ACCOUNTING IN THE KNOWLEDGE ECONOMY

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Lecturers:

Prof. (FH) Mag. Dr. Ferry Stocker, Head of the Economics Department

Mag. Kerstin Strobach

Prepared By:

Burak Özsuna , Business Consultancy International (Master Programme)

1st Semester / University of Applied Sciences Wiener Neustadt

December 3rd, 2010

CONTENTS

Part 1 : The Knowledge Economy

Part 2 : Accounting in The Knowledge Economy

Part 3 : Measuring and Accounting for Intangibles - Current and

Potential Methods -

Part 4 : Conclusion

Part 5 : Discussion / Questions

Sources

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WHAT IS THE KNOWLEDGE ECONOMY?

The knowledge economy is a term that refers either to an economy of knowledge focused on the production and management of knowledge in the frame of economic constraints, or to a knowledge-based economy.

In the second meaning, more frequently used, it refers to the use of knowledge technologies (such as knowledge engineering and knowledge management) to produce economic benefits as well as job creation.

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GENERAL CONCEPT A key concept of the knowledge economy is that knowledge and education (often referred to as "human capital") can be treated as one of the following two: A business product, as educational and innovative

intellectual products and services can be exported for a high value return.

A productive asset

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KNOWLEDGE ECONOMY INDEX

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THE FASTEST GROWING SECTOR

Knowledge workers has been the fastest growing sector in the US economy and comprised 75% of the total workforce in 2006.

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Human Capital

21%

Organizational Capital

17%

Software 17%

Brand Equity 15%

Design 14%

R&D 9%

Other 7%

UK Business spending on intangibles in 2004.

RAPID GROWTH: HUMAN CAPITAL

Source: HM Treasury, October 2007

ACCOUNTING IN THE KNOWLEDGE ECONOMY

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What are the current and hot issues or problems?

Measurement and accounting for intangible assets.

AN INTERESTING COMMENT

“ The market value of S&P (Standard & Poor's) 500 companies is more than six times that of what is on their books. This means that for every $6.50 or so of market value, only $1 appears on the books. It's extraordinary that the balance sheet number reflects only 15 percent or so of the value of the company…“

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Baruch Lev

Director

Vincent C. Ross

Institute of Accounting

Research

“ACCOUNTING PRINCIPLES OUT OF DATE”

Today, most companies show less than 20 percent of their market value in tangible assets.

The real value of the company is in intangible assets, such as customer and vendor relationships, copyrights, patents, knowledge and etc.

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The intangibles may have some monetary value on the company's financials, the resources used to develop these assets are frequently considered expenses.

Therefore, the money paid to build, develop or make human resources more productive does not build any offsetting asset on the company's financials

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ACCOUNTING PRINCIPLES OUT OF DATE (Cont`d)

DEFINITION OF INTANGIBLE ASSETS

Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset.

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THE FORMS OF INTANGIBLE ASSETS

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COMPETITIVE INTANGIBLES

- Knowledge / Know How

- Collaboration Activities

- Leverage Activities

- Structural Activities

LEGAL INTANGIBLES

- Trade Secrets

- Copyrights

- Patents

- Trademarks

CURRENT METHODS FOR MEASURING THE INTANGIBLES

1. Direct Intellectual Capital Methods

2. Market Capitalization Methods

3. Return on Assets Methods

4. Scorecard Methods

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THE APPROACHES FOR MEASURING INTANGIBLES

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1. Direct Intellectual Capital Methods Estimate the money value of intangible assets by identifying its various components. Once these components are identified, they can be directly evaluated, either individually or as an aggregated coefficient.

THE APPROACHES FOR MEASURING INTANGIBLES (Cont`d)

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2. Market Capitalization Methods Calculate the difference between a company's market capitalization and its stockholders' equity as the value of it intellectual capital or intangible assets.

THE APPROACHES FOR MEASURING INTANGIBLES (Cont`d)

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3. Return on Assets Methods Average pre-tax earnings of a company for a period of time are divided by the average tangible assets of the company. The result is a company ROA that is then compared with its industry average. The difference is multiplied by the company's average tangible assets to calculate an average annual earning from the Intangibles. Dividing the above-average earnings by the company's average cost of capital or an interest rate, one can derive an estimate of the value of its intangible assets or intellectual capital.

THE APPROACHES FOR MEASURING INTANGIBLES (Cont`d)

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4. Scorecard Methods The various components of intangible assets or intellectual capital are identified and indicators and indices are generated and reported in scorecards or as graphs. SC methods are similar to Direct Intellectual Capital (DIC) methods, expect that no estimate is made of the money value of the Intangible assets. A composite index may or may not be produced.

INDUSTRIAL BUSINESS VS. KNOWLEDGE BUSINESS

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SAMPLE: THE INCOME FORMULA IN THE NEW ERA*

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CONVENTIONAL ACCOUNTING

Revenues

(Cost of Goods Sold)

Gross Margin

(Operating Expenses)

EBIT

(Interest and Taxes)

Profit

IDEAL ACCOUNTING

Revenue

(Cost to serve customers)

(Cost to produce products/services)

(Cost to develop products/services)

(Administrative Costs)

EBIT

(Taxes)

+/- Noncash Adjustments

Cash Earnings

* For Know – How Companies

In assessing the value of a know-how company, it is necessary to use an overall view. Apart from its had (reported) assets, it has a total know-how capital that makes it possible to attain a long- term profit that is higher than the normal return on the reported shareholders’ equity. This know-how capital consists of three parts:

a) Structural capital

b) Human capital

c) Management capital

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KNOW-HOW CAPITAL = ORGANISATIONAL VALUE

THE KNOW-HOW COMPANY’S PROFIT AND LOSS ACCOUNT (MUST TO HAVE)

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Invoiced sales X

Operating costs before salary costs X

Salaries X

Operating profit before investment in the organisation X

Investment booked as cost

Structural capital X

Human capital X

Management capital X X

Operating profit before depreciation of plant X

Depreciation of plant X

Operating profit after depreciation of plant X

Net financial items X

Profit before appropriations and tax X

Appropriations X

Tax X

Net Profit X

P&L Table

THE KNOW-HOW COMPANY’S BALANCE SHEET

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HARD ASSETS

1. Working capital X

2. Fixed capital X

3. Financial capital X

Reported value X

BALANCE SHEET

Part 1

THE KNOW-HOW COMPANY’S BALANCE SHEET (Cont`d)

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ORGANIZATIONAL VALUE

Know - how capital

1. Structural capital

Business concept X

Company name and market identity X

Business fields and products X

Customers X

Networks of contacts X

Organisational structure X

Administration and accounting systems X

Production routines X

2. Human capital

Key people X

Other personnel X

X

3. Management capital X

Total value X

BALANCE SHEET ( Cont`d)

FINANCING

1.Borrowed capital X

2.Shareholders’ equity X

Untaxed reserves

Taxed capital X

Reported value X

3. Shareholders’ equity

The value of the know-how capital X

Total value X

BALANCE SHEET (cont`d)

Part 2

Part 3

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$ millions

Human Assets 812

Fixed Assets* 329

Net Current Assets 201

1.342

Equity 350

Loan Capital 320

Human Capital 672

1.342*Excludes fixed assets forming part of human assets

Gearing: 26% Equity 24% Borrowings 50% Human Capital

The XYZ Company Ltd Balance Sheet as at 31 December 2009

AN EXAMPLE: BALANCE SHEET WITH HUMAN CAPITAL

CONCLUSION

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The changes occurring in the world-wide economy directs all countries to the search and the trial of different financial methods. This difference didn’t remain only at the financial extent, it also brought about the coordination of some certain changes in other disciplines with the world-wide practices. One of these disciplines is accounting.

Recording methods used in accounting have shown a tendency

of differentiation with the effect of changings taking place in economic structuring. The aim of this presentation is to explain the effects of knowledge-based economy structuring on recording methods in accounting.

DISCUSSION

Can the cost of human capital (as an intangible asset) be the same as the cost of commercial capital? If not, why?

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QUESTIONS

• What are the current methods for

measuring the intangibles?

• While growing the knowledge economy, what are the issues for accounting? Please, explain it briefly.

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REFERENCES

o Bender, C., Röhling, T., Ansätze zur Bewertung und Risikomessung von Humankapital, 2001

o Drucker, P., The Effective Executive, 1966

o Drucker, P., The Age of Discontinuity, Chapter 12, 1969

o Goughnour R.C., Human Resources on the Balance Sheet, Alaska Business Monthly, October 2003

o Kenneth, M.W., Nippani, S., Financial Counseling and Planning Volume 15 (1), 2004

o Leydesdorff, L., The Knowledge-Based Economy: Modeled, Measured, Simulated, 2006

o Mansour, E., Ahmed, M., Missi, F., Validity of Accounting Models in the Knowledge Era, May 2008

o Rooney, D., Hearn, G., Ninan, A. Handbook on the Knowledge Economy, 2005

o Sveiby, K.E., Methods for Measuring Intangible Assets, 2001

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Thank You For Your Attention.

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