INTELLECTUAL

CAPITAL
CONTENT
1. INTRODUCTION
2. DEFINITIONS OF INTELLECTUAL CAPITAL
3. IC MEASUREMENT
-GENERIC MODELS
-INDIVIDUAL COMPANY MODELS
IC VALUATION
1. KNOWLEDGE MANAGEMENT
2. REPORTING INTELLECTUAL CAPITAL
3. CONCLUSION

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1
INTRODUCTION
INTELLECT

The power or faculty of the mind by which one knows

or understands, by which one feels and by which one
wills; the understanding; the faculty of thinking and
acquiring knowledge.

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CAPITAL

A factor of production that is not wanted for itself but

for its ability to help in producing other goods.

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INTELLECTUAL CAPITAL :
THE INTANGIBLE ASSET

Collective knowledge (whether or not documented) of

the individuals in an organization or society.

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2
DEFINITION
➔ Knowledge-based business environment such as knowledge and
competence of human resources, innovation, customer relations,
organizational culture, systems, organizational structures, etc

➔ IC is a non-monetary asset, without physical substance but it

possesses value or can generate future benefits (Choong, 2008).
Marr and Schiuma (2001) define IC as the“possession of knowledge
and experience, professional knowledge and skill, good
relationships, and technological capacities, which when applied will
give organizations competitive advantage”

➔ Baron (2003) also states that in advanced economies, intellectual

capital is the only distinctive asset which cannot be imitated easily
(especially human capital which includes skills, talent, motivation,
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and know how of people)
 CLASSIFICATION OF
INTELLECTUAL CAPITAL
HUMAN CAPITAL RELATIONAL CAPITAL STRUCTURAL CAPITAL

Defined as the Defined as all Defined as the

knowledge, skills resources linked to the knowledge that stays
and experience external relationships within the firm. It
that employees of the firms with comprises
take with them customers, suppliers, organisational
when they leave. or partners in research routines, procedures,
E.g : creativity, and development. systems, cultures
previous Eg : image, customer and databases
experience, loyalty, customer Eg : documentation
satisfaction, loyalty satisfaction service
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“
Intellectual capital is the group
of knowledge assets that are
attributed to an organisation
and the most significantly
contribute to an improved
competitive position of this
organisation by adding value to
defined key stakeholders
Marr and Schluma
(2001) 10
 WHY IS INTELLECTUAL CAPITAL IS SO HARD
TO MEASURE?

HISTORICAL
Accounting rules, although revised on a regular basis, were initially designed
for assets such as plant or machinery – tangible things that represented a
source of wealth during the industrial age.

SOME INTANGIBLE ASSET ARE HARD TO MEASURE

Knowledge-generation process yet is essentially an unpredictable process
with unpredictable outcomes such as creativity.

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 WHY IS INTELLECTUAL CAPITAL IS SO HARD
TO MEASURE?

IDIOSYNCRATIC NATURE OF INTELLECTUAL CAPITAL

What is valuable for one company may be worthless for another. This has
resulted in diverse measuring systems that make comparability across
companies and sectors difficult.

INTELLECTUAL CAN HAVE 2 DIMENSION

The Meritum guidelines distinguish between intangible resources and
intangible activities as a way of highlighting IC’s static or dynamic character.
Dynamic nature of IC means that its individual components are often not
valuable by themselves but work only as a system.
It is the intellectual capital elements interacting that generates value for
companies.
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3 IC
MEASUREMENT
&
IC VALUATION
 IC
MEASUREMENT

Individual
Generic
Company
Models Models

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 BALANCED SCORECARD
A set of cause-and-effect relationships among output measures and
performance drivers in the four perspectives:

● Customer measures: how do our

● financial measures: how do we look to
customers see us, for example, price
shareholders, for example, cash flow as compared with competitors and
and profitability; product ratings;

● learning and growth measures: can

● internal process measures: what must we improve and create value, for
we excel at, for example, length of example, percentage of sales derived
cycle times and level of waste; from new products.

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 PERFORMANCE PRISM
● A second-generation performance measurement and management approach
developed by Cranfield School of Management in collaboration with consultancy
Accenture.
● It recognises the importance of companies taking a holistic approach to stakeholder
management in today’s culture of involvement.
● The performance prism addresses the strategies, processes and, importantly, the
capabilities that are needed to satisfy these two critical sets of wants and needs.
● Allows to be applied to any organisation or organisational component.
● The focus on intangible performance drivers makes the framework useful for
companies attempting to measure their intellectual capital. Also, it creates a visual map
of how the different areas of performance interrelate.

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 KNOWLEDGE ASSETS
MAP APPROACH

● It was specifically designed to help companies identify and measure their knowledge-based assets
and their contribution to value. Having identified the critical knowledge assets, they can easily be
integrated into broader frameworks such as the performance prism.

● Knowledge assets are identified as the sum of two organisational resources: stakeholder and
structural.

● This distinction reflects the two key components of any enterprise: its actors, who can be internal or
external, and its constituent parts, or the elements at the basis of an organisation’s processes.

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18
 THE SKANDIA NAVIGATOR
● Developed in 1994, is probably the best known, even though it is only implemented in
the Swedish part of the organisation.

● It reflects four key dimensions of its business: financial focus; customer focus;
process focus; and renewal and development focus. At the heart of these is human
focus, which drives the whole model.

● Edvinsson says that navigator can be “viewed as a house.

● The financial focus is the roof. The customer focus and process focus are the walls.
The human focus is the soul of the house. The renewal and development focus is the
platform.

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 ERICSSON’S COCKPIT
COMMUNICATOR
According to Ericsson, the aims of this product are:

● a vision-driven organisation, where priority is given to actions that are compatible with the
company’s strategies;
● a communicated strategy linked to indicators and actions;
● a balanced focus on past, present and future performance;
● a balance between short-term results and long-term strategy;
● the ability to evaluate and change organisational strategy rapidly in line with performance
and changing business conditions;
● the ability to manage, measure and
communicate future values. 20
 CELEMI’S INTANGIBLE
ASSETS MONITOR
International training consultancy Celemi monitors three overall categories:
● customers (external structure);
● People (competence); and
● organisation (internal structure).

Under each of these interdependent categories, the three key areas of growth/renewal,
efficiency and stability are tracked, each with its own performance indicators (see figure 6).
Celemi also produces a management training game called Tango which uses intangible
assets monitor thinking and accounting.

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 RAMBOLL’S HOLISTIC
COMPANY MODEL
● Consists of key areas within which certain performance indicators are managed. These
key areas lead to three sets of results – customer, employee and societal – and all
three combine to produce the financial results.

● The key areas are values and management, strategic processes, human
resources, structural resources and consulting services.

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 Bates Gruppen Company IQ
measurement system
It has recently proposed a method that consists entirely of non-financial measures. The
Company IQ allows a company to score its knowledge assets against those of a similar
organisation.

● Stage one- Identify why customers buy from your company as opposed to a rival. This is
best done in a day workshop in which management select between eight and 12 attributes.

● Stage two- Identify the intellectual assets that produce star attributes. Bates
Gruppen has identified 100. Ideally, these should be divided as equally as possible between human,
customer and structural IC assets. All of these assets must either be measurable in
absolute terms.

● Stage three- It is now possible to calculate your CompanyIQ. Scores on the 100
selected assets must first be weighted for relative impact on profitability (available from PIMS) then
compared with similar companies on the chosen database. Bates Gruppen has selected a median score
of 100. 23
IC VALUATION

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● There are various kind of way on valuation of intellectual capital that
exist nowadays
● There are some that is theoretical in nature, some are practically
implemented in various type of enterprises
● Different methods give different opportunities
● All methods cannot satisfy all objectives that are set.
● Some methods are only suitable for some industries.

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 VALUE ADDED APPROACH
● The value added approach or value added intellectual coefficient (VAIC)
allows measurement of resources contributions (human, structural, physical
and financial).
● This approach contains a few steps.
● First step:
a. Calculate company’s ability to create VA
b. VA = OUT - IN
c. OUT represents revenue
d. IN represents the expense
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● Second step
a. The second step is to assess the relation between VA and HC.
b. The value added human capital coefficient (VAHU) indicates how much VA has been created
by one financial unit invested in employees.
c. VAHU = VA/HC
● Third step:
a. Find the relation between VA and SC.
b. STVA shows the contribution of SC in value creation.
c. SC is obtained when HC is deducted from VA.
d. STVA = SC/VA
● Fourth step:
a. calculate the value added intellectual capital coefficient (VAIN).
b. It shows the contribution of IC in value creation.
c. VAIN is obtained by adding up VAHU and STVA
d. VAIN = VAHU + STVA

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● Fifth step:
a. assess the relation between VA and physical and financial capital employed (CA)
b. The value added capital employed coefficient (VACA) reveals how much new value has been
created by one monetary unit invested in capital employed.
c. VACA = VA/CA

● Sixth step:
a. Assess each resource that helps to create or produce VA.
b. VAIC measures how much new value has been created per invested monetary unit in each
resources
c. VAIC = VAIN + VACA

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 VALUE CREATION INDEX
● Tool designed to quantify the link between an organization's non-financial
performance and its valuation in the markets
● Value Creation in today's companies is increasingly represented in the
intangible drivers like innovation, people, ideas, and brand
● Yet these non-financial factors for creating value are difficult to quantify
● The VCI not only quantifies the impact of non-financial performance on
market value, but also identify the specific intangibles that drive value for a
given industry.

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● The value creation research team has settled upon some critical categories of
intangible performance that determine corporate value creation:
○ Innovation
○ Customer relations
○ Management capabilities
○ Alliances
○ Technology
○ Brand value
○ Employee relations
○ Environmental and community issues

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 MARKET OR VALUE BASED APPROACH
● Market approach is a method of determining the appraisal value of an asset,
based on the selling price of similar items
● Business valuation method that can be used to calculate the value of property
or as part of the valuation process for a closely held business.
● Can be used to determine the value of a business ownership interest,
security, or intangible asset.

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 Tobin’s q
● Tobin's Q ratio equals the market value of a company divided by its assets'
replacement cost.
● Thus, equilibrium is when market value equals replacement cost.
● Tobin’s Q = total market value firm / total assets value firm
● At its most basic level, the Q Ratio expresses the relationship between
market valuation and intrinsic value
● it means it estimates whether a given business or market is overvalued or
undervalued.

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 CALCULATED INTANGIBLE VALUE
● Attempts to allocate a fixed value to intangible assets that won't change
according to the company's market value.
● Finding a company's CIV involves seven steps:
○ Calculate the average pretax earnings for the past three years.
○ Calculate the average year-end tangible assets for the past three years.
○ Calculate the company's return on assets (ROA).
○ Calculate the industry average ROA for the same three-year period as in Step 2.
○ Calculate excess ROA by multiplying the industry average ROA by the average tangible
assets calculated in Step 2. Subtract the excess return from the pretax earnings from Step 1.
○ Calculate the three-year average corporate tax rate and multiply by the excess return. Deduct
the result from the excess return.
○ Calculate the net present value of the after-tax excess return. Use the company's cost of
capital as a discount rate.

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 HUMAN RESOURCE ACCOUNTING
● Human resource accounting involves the tracking of all costs related to
employees in a separate report
● It includes
○ Employee compensation
○ Employee payroll taxes
○ Employee benefits
○ Employee training
● Determine where human resources costs are especially heavy or light in an
organization
● This information can be used to redirect employees toward those activities to
which they can bring the most value

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 VALUE ADDED INTELLECTUAL COEFFICIENT
(VAIC)
● The VAIC model is intended to measure the extent to which a company
produces added value based on intellectual (capital) efficiency or intellectual
resources.
● VAIC calculation are based on
○ human capital (HC), which is basically interpreted as employee expenses,
○ b. structural capital (SC), which is interpreted as the difference between produced added value
(VA) and human capital (HC), i.e. SC = VA – HC
○ c. capital employed (CE), which is interpreted as financial capital

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● VAIC is calculated as the direct sum of key efficiency figures, which in turn
are calculated as ratios:
○ a. capital employed efficiency (CEE) = VA/CE
○ b. human capital efficiency (HCE) = VA/HC; and
○ c. structural capital efficiency (SCE) = SC/VA.
● ICE is defined as ICE = HCE + SCE
● VAIC = ICE + CEE
● VAIC method calculates both the overall efficiency of a company, and its
intellectual capital efficiency (ICE).

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4
KNOWLEDGE
MANAGEMENT
➔ KPMG commanly used definition in 2001 : “
Knowledge management is a collective
phrase for a group of processes and
practices used by organisations to increase
their value by improving the effectiveness of
the generation and application of
intellectual capital”

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➔ The elements of the globe expressed combine to create an organisation
that is aligned to achieve its vision which is, in turn, appropriate for its
marketplace and external environment. The interconnectedness serves to
emphasise the importance of looking outside as well as inside. You may
have a sophisticated knowledge management system, but if your
strategy is wide of the mark or you have failed to assess your risks
properly, knowledge management by itself will not give you a competitive
advantage

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 KNOWLEDGE PROCESS WHEEL

The knowledge process wheel, developed by Cranfield School of

Management’s Centre for Business Performance, summarises a set of
knowledge management processes that can be used to grow and maintain
IC.

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5
REPORTING
INTELLECTUAL
CAPITAL
1
2 3

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 1. ACCOUNTING STANDARDS

● The Accounting Standards Board introduced FRS10, the main standard for
reporting intangibles and goodwill
● Intangibles are defined as “non-financial fixed assets that do not have
physical substance but are identifiable and controlled by the entity
through custody and legal rights”.
● Objective of FRS10 :
-capitalised goodwill and intangible assets are charged in the profit and
loss account in the periods in which they are depleted;
-sufficient information is disclosed in the financial statements to enable
users to determine the potential impact of goodwill and intangible assets
on the financial position and performance of the reporting entity.
● IAS38 grew out of an early attempt to devise an accounting treatment for
R&D costs and was finalised in July 1999.
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￮ Its definition of intangible assets is similar to that in FRS10, except it adds
that intangible assets are held for use “in the production or supply of
goods and services, for rental to others or for administrative purposes”.

￮ IAS38 specifies that a company can only recognise an asset if:

-it is identifiable;
-it is controlled;
-it is probable that future benefits specifically attributable to the
asset will flow to the enterprise
-its cost can be reliably measured. These criteria apply to both
purchase and self-created assets. In fact, IAS38 does not specify that
internally generated intangibles can never be recognised as assets.
It is laid out in such a way, however, that it is difficult to imagine items
meeting the recognition criteria (see UK and international Gaap,
Tolley/Ernst & Young).
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￮ If the item does not meet the above criteria, IAS38 requires the
expenditure on it to be recognised as expense when it is incurred.
This also applies to the items at all times:
-internally generated goodwill;
-start-up, pre-opening and
-pre-operating costs;
-training costs;
-advertising costs;
-relocation costs.

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￮ According to the International Accounting Standards website,
www.iasplus.com, examples of possible assets as defined by IAS38 :
-Computer software Patents.
-Copyrights.
-Movies.
-Customer lists.
-Mortgage servicing rights.
-Licences
-Import quotas.
-Franchises.
-Customer and supplier relationships.
-Marketing rights.

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￮ As the UK and international Gaap says: “The notion of maintaining
custody over something that has no physical subtance may seem rather
strange but FRS10 explains that it means such things as keeping technical
or intellectual knowledge secret

￮ IAS38 defines control as the ability to obtain future economic benefit

generated by the resource and the ability to deny those benefits to
others. This normally means legal rights, as in FRS10, but control can also
be demonstrated “in the absence of legal enforceability by factors such
as market and technical knowledge. However, skilled staff, customer
portfolios or market share are unlikely to be controlled in such a way to
meet the definition of intangible assets.”

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 2. OPERATING AND FINANCIAL REVIEW

￮ The recent company law review, to be included in the updated Companies

Act 2003, requires all public and large private companies to produce an
OFR. Also OFR requires companies to include an account of how intangible
assets contribute to its overall value generation and how the conflicting
stakeholder interests are balanced.

￮ The IC reporting point of view is the “dynamics of the business” – in other

words, known trends, events, uncertainties and other factors that may
substantially affect future performance, including investment
programmes.

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￮ The report specifies some of the areas that companies may be required to
address – for example, risks and opportunities and related responses in
connection with:
-competition and changes in
-market conditions;
-customer/supplier dependencies;
-technological change;
-financial risks
-health and safety;
-environmental costs and liabilities;
-projects and programmes to maintain and enhance tangible and
intellectual capital, brands, R&D and training.

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￮ The strengths and resources of the business that will help it in the pursuit
of its objectives and particular, on those items that are not reflected in the
balance sheet. Such items might include:
-corporate reputation and brand equity;
-intellectual capital;
-licences, patents, copyrights and trademarks;
-R&D;
-customer/supplier relationships;
-proprietary business processes;
-websites and databases
-market position/dominance.

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￮ The ASB adds: “The use of relevant financial and non-financial measures
will often assist the user’s understanding of the potential value of such
items.

￮ Moreover, not intended that an overall valuation of the business must be

given, nor, in the case of listed companies, for net asset value to be
reconciled to market capitalisation.”

￮ Recent report shows that the more innovative disclosures in the ASB
proposal – such as the dynamics of the business, forward- looking
disclosures, revenue investment and soft assets – are generally being
resisted by companies, including some of the biggest (“Half the
story”,Association of Chartered Certified Accountants, 2003).

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￮ The OFR is a “through the eyes of management” statement which :
-Relies on directors’ judgment of materiality. It may therefore lack
comparability, both between companies/sectors and year on year.
-Material disclosed will be too vague and difficult to understand.
-It is precisely this judgment of what is material for individual businesses
that could accommodate the idiosyncratic nature of many intangibles.

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 3. INTELLECTUAL CAPITAL REPORT

❏ Some research (Holland, 2002) points to the fact that much of this
information does in fact get communicated, albeit in private meetings
between companies and investors

❏ It is not an ideal situation for the investment community as a whole, as it is

biased towards the big institutional investors

❏ As a way of overcoming the information imbalance, these research

projects suggest that companies start publishing a supplement to the
annual report – a so-called intellectual capital statement

❏ Based on best practices observed in more than 100 European companies,

the projects have resulted in guidelines on how to report intellectual
capital 53
❏ Organisations are encouraged to produce reports that contain the
following three elements:
-narratives about the company vision;
-management challenges and actions;
-a set of indicators

❏ Give organisations the space to explore their strategic objectives, the

products they sell and their customer approach

❏ Identifies the critical intangibles and describes how they drive

performance and deliver value to stakeholders.

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6
CONCLUSION
★ Intellectual capital is important in organisations. It
can be a source of competitive advantage for
businesses and stimulate innovation that leads to
wealth generation

★ Companies depend on being able to measure,

manage and develop this knowledge.

★ Management efforts therefore have to focus on the

knowledge resources and their use.

★ Intangibles and how they contribute to value creation

have to be appreciated so that the appropriate
decisions can be made to protect and enhance them

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★ There must also be a credible way of reporting those
intangibles to the market to give the investment
community comprehensive information to assist in
valuing the company more accurately

★ Huge investment flows in intangibles do not appear

as positive asset values on financial statements, so
the traditional accounting model does not represent
them in a meaningful format. But financial
statements should be seen as only a part of the
jigsaw in how companies assess and communicate
value.

★ The finance function has a key role to play in

managing knowledge assets and understanding and
communicating sources of enterprise value. 57
Thanks!

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