Ana Fuentes | “Goodwill only appears with the acquisition of a company. Not if you just grow organically, which makes comparisons difficult. Skype paid 2.6 billion dollars for eBay and goodwill was 2.3 billion. We need to be capable of making a valuation of the intangibles in this type of company…,” explains Anne Jeny, member of the Management Committee of the European Accounting Association and professor at the ESSEC Business School.
Q: Is European and Anglo-Saxon accounting still so far apart?
A: Not now. It’s true that it used to be the case. Of course there is a cultural component involved in the way we calculate the value of companies and transactions. But since 2005 the IFRS [International Financial Reporting Standard] are obligatory for all European listed companies, at least as far as the consolidated accounts are concerned. These international regulations have been adopted in practically all the world expect in the US. Now we really do have accounting rules in common, but only for consolidated accounts and for listed firms. And there are two different systems which co-exist: the IFRS, very much focused on the information needs of investors and capital markets, it’s more like the Anglo-Saxon way of looking at a company, and then the local regulation: in France, Spain and in the US, the so-called US GAAP…and these rules have more to do with tax issues, etc etc. But they have changed a lot with the introduction of the international regulations.
Q: And what are the consequences of the fact that the world’s biggest economy adheres to its own accounting rules?
A: Everything is really a pulse between the US and the international accounting regulator, because it’s believed the US GAAP could have been used like the international regulations for every company in the world. But finally the IASB regulation has been implemented everywhere except the US. Meanwhile the international rules have been changed to be more in line with the US GAAP to avoid big differences. The exception to this is the recognition of intangible assets.
Q: Let’s talk about these intangibles, your speciality. They don’t appear that often, but are increasingly more important. In what sectors are these underestimations more noticeable?
A: For what we call the new economy or the economy based on Internet, the difference between the book value and the market value is huge. One problem comes from what we refer to as intangible assets developed internally. For example, if you have created your own registered brand or a patent, according to current accounting legislation you don’t have the right to register them as an asset on your balance sheet.
Q: Is this just in the US or in general?
A: It all depends on the accounting regulations which you are subject to. If you just have to provide information exclusively to the financial markets or if you believe that the function of accounting is to provide a certain level of security in transactions for different users, not just the markets, but also debt holders, clients, suppliers, governments, tax administrations, employees…then you can’t base everything on the market value, which is enormously volatile. And if you introduce too much volatility in accounting it’s dangerous.
Q: At the end of the day, the question is that the “real” value does not exist…
A: No, it’s a utopia. There are different real values, some work for some users and others for other users. The rule in accounting is that if a transaction happened at a specific moment in time and had a value, it was real. There was a buyer and a seller, they agreed on a price and this is registered. If you buy a registered brand or a patent for a price, the buyer will have the option to register this intangible asset on his balance sheet. Because there was a price. But if you develop your brand or patent internally, you can’t do that. There is not enough certainty with respect to the value.
Q: The system is based on something incomplete
A: Yes. But at the same time it’s so complicated calculating these intangibles...Because if, for example, you want to calculate the value of a registered brand you will use what we call discounted cash flow models, you have to estimate the gains or cash flows for the next five years and base this on suppositions of infinite growth. But in reality, you don’t exactly know what revenues are generated by the brand. And when you look at the mathematical model behind the valuation you see that it’s complex. I understand why the regulators have so many reservations when it comes to introducing these values on balance sheets. When you think about the role of accounting, its end objective is to represent the value of a company in a reliable way…
Q: Would there be room for the adjustment?
A: The regulators should think about extending the recognition criteria in order to be able to register an asset generated internally in a company. This is the case with development costs, those related to D in the R&D. If a project meets specific criteria, you even hav the obligation of registering it as an asset on your balance sheet under IFRS. But this is not the case under US GAAP. I believe that we academics have to present more research to show that there is no discretional use of these rules on R&D. We know from the pharmaceutical and automobile industries what a business cycle of an R&D project is. We have enough information, not about the accounting literature, but about the business. In the pharma sector we know that if we spend 1 euro today we will increase our revenues, for example, by 10% in 15 years etc. So the accounting organisations have been able to translate business cycles into criteria, but we don’t yet know what the cycle of these new industries is.
Q: You are referring to Twitter, Facebook, Amazon…
A: Yes, all of them. Very few are profitable. Twitter still isn’t. And yet the stock market puts a high value on them.
Q: Do such stock market valuations make sense when it’s been years since some of these companies have brought out a new product? Is it a bubble?
A: I don’t know if we can call it a bubble. If we think about Apple, for example, they were disruptive, really innovative and I believe they have created a brand thanks to this innovation. Nowadays they sell more marketing than technical innovation. It’s the value of being a market leader. But it’s something which is really volatile. A brand can lose all its value in just three days. I am thinking about the scandal surrounding Lactalis, the baby milk producer. In France it has lost a lot of value. But they can also recover.
Q: And how would all this fluctuation be registered in accounting terms?
A: If the accounting regulations decide to register this type of asset at its fair value a lot of volatility is introduced. That could be counter-productive for businesses. If we think about the 2008 crisis, it erupted just after the IFRS was introduced and many people said that had a lot to do with it. Now we know it was more to do with the subprime and other factors, but it’s clear that the fact companies and banks could register assets at their market value added a procyclical effect in the crisis.When we introduce fair value in the accounting that’s what happens. But all this is regulation for consolidated accounts, not for individual ones. In consolidated accounts, the aim is to have an impression of the capacity to generate value. If we think about individual accounts, the role of accounting is to ensure there is proof of each transaction carried out in a company. It’s very risky to register and give value to something which we are not going to be able to sell.