FINANCE FOR NON-FINA ANCIAL SORTS
IN RESPONSE TO
Accountants have the ability to irritate almost all people sitting around the boardroom table, see Finance for non-financial sorts: Examining the missing assets ( Finweek, 23 January issue). Jeremy Sampson is one such person and he has given a number of reasons for his unhappiness in his letter last week, which was featured in the Feedback section in the 6 February issue. What follows is an explanation of the method behind the seeming madness of accountants.
One of the main points made was that the most valuable assets of a f irm are intangibles. While this is true in some cases, these intangibles are not recorded by accountants because they cannot be reliably measured. If you ask one group of experts to value your brand you will be certain of the value. Ask another group of experts to value that same brand and you start to see a problem emerge − the numbers will often be vastly different. Until there is an agreed-upon methodology for valuing intangibles, this will be a problem. Accountants therefore prefer to leave these highly subjective numbers off the balance sheet and allow investors to make up their own minds as to their value.
The letter writer correctly points out that brands can be sold for large amounts. When this occurs, the brand will appear on the balance sheet of the purchaser because the value has been clearly establ ished by the negotiating parties and uncertainty around measurement has been removed.
My major caution is with respect to t he i mplication t hat t he l a rge gap between the market value of a company (as determined by the share price) and the asset value (as determined by the accountant) is made up primarily by ‘ brands’. That is quite simply not true. In the case of mines as well as oil and gas companies, t he reser ves sti l l i n t he ground drive a large part of the share price but yet would not be on the balance sheet because they are yet to be developed. For a life insurer, the embedded value of contracts already written is the number most closely watched by investors but it is not recorded as an asset because it relates to future business still to be concluded. For a company like Apple, the value of the network created is the largest intangible. This is a network where songs can be downloaded, apps can be purchased and devices can be synced effortlessly. This has little to do with the brand but rather relates to the ecosystem that has been created by Apple to keep customers linked into their products and services. How valuable is that net work? Very valuable. How much exactly in dollar terms? It is too hard to reliably measure and is therefore excluded from the balance sheet.
Another comment worth making is that not all efforts to build a brand lead to wild success. I am reminded of an episode of the popular TV series Parks and Recreation. One of the characters starts a business, Entertainment 720, and spends a fortune on parties and various items of merchandise with the company logo boldly displayed. After a short period of time, with cash reserves down to zero, the perplexed character is heard saying: “I just don’t understand it. They say you’ve got to spend money to make money. Well, I spent all my money and I made nothing!” This example is over the top but it does display the problem of recognising all advertising and marketing efforts as being well-directed and effective. How could you tell if a cam-
paign is going to be as effective as CocaCola (or any of the other great brands mentioned in the letter) or whether it was destined to be the next Entertainment 720? Accountants are not qualified to do so; in fact, I would suggest that no-one is positioned to do so with precise numerical values attached. For that reason, all amounts are expensed and investors can make up their own minds about the value of the brand.
Valuing a company is not easy. For the most part, a valuation looks at the future cash f lows generated by the business, calculated in today’s money through the use of an appropriate discount rate. What that means is that valuation experts are looking at the f uture to arrive at the value of the company and will take into account a lot of what accountants ignore due to uncertainly around measurement. Should accountants hang their head in shame? No, investors are just one group of end users for f inancial statements. There are also the banks, employees, revenue services (Sars) and trade unions, to name a few.
What accountants aim to provide therefore is decision useful information to all these diverse users, with transparency about how the numbers were arrived at. All users can then undo and reshape the numbers to their hearts’ content in order to arrive at the numbers that help them the most. Providing all this additional information is partly the reason why f inancial reports have grown in length and is also the reason for a group to push for extensible business reporting language (XBRL), which provides real-time information about the accounts as opposed to users having to wait months for an annual report to be released.
I have much sympathy for t hose unhappy with the methods of accountants but with so many different constituents to please, it is probably the correct outcome that everyone is a little upset with us!
Paul Maughan CA(SA) is a UCT Board Course senior lecturer.