Intangible Assets and Sustainability Reporting
The EU’s Corporate Sustainability Reporting Directive (CSRD) includes the requirement to report on ‘key intangible resources’. So, what does this mean exactly?
To answer this question, I need to start with the amendments to Directive 2013/34/EU as published in Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 in regard to corporate sustainability reporting. The amendment is clear, it defines “key intangible resources means resources without physical substance on which the business model of the undertaking fundamentally depends and which are a source of value creation for the undertaking.”
The CSRD states “…certain information on intangible resources is intrinsic to sustainability matters, and should therefore be part of sustainability reporting. For example, information about employees’ skills, competencies, experience, loyalty to the undertaking and motivation for improving processes, goods and services, is sustainability information regarding social matters that could also be considered as information on intangible resources.
Likewise, information about the quality of the relationships between the undertaking and its stakeholders, including customers, suppliers and communities affected by the activities of the undertaking, is sustainability information relevant to social or governance matters that could also be considered as information on intangible resources. Such examples illustrate how in some cases it is not possible to distinguish information on intangible resources from information on sustainability matters.”
The Importance of Intangible Resources
The goal of the CSRD is to provide clarity that will help investors, analysts, consumers and other stakeholders better evaluate EU companies’ sustainability performance and the related business impacts and risks.
In recent decades, the ability to interpret financial statements has become more challenging. This is primarily due to the shift from an economy dominated by tangible assets to one dominated by intangible assets.
Tangible assets are physical in nature. For example, they might include buildings, property, specialized equipment, trucks, inventories or computer hardware. Intangible assets, on the other hand, are non-physical in nature. These might include, for example, the brand, the culture, software, the talent you have in-house, the customer experience and customer loyalty.
In 1975, Intangibles comprised just 17% of enterprise value in the S&P500, while today (2024) that number is 85%. The digital economy is driving much of this transformation, but it also reflects the increasing relative importance of all intangible assets.
According to Brand Finance, “The majority of intangible assets are not recognised, due to the limitations set by the financial reporting rules, which state that internally generated intangible assets such as brands cannot be disclosed in a company balance sheet. Investors should not be deprived of this critical information. Intangible assets such as strong, valuable brands and innovative technology can be the differentiators that drive a $2 billion company to $2 trillion in 25 years — as witnessed with Apple.”
Reporting on Intangible Assets
A key impediment is that modern accounting standards have not fully kept pace with the evolution from tangible assets to intangible assets. There remains debate as to whether accounting methods take into consideration the full range of intangible assets companies may possess. In simpler terms, the lack of a standard definition means intangible value creation remains somewhat poorly understood — even when it represents the most material aspect of a company’s worth.
A defining result of this process is that it makes the incorporation of relevant and material environmental, social and governance (ESG) factors that are much more vital to the evaluation of a company. The emphasis on ESG is not a trend; rather, it is demand-based and has become an expectation of each company’s senior leadership to acknowledge and adopt these factors accordingly. Why? Because the world is watching. Consumer preferences, institutional investors and now regulatory frameworks are requiring greater transparency on intangible factors. ESG considerations add a new lens to evaluate how well an entity is managing its intangible assets now and into the future.
Companies must for now work with what is currently available from various sources, including for example the sustainability accounting standards, to ensure that reliable and transparent messaging is provided to investors and other stakeholders. A clearer horizon appears in sight for comprehensive reporting…Deloittes
Reporting on intangible assets can bring a company many benefits, such as enhancing your credibility and reputation, building trust with stakeholders, demonstrating your value proposition, attracting and retaining investors, customers and talent, improving risk management and opportunity identification, enhancing performance and decision-making, and contributing to sustainability goals. The EU have now made it mandatory to report on intangible assets and the rationale behind this decision is obvious.
However, it also presents some challenges. These include finding the right frameworks and standards to follow, measuring and valuing intangible assets accurately and consistently, reporting and communicating them clearly and effectively, balancing the costs of reporting against the benefits, managing stakeholder expectations and feedback, and dealing with the uncertainty of intangible assets.
Conclusion
The EU’s CSRD reporting requirements have brought the value and vitality of intangible assets and resources to a wider audience. Although the frameworks for reporting in relation to sustainability are still a work in progress, there is no doubt a common framework will evolve. The International Accounting Standards Board adopted IAS 38 Intangible Assets in 1998. Over the years there have been several amendments.
The final words come from CPA Australia (Certified Practising Accountant). They claim, “Businesses are increasingly investing into and benefiting from a range of intangibles including technology, branding, research and development (R&D) and intellectual property.
There is broad consensus among preparers, auditors, valuers, regulators and users of financial statements that the current requirements would benefit from a review.”
And now, the EU’s CSRD reporting Directive requires companies to report on certain information on intangible resources that is intrinsic to sustainability matters.
***************************
Ms Adrienna Zsakay is the Founder and CEO of Circular Economy Asia Inc, and this article represents her opinions on the circular economy. Circular World Video of the Week is brought to you by Circular World™ Media — a brand owned by Circular Economy Asia Inc.
For all the best content, join one of the fastest-growing circular economy groups on LinkedIn — Circular Economy Asia.
***************************
Clarification
During the course of writing this article, it became apparent there may be a difference between ‘intangible resources’ and ‘intangible assets’. The best information I could find to clarify this point is from ‘Teece, David J. The Palgrave Encyclopedia of Strategic Management, 2013 Palgrave Macmillan, reproduced with permission of Palgrave Macmillan’ who writes “Intangible resources are stocks of strategic information and intangible assets that the organization can employ as needed in pursuit of its goals.”
References
‘How the rise of intangible assets is forcing leaders to up their game’ By Brent Snow and Sean Murray, published by Advantage, June 20, 2024
‘What is the Corporate Sustainability Reporting Directive (CSRD)?’ published by IBM
‘Microsoft Overtakes Apple to Become World’s Most Intangible Company’ published by Brand Finance, 16 September 2021
‘Setting the New Agenda for CFOs — Understanding the Role of Intangibles in Value Creation’ published by World Intellectual Capital/Assets Initiative, May 2021
‘As Intangible Assets Grow, So Does The Role Of ESG Standards’ by Martin Jarzebowski, Forbes Councils Member, published by Forbes, 29 December 2020
‘What are the challenges of reporting on intangible assets like human capital and intellectual property?’ Powered by AI and the LinkedIn community
‘Comprehensive Corporate Reporting — Tangible or Intangible?’ published by Deloitte, 14 July 2022
‘Closing the financial reporting gap’ by Ram Subramanian, published by CPA Australia, In The Black, 01 July 2022
Originally published at https://www.linkedin.com.
