Accounting
Intellectual Capital Reporting: Challenge Of Standardisation And Harmonisation Intellectual Capital (IC) reporting has been receiving increasing attention from accountants in recent years. However, because the IC concept is new, it is yet to be fully incorporated in financial accounting reports. At present, very few companies are making ICrelated disclosures and that too on a voluntary basis. Omission of IC information may adversely influence the decisions made by shareholders or lead to material misstatements. As such, there is a tremendous need for standardisation and harmonisation in the field of IC reporting. This article attempts to review some prominent internal and external IC measurement methods and maps the current state of IC-related disclosures in the Indian corporate scenario.
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ise of ‘virtual’ corporations and a flourishing service industry has brought the Intellectual Capital (IC) in sharp focus in recent years. For these businesses, intangible assets are the ‘core’ assets that lead to business success in today’s challenging business climate. Several studies in the past had shown that future growth is determined not by ‘historical’ financial accounts alone but by factors, such as management skills, innovation capability, brands, and the collective know-how of the workforce. Consequently, more and more organisations are starting to address the measurement and management of intangible assets, such as, knowledge and IC. The last few years, therefore, have seen an increasing interest in getting to grips with measuring and reporting IC— the difference between the “book value” of companies as measured by financial measures, and the “market value” as expressed by share price. When there is a wide disparity between a firm’s market value and book value, that difference is often attributed to “intellectual capital.” It has become standard to say that a company’s IC is the sum of its human capital (talent), structural capital (intellectual property, methodologies, software, documents, and other knowledge artifacts), and customer capital (client relationships). IC is the ability to transform knowledge and intangible assets into wealth creating resources, by multiplying human capital with structural capital. With the growing – Dr. Madan Bhasin (The author is Head, Accounting Department, Mazoon College, Muscat, and Sultanate of Oman. He can be reached at
[email protected])
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realisation that financial measures “look backwards and at physical assets only,” organisations need to pay immediate attention on measuring what is perhaps their most valuable asset— intellectual capital. Led by initiatives in Scandinavia, many organisations are now coming forward to tackle the problem of intangible measurement. Undoubtedly, measuring the ‘exact’ value of IC is difficult but there are methods that can do it. The whole concept of IC measurement and its management is still relatively new. Accountants, business managers and policy makers have still to grapple with its concepts and detailed application. Only a few of pioneering companies are using the newer IC measurement methods.. The Swedish insurance company, Skandia, published the first “Intellectual Capital Report (ICR)” in the year 1994 which had attracted a lot of attention. Among the other pioneers were corporations like the Danish company Ramboll and Dow Chemical Company. Both the Skandia and Ramboll included various aspects of IC in their 1994 annual reporting. In the same year, Dow Chemical Company also prepared and published a conceptual framework for assessing the contribution of IC to the overall value of the company. According to the “Intellectual Capital and Knowledge Management Survey” (see Box-1) some firms operating in Austria, Denmark, India, Israel, Korea, Spain and Sweden are also elaborating their IC reports. The Electronics and Telecommunications Research Institute (ETRI visit www.etri.re.kr) from Korea is today doing pioneering work in the area of measurement and reporting of IC. As per the OECD research reports companies in Europe are way ahead
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of their counterparts elsewhere when it comes to the measurement, reporting and management of their IC. Some leading Asian companies dedicated to growth through innovation and knowledge management are outperforming their competitors, across a range of financial and non-financial metrics. Box-1: Company’s Showing IC Reports Country Austria Denmark India Israel Spain Sweden
Firms Reporting IC ARCS Carl Bro Gruppen, Cowi, Systematic Software Engineering Reliance Optimet, Teva Bankinter, BBVA, BSCH, Mekalki, Union Fenosa Skandia
It should be noted at the outset that the level of IC reporting in India is still in its infancy and is still evolving. While currently there are no officially recognised guidelines issued by the Institute of Chartered Accountants of India (ICAI) or reporting standards on IC reporting, there has been an increasing trend amongst companies to publish a variety of information relating to IC. Indian companies, therefore, present diversity in content and format under the overall umbrella of IC reporting. Three big Indian companies, namely, Balrampur Chini Mills Limited, Reliance Industries Limited, and Shree Cement Limited have successfully published their IC reports. The IC reports prepared by Indian companies presents a “narrative” style— basically describes a firm’s IC and analyses its components without focusing extensively on specific indicators that measure these components. Moreover, these IC reports constitute ‘independent’ documents that complement the Annual Report but their length is much larger than the European companies’ IC reports. Traditionally, while many organisations (both in the public and private sector) have been using IC-related information for internal decisionmaking, reporting to external stakeholders has not been a common practice in India. Recently, the Wipro Technologies and Infosys Technologies
were individually declared “The 2004 Asian MAKE” and “The 2005 Global MAKE” award winners, respectively, for their long-term potential due to their intellectual capital driven wealth creation. Both these IT companies have been recognised for their organisational learning and for transforming enterprise knowledge into shareholder value. Companies that are applying IC measures, however, have found that it gives them better understanding of the‘drivers’of value and is improving management and growth of these vital assets. In fact, the whole field of IC management is still relatively ‘new’ and evolving. Accounting for IC is being increasingly recognised as an important challenge facing the accountancy profession. In fact, there is a clear need to have accepted guidelines for firms willing to report their knowledge-based resources. The development of a set of ‘homogeneous’ norms, principles, indicators and structure is a high priority in the IC report agenda. The biggest challenge by far is establishing a consensus about ‘what’ and ‘how’ to report it. The question is no longer about whether or not to measure IC; it is about how to do it most effectively. In a nutshell, the accounting profession is at a crossroads, especially on how to disclose the IC-related information because of lack of consensus and authoritative or universally accepted broad guidelines. Accounting bodies at the global level should join hands to develop an internally and externally accepted valuation and reporting system in respect of IC. All companies need to learn to clearly identify measure and manage the real value drivers within their organisations in order to remain competitive, provide accurate and meaningful reports to stakeholders and create a mechanism for informed decision making.
What is Intellectual Capital? According to Thomas Stewart,“Intellectual capital is intellectual material—knowledge, information, intellectual property, experience— that can be put to use to create wealth.” IC is often, indifferently also referred to by various other terms, such as intangibles, intellectual assets, (sometimes limited to) human capital, organisational knowledge, etc. However, while the term ‘intangibles’ can be considered to be equivalent in scope to IC, other terms vary in scope and focus. June 2007 The Chartered Accountant
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Although IC definitions and conceptualisations are not entirely identical, the field is starting to see a ‘convergence’ of what KM and IC encompasses. Generally, the literature has identified three subphenomena that constitute the concept of IC: human capital, relational capital, and organisational capital. They are briefly summarised below. Quite simply, human capital represents the individual knowledge stock of an organisation as represented by its employees. It is the accumulated value of investments in employee training, competence and the future. Human capital is important, because it is a source of innovation and strategic renewal. For example, top Indian conglomerate Reliance Industries Limited states, “the Reliance’s employee skills are its competitive muscle. Its skills differentiate Reliance from its competitors— whether it be through the speedier implementation of a project or in its implementation at a cost which is significantly lower than that of the competition, or in the ability to extract more out of capital equipment, even when it ages. These skills are germinated in the Reliance culture” (Reliance, 1997, p.5). Relational capital represents the relationships with internal and external stakeholders. It is the knowledge embedded in the organisational relationshipswithcustomers,suppliers,stakeholders, strategic alliance partners, etc. Organisational capital is defined as the knowledge that stays within the company at the end of the working day. According to Bontis, it “includes all the nonhuman storehouse of knowledge in organisations, which includes the databases, organisational charts, process manuals, strategies, routines and anything whose value to the company is higher than its material value.” Further, organisational capital can be broken down into innovation capital and process capital. Innovation capital refers to the explicit, packaged result of innovation in the form of protected commercial rights, intellectual capital and other intangible resources and values. Process capital is “the combined value of value-creating and non-value-creating processes”. There is no doubt that key components of IC are an indication of a company’s future value and ability to generate financial results. That is why a more systematic method of reporting and managing these
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intangible dimensions is needed. Thus, IC provides firms with a huge diversity of organisational value such as profit generation, strategic positioning (market share, leadership, name recognition, etc.), and acquisition of innovations from other firms, customer loyalty, cost reductions, improved productivity and more. Successful firms are those, which routinely maximise the value from their IC.
Why to Measure Intellectual Capital? Companies want to measure intellectual capital (IC) for five reasons. First, measuring IC can help an organisation to formulate business strategy. By identifying and developing its IC, an organisation may gain a competitive advantage. Second, measuring IC may lead to the development of key performance indicators that will help evaluate the execution of strategy. IC, even if measured properly, has little value unless it can be linked to the firm’s strategy. Third, IC may be measured to assist in evaluating mergers and acquisitions, particularly to determine the prices paid by the acquiring firms. Fourth, using non-financial measures of IC can be linked to an organisation’s incentive and compensation plan. The first four reasons are all internal to the organisation. A fifth reason is external to communicate to external stakeholders what intellectual property of the firm owns.
Internal Reporting of Intellectual Capital Two of the more noteworthy attempts to measure and report IC “internally” are: Skandia’s Navigator, and Kaplan and Norton’s balanced scorecard. Both approaches are designed primarily for internal reporting, although Skandia did attempt to report IC externally using supplements to its interim and annual reports from 1994 to 1998. There are strong similarities between the Skandia Navigator and the Balanced Scorecard developed in the US and associated with Kaplan and Norton. We are going to summarise two major methodologies widely publicised—Skandia’s Navigator and Balanced Scorecard, respectively.
Skandia Navigator The Skandia, a Swedish company, documented its approach to measuring IC in their supplements. As per the company’s hierarchy of IC, the overall
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market value of the firm can be split into two parts: the financial capital (as recorded in the financial reports) and intellectual capital (IC). Skandia breaks IC into several components of human capital and structural capital. Human capital cannot be owned; it is the value found in employee training, employee competence, and know-how. Structural capital is what remains after the people have left for the day and can be split into customer capital and organisational capital. Organisational capital can be broken down further into process capital (how things get accomplished) and innovation capital (protected commercial rights and intellectual property). The Skandia Navigator measurement tool has five main components: financial, customer, process, human, and renewal and development. A house analogy is used to depict the Navigator (see Figure1). The financial focus is akin to the roof of the house where the recorded accounts are stored. The foundation of the house, representing the future, is the renewal and development focus. The roof and foundation measure how well the company is preparing for the future? The supporting walls, representing the present, are the customer and process focus. The centre of the house is the human focus because people have a hand in all of the other four focuses. Moreover, Table-1 (on next page) adapted from Skandia shows an example of how values can be assigned to each of these five components. Figure-1: Five Components of Skandia’s Intellectual Capital Measurement Methodology
Balanced Scorecard The Kaplan and Norton’s (1996) “balanced scorecard” approach is an organisational framework for implementing and managing a strategy at
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all levels of an enterprise by linking objectives, initiatives and measures to an organisation’s vision and strategy. It translates a business’s vision and strategy into objectives and measures across four balanced perspectives: (a) financial performance, (b) customers, (c) internal business processes, and (d) organisational growth, learning and innovation (see Figure-2 on next page). The balanced scorecard approach is similar to Skandia’s Navigator in its use of multiple perspectives. A balanced scorecard is a structural way of communicating measurements and targets. It is used as a tool for managing, measuring and communicating a company’s financial and nonfinancial information. In fact, the balanced scorecard uses four specific perspectives: financial (how do we appear to our stakeholders?), customer (how do we appear to our customers?), internal business process (what business processes must we excel at?). The learning and growth perspective includes categories for employee capabilities (human capital), information systems capabilities (information capital), and motivation, empowerment, and alignment (organisational capital). Kaplan and Norton have attempted to demonstrate how the intangible assets of human, information, and organisational capital could be measured. To sum up, human capital includes the skills, training, and know-how of employees. Similarly, information capital includes systems, databases, and networks. Organisational capital, in fact, includes such concepts as culture, leadership, teamwork, and alignment with goals. The value of these assets comes from how well they align with the overall strategic priorities of the organisation. Thus, IC is measured by evaluating how well assets contribute to achieving organisational strategy. Comparing the definitions of IC developed by Thomas Stewart and Leif Edvinsson, respectively, with the four perspectives of the balanced scorecard highlights how the balanced scorecard can be used to measure IC. IC is a combination of human capital— the brains, skills, insights, and potential of those in organisation
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Figure-2: Balanced Scorecard Components
brands, and IT systems (learning and growth perspective: information capital). It is the ability to transform knowledge (learning and growth perspective: organisational capital) and intangible assets into wealth creating resources, by multiplying human capital with structural capital.
External Reporting of Intellectual Capital Undoubtedly, the results of measuring IC can be useful to investors also. Outside the traditional approaches (Skandia’s Table-1: Assigning Values to Skandia’s Intellectual Capital Measurement Methodology 1997 1996 1995 1994* FINANCIAL FOCUS Operating income (MSEK)** 104 86 85 75 Total operating income (MSEK) 398 373 351 226 Income/expense ratio after loan losses 1.35 1.30 1.32 1.49 Capital ratio (%) 12.90 14.95 24.48 25.00 CUSTOMER FOCUS Number of customers 197,000 157,000 126,000 38,000 HUMAN FOCUS Average number of employees 218 200 163 130 Of whom, women (%) 56 49 45 42 PROCESS FOCUS Payroll costs/administrative expenses (%) 49 46 42 38 RENEWAL & DEVELOPMENT FOCUS Total assets (MSEK) 9,100 8,100 5,600 3,600 Share of new customers, 12 months (%) 25 25 232 N/a Deposits and borrowing, general public (MSEK) 7,600 6,200 4,300 1,300 Lending and leasing (MSEK) 8,500 7,600 3,700 3,200 Net asset value of funds (MSEK)*** 9,900 7,400 6,300 4,700 *Accounting-based indicators for 1994 have not been recalculated in accordance with the new Swedish Insurance Annual Accounts Act, which took effect on January 1, 1996. **MSEK = Million Swedish Krona. ***Changed calculation methods for 1996 and 1997. (Source: Skandia, “Human Capital in Transformation,” Intellectual Capital Prototype Report—A Supplement to Skandia’s 1998 Annual Report).
(learning and growth perspective: human)—and structural capital—things like the capital wrapped up in customers (customer perspective), processes (internal business processes perspective), databases, 1848 The Chartered Accountant June 2007
Navigator and Balanced Scorecard), in the European and Scandinavian arena, new developments assume a different narrative form. They pay specific attention to the interactions between various
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sorts of IC and eschew a preoccupation with the traditional financial accounting framework. So far, four noteworthy contributions have been made, namely, SFAS No. 142 by FASB, value chain scorecard by Lev, intangible assets score sheet by Sveiby, and the Danish IC Statements. Let us briefly look at these approaches to external reporting of IC. 1. SFAS No. 142: The Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” provides the accounting basis for measuring intangible assets. An intangible asset that is acquired from an external source is initially recognised at its fair value. If an intangible asset is developed internally, it is recognised as an expense when it is incurred. This will limit the recognition of most IC to what is purchased from outside the organisation, such as patents, licenses, and trademarks, because they are the only ones recognised as assets. It should be noted here that Generally Accepted Accounting Principles (GAAP) do not recognise the value of human capital nor much of the structural capital, such as, internally developed software, patents and brands. In developing the Statement No. 142, the FASB relied on the four recognition criteria found in FASB Concepts Statement No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises.” These criteria are: (1) The item meets the definition of an asset, (2) the item is measurable with sufficient reliability, (3) the information is capable of making a difference in decisions, and (4) the information indeed represents what it claims to represent, is verifiable, and is neutral. Since IC is a relatively new concept and there is no agreement on how to measure it, many IC items will fail on criterion two (reliability in measurement) and criterion four (verifiable). Until these two criteria’s can be met, it is doubtful whether many IC assets will be included in financial statements. Even so, the amount of IC a firm has can still be conveyed to investors. 2. The Value Chain Scorecard: Professor Baruch Lev has proposed a “value chain scorecard” approach to provide investors and external decision-makers with information relating to an organisation’s utilisation of IC. In an economy with joint ventures and alliances, outsourcing, built-to-customer ordering, supply chain management, and open source software, many important decisions are now
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made in consultation with partners in the value chain, who are outside the organisational boundaries. Lev’s scorecard provides non-transaction and nonfinancial information to support these decisions made with others in the value chain. The value chain scorecard mirrors three portions of the value chain: discovery and learning, implementation and commercialisation. Each of these three can, in turn, be subdivided into three additional categories for a total of nine categories. The first phase of the value chain is the discovery of new products or services. These ideas can be generated internally through R&D efforts or employee networks. They can be acquired from outside the entity, and be identified through active and formal networks, such as, joint ventures, alliances, and supply chain integration. The second major phase of the value chain is the transformation of ideas into working products or services. This can be measured through a variety of milestones: patents, trademarks, or other intellectual property; passing formal feasibility hurdles; and related to Internet technologies, quantitative measures of activity. The third phase of the value chain is the commercialisation of the products or services. Customer measures could include brand value, marketing alliances, and customer churns. Performance indicators could include innovation revenues, market share, economic value added, and knowledge earnings. A final category would provide forward-looking information on the product/service pipeline. A variety of indicators, however, can be chosen for each of the nine portions of the scorecard. The indicators should have three key attributes: They should be quantifiable; they should be standardised so that computations can be made across firms; and there should be statistical evidence to link the indicators to corporate value. Although much of this information is historical, it is not necessarily based on transactions. Thus, little will be found in the existing accounting information. 3. Intangible Assets Score Sheet: Today’s discerning investors take a critical look at both financial and non-financial parameters that determine the long-term success of a company. The non-financial parameters challenge the approach that evaluates companies solely on the traditional measures, as they appear in their financial reports.
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Thus, intangible assets of a company have been receiving considerable attention from corporate leaders in recent years. The intangible assets of a company can be classified into four major categories—human resources, intellectual property assets, internal assets and external assets. The Infosys Technologies Limited from India has published the “Intangible Assets Score Sheet” in its Annual Report 2004-5. The Infosys score sheet is broadly adopted from the intangible asset score sheet outlined by Dr. Karl-Erik Sveiby, in his book titled as “The New Organisational Wealth.” The company firmly believes that such representation of intangible assets provides a tool to our investors for evaluating our market-worthiness. Details are given under the following heads: Clients: The growth in revenue is 47% this year, compared to 33% in the previous year. Our most valuable intangible asset is our client base. Marque clients (or image-enhancing clients) contributed 50% of revenues during the year. They give stability to our revenues and also reduce our marketing costs. The high percentage, 95%, of revenues from repeat orders during the current year, is an indication of the satisfaction and loyalty of our clients. The largest client contributed 5.5% to our revenue as compared to 5% during the previous year. The top 5 and 10 clients contributed around 21.0 and 33.6%, respectively, of our revenue, as compared to 22.6% and 36%, respectively, during the previous year. Our strategy is to increase our client base, and thereby, reduce the risk of depending on a few large clients. During the year, we added 136 new clients as against 119 in the previous year. Organisation: During the current year, we invested around 5.41% of the value-added on IT infrastructure, and around 1.31% of the valueadded on R&D activities. A young, fast-growing organisation requires efficiency in the area of support services. The average age of support employees is 31.9 years, as against the previous year average age of 32.2 years. The sale per support staff, as well as, the proportion of support staff to the total organisational staff, has shown improvements over the previous year. People: We are in a people-oriented business. The education index of employees has gone up substantially to 100.351 from 74.057. This reflects 1852 The Chartered Accountant June 2007
the quality of our employees. The average age of employees as of March 31, 2005 was 26, the same as in the previous year. 4. The Danish Intellectual Capital Statements: The Danish Ministry of Science, Technology and Innovation has published several reports introducing IC statements. The Danish Financial Statements Act (June 2001) requires supplementary disclosure of intellectual assets, if they are likely to affect future earnings. The disclosures are required for all except the smallest enterprises (fewer than 50 employees) or sole proprietorships. An IC statement consists of four elements: a knowledge narrative, a set of management challenges, a set of initiatives, and a set of indicators. See Table-2 (on next page) for a sample IC statement. The knowledge narrative expresses how the products and services of the organisation provide value to the user. It addresses such questions as: What product or service does the company provide? What makes a difference for the consumer? What knowledge resources are necessary to be able to supply the product or service? What is the relationship between value and knowledge resources? Management challenges include existing knowledge resources that should be strengthened and new knowledge resources that are needed. Three general types of challenges recognise that a company’s knowledge lies in its information systems, the cooperation among employees, and the individual expert or group of experts. Each management challenge is made up of a number of initiatives, which are actions concerned with how to develop or obtain knowledge resources and how to monitor them. Questions that are addressed include: What are the existing and potential initiatives and objectives that relate to the company’s knowledge management? How do the initiatives and objectives work? What initiatives can be used to boost the company’s knowledge management? Indicators are the measures of the initiatives, expressed in effects, activities, and resources. They define the management challenges of the initiatives and make it possible to assess whether initiatives have been implemented and whether they have the desired effect. To conclude, the Skandia’s Navigator and the balanced scorecard have been used extensively as measurements of IC that help develop strategy,
Accounting Table-2: Danish Intellectual Capital Statement Knowledge narrative l
l
l
Product or service: Secure and systematic assessment of taxes for businesses. Use value: Prevention of unfair competition. Knowledge resources: A simple, effective and correct tax collection system advising users on the administration of often complex statutory rules and regulations.
Management challenges l
l
Deep insight into users’ conditions
Hiring and retaining employees
Initiatives l l l
l l l
l l
l
Development l of professional and personal competencies among the l personnel l l
l
l
l
Development of new effective processes
l
Electronic accessible rules, practices, processes and experience
l
Quality assurance with respect to equal treatment
l l
Indicators
Analyse users’ expectations and satisfaction Monitor business activities Monitor new legislation
l
Plan future need for competencies Create a family-friendly workplace Promote Odense Customs and Tax Region, including its role in society Develop a relationship between wages and results Develop assignments characterised by responsibility and independence
l l l
Create an overall understanding of Odense Customs and Tax Region’s products Develop knowledge sharing across professions Introduce competency development Introduce development methods
l
Develop a process and a culture of improvement
l
l l
l l l l
l
l l l
l l
l
l l
Anchor rules, practices, processes and experience electronically Monitor results of new legislation, user behaviour etc.
l l l
Number of new laws on taxes, excises and duties User satisfaction measurement Number of annual surveys Staff turnover Age distribution Number of schemes on part-time work, leave and other time off Number of applicants Number of employees with new salaries Number of employees with bonuses Employee satisfaction survey Number of job changes in the organisation Number of courses and other knowledge sharing activities Number of international exchanges Training cost size Competency evaluation Number of process descriptions Number of improvement proposals Benchmarking Number of applied process descriptions Number of decisions Number of new acts and changed practices
Prepare quality declarations Prepare quality assurance guide Analyse users’ expectations and satisfaction Always behave politely and correctly
Source: Jan Mouritsen, et.al. “Intellectual Capital Statement—The New Guideline,” Danish Ministry of Science, Technology and Innovation, 2003, page 17 (www.videnskabsministeriet.dk).
assess the effectiveness of corporate strategy and formulate compensation plans. These are primarily internal uses of IC. Currently, IC is not being reported to external stakeholders because there is no agreement on acceptable approaches to measuring 1854 The Chartered Accountant June 2007
IC and the measures that are used do not yet meet accounting standards for reliability and verifiability. With the rise of the “knowledge economy” over the past 20 years, however, IC is becoming more important and should be disclosed. In this regard,
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two newer approaches, Lev’s value chain scorecard and the Danish approach for supplemental disclosure of IC, hold much promise.
Intellectual Capital Reporting Scenario in India In view of the lack of regional research on IC reports in India, it is desirable to look at IC reports published by Indian pioneer firms. It has been found three big companies had successfully published their first IC reports in 1997. These firms are Balrampur Chini Mills Limited, Reliance Industries Limited, and Shree Cement Limited. Mr. Nandan M. Nilekani, CEO, President and MD of Infosys Technologies had remarked: “At Infosys, Knowledge Management (KM) is central to a core strategy of providing differentiated value to customers and enabling their business growth. The company is reporting in its annual report details about the intangible assets score sheet, human resources accounting, brand valuation, etc. Here, let us study the experiences of three leading firms, which had taken the lead by providing ICrelated disclosures.
1. Balrampur Chini Mills Limited The Balrampur Chini Mills Limited (visit www. chini.com) is one of India’s largest sugar companies, with three factories in Uttar Pradesh. In addition to the core sugar business, the company also produces and sells molasses and alcohol. In the 1997 Annual Report, the firm elaborates about the rationale of IC and intangible report as: “to provide share owner a different and broader perspective of the company, and the fundamentals that drive its business.” The Balrampur Model is specific to the company as “it reflects our priorities, our method of working, our attitude and our people.” If successfully activated, this model becomes regenerative. As the company states, “as we keep this intellectual capital wheel in motion, the Balrampur will always be a growing company.” According to the firm, the five elements of IC are credibility, efficiency, human, structural and customer capital. Customer capital has a strategic importance for the firm. Moreover, the company stresses the benefits of valuing brands. The ability to outperform the sugar industry average is a reflection of the considerable intellectual capital that it has built into its business—at the farm, factory 1856 The Chartered Accountant June 2007
and marketing levels. The Balrampur Chini Mills’ IC report constitutes an independent document to the annual report. These reports had 11 pages (in AR 1996-1997), 24 (in AR 1997-1998), 48 (in AR 19992000) and 40 (in AR 2000-2001), respectively.
2. Reliance Industries Limited The Reliance Industries Limited (RIL) activities include exploration and production of oil and gas, refining and marketing, power, telecommunications, petrochemicals, textiles, financial services and insurance, and infocom initiatives (visit www.ril. com). The IC report of 1998 of RIL aims to: “redress the imbalance between non-financial and financial data, in recognition of the belief that value of organisations will, in times to come, increasingly reside in their intangible assets.” The IC report is just focused on intellectual capital and addresses several key topics: the importance of the IC report itself, IC and value creation, human capital, structural capital, customer capital, and investor capital. However, it does not address the business model. It constitutes an independent document from the annual report with a total of 20 pages. The firm recognises that “the development and the use of human potential and a learning organisation is Reliance’s bridge to continued success in the future.” It uses the term “customer capital” not “relational capital” as most firms do.
3. Shree Cement Limited The Shree Cement Limited (visit www. shreecementltd.com) is operating in the cement industry, which possesses two cement plants at Beawar, Rajasthan. It has one of the few R&D centres in the Indian cement industry and a worldwide reputation for maximising capacity utilisation and low energy consumption level. Shree Cement Limited’s IC report is an independent document (having 28 pages) that constitutes a ‘Supplement’ to the Annual Report 2001. The firm understands that IC is “capturing our various experiences for organisational benefit, cross-pollinating our collective knowledge across various operational tiers, maximising output with the minimum of resources, and doing things right the first time.” The Company’s IC resides in its own employees. The IC report of the firm, in fact, is in “narrative style” as it does not incorporate double-entry tables with indicators for its intellectual capital.
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To conclude, the IC reports prepared by Indian companies, however, do not focus on the business model, values, mission and vision and/or knowledge management issues. It presents a “narrative” style, that is to say, it basically describes a firm’s IC and analyses its components without focusing extensively on specific indicators that measure these components. These reports do not combine a “narrative” and “quantifying” style. All Indian IC reports analysed here constitute ‘independent’ documents that complement the Annual Report. However, their length is much larger than the European companies IC reports.
Challenge of Standardisation and Harmonisation of IC Reporting Form A standardised reporting form requires that all corporations shall report about the same facts using common indicators. But depending on the type of companies, different IC aspects dominate and many companies refuse to disclose their IC data. They declare them as strategic and secret information, which are reserved for the internal IC management. Thus, the impossibility of comparing IC data in a standardised and benchmarked manner requires an alternative IC evaluation format. The concept of IC report is still too new to be completely standardised. Let’s not forget for instance that it has taken decades for IFRS to be introduced in traditional accounting. Indeed, we should wait for the concept of IC reporting to grow and develop in the near future. On the other hand it is more important at this stage that corporate world gets accustomed to reporting on IC and start using it as a management tool. The companies should clarify if the report has been developed for ‘internal’ managerial use only, or also for ‘external’ communication purposes. In a second step they should consider making some of these indicators public: only at that point, we would need a more detailed standardisation. If we try to impose some stringent rules now, we would risk jeopardising the development of the instrument. In other words, at this stage, we should promote the “awareness” of the importance of reporting IC in the corporate world rather than create a detailed top-down standard. At present, there are several industry-based guidelines, often developed by consulting firms and research institutes. It is appropriate to start discussing about having “harmonised” guidelines (for instance, the Danish guidelines could represent 1858 The Chartered Accountant June 2007
a benchmark in this respect). In practical terms, professionals should assist to: (1) sharing guidelines, and (2) standardisation of contents/indicators (bearing in mind that several of them are “firm specific”). Going forward, a convergence with other forms of reporting should be encouraged (e.g., sustainability report, social and environment report) that often tend to overlap one another. At this stage, harmonisation could take the form of defining the key areas that should be included into an IC statements. For instance, with reference to the scheme developed in the “Quaderno AIAF,” the five dimensions of the IC reports should be: Strategy, Clients and markets, Human resources, Process and innovation, and Organisation but we would not “impose” a detailed list of indicators, decided by an external body. Certainly, other dimensions could well be taken as a benchmark. Two points are of particular relevance for a financial analyst, who has the task of valuing a company “as an outsider,” (i.e., using only publicly available information). It is recommended that companies producing IC reports should be “consistent” over time, and secondly, they should explain the meaning of the indicators they use, and how they have built those indicators, and so on. A natural question arises: Should there be a harmonisation or standards for the quality of the IC reporting process, similar to, for example ISO9000, quality standard? This can be seen as a final step in the process, not an immediate need as of now. Harmonisation process could be strengthened and speeded up if a recommendation is made by a supra-national, authoritative body, such as, the European Commission, OECD, World Bank, etc. Corporate world experience, across the globe, suggests that rushing into the details of IC measurement before understanding its fundamentals is bound to be counter-productive.
Conclusion The IC report celebrates a decade of its existence in some companies across the globe. This period can prove to be a valuable learning experience for those firms that are interested in publishing IC reports but so far have not started doing it. In fact, the whole area of IC management is still evolving. Accountants, business managers and policy makers are still grappling with IC concepts and the related detailed application methodologies, and there is a long way to go in this regard. r
