Corporate Governance and Intellectual Property Assets
By Dr Janice Denoncourt
Posted: 23rd October 2017 08:49Intellectual property (IP) rights are complex intangible legally recognised exclusive rights that play an integral role in modern corporate value creation. An important question that more and more stakeholders are asking is whether the current accounting treatment of intangibles under UK and international standards provides a ‘true and fair view’ of a company’s financial position. The fascinating inter-relationship between corporate governance, IP assets and traditional financial accounts will be of interest to those in civil, common law and other international jurisdictions where IP rights are growing as an asset class.
The starting point is traditional financial reporting which is ill-equipped to deal with IP, a problem compounded by under-developed corporate narrative reporting with respect to intangibles. Essentially, accountants must comply with the International Accounting Standard (IAS) 38 for intangibles, however, the balance sheet is often unable to adequately capture internally-generated IP which is regarded as off-balance sheet and therefore invisible to stakeholders. To illustrate, consider the anomaly of key patents in early-stage companies being treated as off-balance sheet assets that may later have to be disclosed in an annual report when they expire due to the detrimental impact on profitability. Other concerns involve the inadequacy of the annual reporting cycle, depreciation of IP assets (which conversely often increase in value over time) and the difficulty in re-valuing IP assets under the accounting standards. The IP information gap is unmistakeably problematic from a corporate governance point of view: shareholders’ needs for corporate IP asset information are not being met. As a result, corporate disclosure of more relevant, accurate and timely information regarding a company’s patents, trade marks, copyright and other IP rights (the type of information typically only known to internal management and their professional advisors) is needed to triangulate intangibles financial data through cross verification with corporate narrative disclosure.
As a matter of good corporate governance, it is important to have an understanding of the IP value story in connection with the company’s business strategy to provide the basis for a standard SWOT-style analysis. This is the first step in assessing whether the company’s directors are managing the IP assets in the interest of the company. Although companies required to do so publish annual reports that are longer and richer in content (which make them more costly to prepare) important IP information remains indiscernible. The Association of Chartered Certified Accountants (ACCA), the global body for professional accountants, having surveyed 500 annual report users in three common law jurisdictions (the UK, United States and Canada) maintains that shareholders (equity investors) are the foremost audience of the annual report and that their needs must be placed at the heart of future developments in corporate reporting. Half (50%) of the survey respondents confirmed that the annual report is their primary source of information, yet more than a quarter of the sample (26%) felt that it was difficult to assess a company’s performance from the report.
Good corporate governance requires additional narrative disclosure of ‘true and fair’ IP information to supplement the traditional financial accounts. The lack of IP asset transparency across all companies, small and large, also negatively impacts those in corporate finance ecosystem e.g. lenders and financiers, who rely on accounts and annual reports to evaluate the creditworthiness of company. Without more detailed narrative IP asset disclosure to explain the role of IP assets in future value creation, IP-rich companies will be subject to a ‘rustic’ valuation where the focus is primarily on tangible assets and cash flow as there are no or few historic financial transactions. As such the company valuation will be heavily influenced by norms in the relevant business sector e.g. IT, fashion etc. because the balance sheet is only really useful for companies that have a trading history. In addition to narrative IP value story, increasing and improving the use of ‘notes’ to the accounts would assist to provide relevant IP asset information and support innovation.
Accordingly, it makes sense that Finance Directors become better integrated in R&D, IP and business strategy. It is crucial for the Finance Director to identify and record IP assets, EVEN IF they are off-balance sheet items, as they will undoubtedly become more important and valuable to the enterprise as it matures. Moreover, to ensure the integrity of the accounts, the financial value of IP assets should be traced back to the day the company came into existence. This finance information will then be available both to internal management who determine strategy and as the basis for future accurate corporate disclosure to the public and importantly, counteract the negative impact of off-balance sheet IP assets.
In conclusion, traditional financial accounts on their own, struggle to provide true and fair view of an IP-rich enterprise. Indeed, it could be argued in some cases, the accounts even give third parties a misleading view. In terms of future corporate governance and accounting policy, company directors should consider recording off-balance sheet early-stage IP asset financial information from the date of incorporation to ensure traceability and integrity of financial accounting information, currently not a requirement of IAS 38. These records support the contextual narrative IP asset information to provide a true and fair view of the financial position of an enterprise.
This contribution stemmed from Janice’s article “True and Fair Intellectual Property Information: A Corporate Governance Issue” published in the Journal of Business Law  Issue 1, pp47-72.
Dr Janice Denoncourt
BA McGill, Grad Dip. Bus. Curtin, LLB Western Australia, LLM Murdoch, LLM Bournemouth, PhD Nottingham, Barrister and Solicitor Western Australia, Solicitor England and Wales (non-practising)). Before turning to academe, Janice was a Senior Associate with Minter Ellison Perth, in-house counsel for a publicly listed Western Australian company and Legal Affairs Manager for a private UK company. She is currently a Senior Lecturer at Nottingham Law School, Department of Academic Legal Studies, Nottingham Trent University, Nottingham NG1 4BU, Tel: +44 (0)115 848 2130
Accountancy Futures, Re-assessing the value of corporate reporting (2012) Association of Chartered Certified Accountants, p 4 at http://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/reassessing-value.pdf[Accessed 10 October 2014]