved by the Navigator and IAM
1. Market based IC value can not be calculated for the companies, which are not on the stock
market so that these companies need an alternative way to determine their market based IC
2. There is no adequate system monitoring the efficiency of current business activities
performed by the employees, indicating whether their potential is directed towards value
creation or value destruction.
Another criticism of these two models revolves around how they define intellectual capital.
Both models define IC as being divided into essentially three parts: human, customer and
structural capital. The problem arising from this approach, critics argue, is how to measure IC
performance defined as such. For the analysis of human, customer and structural capital many

Public (2000).
. Case Study: SkandiaBanken Fonder

SkandiaBanken Fonder is the Skandia business unit that manages and markets securities funds. In
this case the company vision is focused on this unit of Skandia being viewed as the best and most
customer-oriented business of its kind. Their goal is to be the market leader outside the traditional
banking community. The measures selected using the Navigator model were as follows.

• Financial Focus – total assets, assets per employee and ratio of income to managed assets.
• Customer Focus – market share, number of accounts and customer lost.
• Process Focus – administrative expense to managed assets ratio, and cost of administrative error
to management revenues ratio.
• Renewal and Development Focus – competence development expense per employee, employee
satisfaction index and marketing expense per customer.

In this case it is easy to see that from a financial perspective, the key behaviours will centre around
growth of fund assets, the efficiency of maintaining those assets, and increasing the income per unit
of assets. At the same time, the customer focus will be on growing the market share, increasing
accounts, and not losing customers. Concurrently, from an internal process perspective, the cost of
managing per unit asset will be watched while at the same time will be reducing the process errors.
Finally the unit is encouraged to invest in its people, while driven internal satisfaction up, and
investing in its customers through marketing. SkandiaBanken Fonder has found that through
focusing on such key areas their business performance has improved substantially.
indicators have been developed, but most of them are subjective. Many critics argue that one
common objective indicator is needed -as to facilitate comparisons between companies

4.5. The Balanced Scorecard

The Balanced Scorecard (BSC) is an organisational framework for implementing and
managing a strategy at all levels of an enterprise by linking objectives, initiatives and measures
to an organisation’s vision and strategy

Fig. 3. – The Balanced Scorecard

Perspective: financial
Objectives Measurement

Perspective: customers Perspective: internal activity
Objectives Measurement Objectives Measurement

Perspective: innovation and

Source: Kaplan e Norton, 1992, p. 72.

The BSC translates a business’s vision and strategy into objectives and measures across four
balanced perspectives - financial performance, customers, internal business processes, and
organisational growth, learning and innovation. Put simply, a BSC is a structured way of
communicating measurements and targets, and is becoming a widespread way of how to
manage, measure and communicate the financial, non-financial and intangible assets of a
company. The BSC allows an organisation to monitor both its current performance (financial,
customer satisfaction and business process) and its efforts to improve processes, motivate and
educate employees and enhance its ability to learn and improve. The BSC is closely related to
the concept of intellectual capital and comprises not only tools for the measurement of
intangible resources but also a vision of continuous learning and change as to create value for
the future
. Since being introduced in 1992, the balanced scorecard concept has been
implemented at the corporate, strategic business unit and even individual level in hundreds of
public and private sector organisations worldwide

See Public (1998).
Kaplan & Norton (1992).
Ulf Johanson et al 1999).
Despite its widespread use, the balanced scorecard concept does suffer from several
. Firstly, the creation of a BSC can involve a considerable amount of time on the
part of everyone whose performance is to be measured. The selection of appropriate measures
for the four perspectives can be especially time consuming. This is due to that fact that in any
company there are a large number of potential goals and targets, and even more ways to
measure them. People are likely to disagree about which objectives should be measured and
how to measure those objectives, and it will take time until consensus is achieved. Secondly, a
well-designed scoreboard will be useless without the participation and commitment of staff in
implementing and using it. Thirdly, companies using BSC often come up with too many
measures. For example, a division of one company came up with 500 important measures for
its scorecard on the first pass. This is a problem because it is very difficult to accurately track a
large number of measures. Fourthly, the BSC does not have an explicit focus on intellectual
capital - unlike some later IC measurement models. Finally, the fact that a BSC gathers all key
indicators of business performance (and their linkages) into one management tool may deprive
a company’s executives of the various information flows required to remain competitive in
today’s challenging business environment.

4.6. Other Intellectual Capital measurement tools

In addition to these five IC measurement tools, there are a wide variety of other intellectual
capital models in use. Indeed, due to the lack of formalised IC reporting standards, many firms
have devised their own methods/models of reporting their intellectual capital. Other popular IC
measurement systems include: the Intellectual Capital IndexTM; the Holistic Approach; and
the EFQM (European Foundation for Quality Management) Business Excellence model.

(Leadbeater, 1999 & www.isds.bus.lsu.edu)
Case Study: Mobil North American Marketing and Refining (NAM&R)

Mobil NAM&R, a $15 billion per year of Mobil Corporation, started it’s BSC program in 1994. The
scorecard was instituted to support the transformation of this division from a functional , highly
centralised, product-centric organisation – to a decentralised, profit centre, customer focused one.
NAM&R’s ranking, using the standard industry measure of profit-per-gallon, ranked it last (7
) among its
industry peers of integrated oil and gas companies. Mobil’s return on capital was 7%, wellbelow its cost
of capital. Moreover, it also required a cash infusion of about $US500 million from the parent company
to maintain and upgrade its facilities.

NAM&R’s management launched new customer-focused strategy, along with the BSC. Mobil soon
jumped to the top of its industry peer group in profitability. It was the industry leader in profitability for
1995, 1996, 1997 and most recently, 1998. Despite falling prices, AM&R produced a 14% return on
invested capital, and generated a $900 million cash surplus, in 1998. The nearly almost $1.5 billion of
operating cash flow improvement in Mobil’s operations, and its unprecedented ability to sustain it’s
industry leading profitability ranking – occurred in an industry selling a commodity, not-differentiated
product with generally strong and respected competitors.
4.7. Some examples of firms that seem to have benefited from reporting IC

The following examples are companies that have benefited from the reporting of their
intellectual capital. A wide variety of different IC measurement tools have been used by such
• PLS Consult, a Danish consulting firm has worked with intellectual capital issues since
the early 1 980s. PLS Consult credits their considerable growth (in particular, the
systematic and future-oriented management of this growth) experienced in the past 5 years
to their use of their IC accounts. At PLS Consult, the IC accounts focus on objective
statistical information about the education, age and experience of their human resources
• Skandia, the first company to release an intellectual capital supplement to its annual
financial report, found that its stock price rose by approximately 40%. Leif Edvinsson, vice
president for intellectual capital, reports that Skandia considers 25 of those percentage
points to be a direct response to the IC supplement
. In addition, Skandia through the reuse
of knowledge and transfer of experiences have been able to reduce the time involved with
the administration aspects of acquisitions by 60-70%.
• According to Consultus, another Swedish consulting firm, the publication of their
intellectual capital accounts helps define - internally as well as externally - the direction of
the company in regards to the strategy for the functioning of organisation and management.
Consultus have measured their intellectual capital through the use of their “Complete
Balance Sheet”. Using the “Complete Balance Sheet”, “soft” factors such as structural,
human, customer and social capital would be recorded as a liability and when aggregated
must be equivalent to the goodwill on the asset side of the accounts.
• ABB Sverige is Sweden’s largest industrial company and has an internal and external
IC management system. Since introducing the system, ABB has become more productive
with an increase in turnover per employee from approximately SEK65,000 to approx. SEK
150,000. In addition, there has been important lead time reduction. ABB have been using
human resource accounting (for external purposes) and their EVITA system (for internal
purposes such as developing corporate strategies) to bring the upgrading of employee
qualification and responsibilities into focus and improve the co-operation with suppliers
and customers.
• At WM Data, Sweden’s fastest growing IT company, intellectual capital accounts have
been used to identify problems with the composition of the company’s staff, such as age
structure, seniority, and educational background. Staff turnover ratio is used to assess
whether knowledge crucial to the company can be maintained.
• In Australia, Morgan and Banks publicly acknowledges the role that their intellectual
capital plays in their financial success, and have included such information in their reports
to shareholders. For example, in their 1998 Annual Review, Morgan and Banks explicitly
acknowledges the importance of their customer capital, human capital and structural capital
to their success.

4.8. Some emerging problems with the "new accounting and reporting"

Despite a rapid success and spreading - at least in some countries - of the above described new
forms of company reporting (both at the internal and external level), it is also clear that there
are some issues and problems which are linked with those forms. These issues and problems
can be summarised as follows:

The Danish Trade and Industry Development Council (1999, p. 32).
Sullivan (1998, p. 301).
- attribution of a value in absence of a market price: this can be seen as the re-emergence of
the old problem of value in use vs. value in exchange, bringing about problems credibility
and meaningfulness vis-à-vis these new reports;
- interpretability of these reports: it is not clear how the new metrics should be interpreted in
the light also of the many qualitative variables used;
- specificity vs. generalisability: very often these new forms of reporting are based on
indicators, parameters, and measures that are specific to the reporting organisation. This of
course causes problems of consistency, comprehensiveness, and comparability of data (at
least between companies);
- regulation vs. voluntary compliance: shall the new forms of reporting be left only to a
voluntary decision of the company management, or also some forms of (soft) regulatory
framework should be imposed on companies in this subject area?
- atomistic vs. holistic measurement approach: when comparing the methods proposed in
section 3 and the EVA and the remaining ones presented in section 4, it is easy to detect
that there are two rather different approaches to the measurement and representation of
Intellectual Capital: one is more holistic and it looks at the comprehensive value of this
Capital, while the other is far more analytical leading to an "atomistic"
representation/quantification of the various components of the Intellectual Capital;
- common measurement unit vs. different measurement unit: in the new forms of reporting
there seems to be a lack of a common measurement unit (like it is money in the traditional
financial statements), and this reinforces the above mentioned interpretability problem due
to the lack of a synthesis;
- relevance vs. reliability: this aspect has also been mentioned before with regard to the
traditional accounting and its problems vis-à-vis intangibles. Also with the "new
accounting" the relevance of the data can be in conflict with their reliability, in that the
intangibles phenomena represented by this data are difficult to measure with a sound
degree of reliability.
- intended users: who are the intended users of these new reports: e.g. management,
shareholders or stakeholders, or a combination of these categories?

5. Accounting for Intangibles and public sector entities

The research unit has also focused on the analysis on the subject of the role of intangible assets
in non-profit organisations. The rationale has been the attempt of exploring intangibles value in
a non-profit context in order to put in light whether also non-profit organisations have a need
for representing and managing intangibles. The objects of the research can be summarised as
- Are non-profit organisations aware of the importance of intangibles resources?
- Are they are going along a path of identification of such variables? and
- Are such variables part of the system of indicators of the internal performance
measurement system?

In order to carry out the research an inductive approach has been followed, based on a
theoretical framework. The steps have been:
1. Identification of the object of the analysis
2. Identification of the geographical area where to carry out the empirical research
3. Definition of the research-path

In this respect, the research has focused on the case of healthcare organisations. Indeed,
healthcare organisations are undergoing a period of profound innovations from different points
of view: the institutional framework, the financial performances, the stakeholder relationships,
the internal organization, and the service quality are all under pressure for a change. This has a
strong influence on the definition of the variables that healthcare organisations have to monitor.
As for the geographical area, the research has focused on the case of the Tuscany. In Tuscany
the healthcare organization have been gathered in specific geographical area, called “Area
vasta” (large area). In “area vasta” are present: one highly-specialized hospital and several
local health units. The purpose is to delimitate a geographical area where the inhabitants have
an healthcare organization for highly-specialized operations and local organizations for less
specialized operations. For the research, it has been analysed the case of the “Area vasta
tirrenica” referred to the hospital of Pisa. In such an area are present: the hospital organization
of Pisa, the local health organization of Pisa, the local health organization of Lucca, the local
health organization of Massa-Carrara, the local health organization of Livorno, the local health
organization of the area of Versilia.
From the research path carried out, it emerges that healthcare organisations operating in the
“Area vasta tirrenica” appear to tentatively consider in their performance measurement systems
not only the economic-financial perspective, but also other perspectives related to the
intangible resources. The implementation of management systems which are focused on
economic factors could only be partially useful. Indeed, concentrating exclusively on the
accounting-based financial information could determine the development of healthcare
activities with a short term view and without enough focusing on the intangible resources.
In this respect, it could be observed that much attention is being devoted to the role and value
of intangibles in companies, but, interestingly, not enough attention has been given to the role
and value of intangibles in public sector organizations. In particular, it is rather evident that
intangibles have a fundamental role especially in healthcare organizations.
In this research, the categorization of the intangible resources in human capital, organisational
(structural, internal) capital and relational (external) capital has been followed. In order to
better represent the characteristics of healthcare organizations, relational capital has been
further divided into three categories: the customer and quality of services, the quality of the
relationship with the stakeholders, and the quality of the relationship with the Regional
Authority owing to the Italian institutional framework. Indeed, in the Italian case, the Regional
authority has a fundamental role in addressing and controlling the activities of healthcare
From the empirical analysis it emerge a growing attention to the parameters tied to the quality
of services (belonging to the relational capital). The other perspectives are often considered,
but not in a systematic way. However, there seems to be a large awareness of the importance of
such variables. Furthermore, the research has evidenced that the management control systems
of the healthcare organizations investigated are going to be improved (even if at a different
pace) towards a comprehensive performance measurement system able to embrace also the
intangible resources.
Hence, it emerge a need for an enlargement of the performance measurement systems in order
to support the focalisation on intangible resources. In this sense, it is argued that the
measurement of indicators related to intangible resources does not make intangible assets
tangible, but it makes them more controllable. In fact, in this case the attention of the managers
is directed not only on indicators tied to tangible assets but also in indicators tied to intangible
This research suggests that this area dealing with the degree of implementation of performance
measurement systems able to encompass intangible resources is promising for future scholarly
enquiry. In particular, a comparative approach within an international view could allow to
better analyse and understand the degree of implementation of indicators related to intangibles
in non-profit organizations.

6. Conclusions

The issues linked to the intangibles and their role vis-à-vis accounting, audit and financial
analysis are complex and very broad. On the other hand, much of the extant literature have
focussed on these issues, so that one could say that this is at the same time one of the largest
but also one of the most investigated fields in the new intangibles literature.
In the light of the above, the research lines along which the WP 4 intends to move can be
delineated as follows:

A) “IC reports and the new forms of company reporting: a preparer and regulatory
perspective.” (Zambon-Abernethy-Masino-Donato-Cordazzo-Del Bello)

This sub-project deals with the issues linked to the production and publication of
IC/Intangibles reports from the point of view of preparers (especially companies) and
regulatory bodies.
Within this general frame and objective, the research activity in this field will examine the
following topics:
A.1) The relationships of the IC reports with other innovative forms of company reporting,
such as social and environmental reports. The aim is to shed light on the content
differences between these forms of reporting.
A.2) A comparison of the different Guidelines which have been issued so far by diverse bodies
and entities for regulating IC reports (Nordika, Danish Agency of Trade & Industry,
Meritum, GRI, and so forth).
A.3) An analysis of the company attitudes and changes in managerial and organisational terms
vis-à-vis IC/Intangibles reports and similar statements, including internal management
A.4) An analysis of the recognition, representation and management of intangibles in a non-
profit context, such as that of local health care units. The rationale is to explore intangibles
in a non-profit driven context in order to put in light whether and to what extent also non-
profit organisations have a need for representing and managing intangible resources.

B) “Intangibles and the traditional financial reporting: the path ahead in a European and
accounting policy-making perspective.” (Zambon; Crosara; Ramin)

This section of the Project deals with the most recent developments in the rules and practices
regarding the treatment of intangibles within the traditional financial reporting framework.
Within this general frame and objective, the research activity in this field will examine the
following topics:
B.1) The quantitative impact of the new US rules on intangibles and goodwill (SFAS no. 141
and no. 142) on the profitability and equity value of European companies will be
B.2) Features and implications of the Extended Business Reporting Language (XBRL) Project,
which is to be intended as an intangible resource per se, and which will contribute to cross-
country comparison.

C) “Reporting on intangibles and the users' information needs.” (Zambon; Bergamini)

This section of the project deals with the user perspective vis-à-vis the traditional as well as the
new forms of reporting on intangibles.
Within this general frame and objective, the research activity in this field will examine the
following topics:
C.1.) An analysis of the financial analysts' new models for interpreting, measuring and
assessing this type of information.
C.2) An analysis of the rating agents' models for considering intangibles in arriving at a credit
score of a company.

The 'proof-of-concept' phase is essentially concluded, and the actual research work has now
begun following the previously delineated guidelines.