Intangible Assets at Woolworth - Case Study Example

Intangible Assets at Woolworth Name Institution Executive Summary Accounting for intangible assets has been faced with numerous challenges today. Due to changes in business environment, intangible assets are becoming prevalent and account for the success of a business. However, the current accounting standards prevent reporting of their true value. This report is based on the intangible assets of Woolworth. The paper has established that Woolworth does not recognize all its intangible assets as a result of the restrictions put forth by AASB. The recognizable intangible assets include liquor and gaming licences, goodwill and brand name while the unrecognizable ones include human capital and relationship capital. In order to understand the accounting procedure of Woolworth, this report has evaluated the current treatment of intangible assets and the changes that need to be done in order to improve intangible asset reporting. Also, the paper has established that Woolworth needs to employ voluntary disclosure of intangible assets in order to establish the true value of all its assets. Table of Contents Executive Summary 2 Table of Contents 3 Introduction 4 Intangible Assets 4 Intangible Assets Recognized by Woolworth 5 Goodwill 6 Brand Names 6 Liquor and Gaming Licences 7 Unrecognizable Intangible Assets 7 Human Capital 8 Relationship Capital 8 Accounting Treatment of Intangible Assets 8 Initial Recognition 9 Amortization of Intangible Assets 9 Impairment Testing 9 Changes to be made in the Current Accounting Standards 10 Recommendation 10 Conclusion 11 References 12 Introduction In the 21st century, being a knowledge-driven and service-dominated economy, intangible assets are playing a huge role in shaping companies’ success (Ghamari et al., 2012). In 2005, the Australian Accounting Standards Board (AASB) introduced a new era based on AASB 138 intangible asset and impairment provisions. These provisions are intended to govern the valuation and disclosure of intangible assets and treating their inevitable impairment. The AASB 138 outlines the accounting requirements attached to the intangible assets of a company (AASB, 2005). Nevertheless, the accounting for intangible assets has been faced with numerous challenges that affect their recognition and measurement. There is therefore a need to reform the current accounting standards in order to ensure effective reporting and measurement of intangible assets in today’s changing business environment. This report is based on the analysis of the measurement and recognition of intangible assets of Woolworth. The paper will describe the intangible assets that Woolworth recognizes and those that the company is prevented from recognising as governed by the accounting standard. Also, the report will evaluate how the current accounting standard treats the intangible assets. Form this analysis; it will identify the changes that need to be made to ensure effective recognition of intangible assets. Lastly, the paper will offer some recommendations that will assist Woolworth effectively report, measure and recognize its intangible assets. Intangible Assets According to McNicholas (2001), an intangible asset is one that lacks a physical form but has great value to an organization. According to accounting standards of different jurisdictions, due to their importance, companies need to disclose their intangible assets in the financial reports. However, many businesses only disclose good will and their brand as their intangible assets. The Australian Accounting Standard Board has offered requirement for treatment of the intangible assets and only if they meet specific characteristics. Based on the AASB 138, an intangible asset must be identifiable (AASB, 2008). This means that it should be separate in order to be sold, rented or licenced and in order to be different from goodwill. Also, intangible assets should be non-monetary in nature. This ensures that receivables are separate entities from intangible assts. Intangible assets should also lack a physical substance in order to be differentiated from tangible assets like equipment and property. AASB has also reported that intangible assets need to have economic benefits that can flow to the entity and their costs can be measured reliably (AASB, 2010). Intangible Assets Recognized by Woolworth Intangible assets are considered very important by Woolworth Corporation. The company has valued its goodwill and other intangible assets to be about $3.078 billion (Woolworth Limited, 2012). Woolworth conducts its estimations of its intangible assets annually and when there is a sign of impairment. Woolworth only recognizes intangible assets that have indefinite useful life and are measurable. According to Australian Accounting Standards Board, any company in Australia should record its financial report according to the Australian Accounting Standards. Woolworth recognizes goodwill and intangible assets that generate cash flow and add indefinite value to the company (Woolworth Limited, 2012). Some recognizable intangible assets by Woolworth include gaming licences, liquor licences, brand name Goodwill. Goodwill According to Ramanna and Watts (2009), goodwill is an intangible asset that comes into existence when there is an acquisition of one company by another. The acquiring company pays for assets such as customer base, employee relation, patents and technology that are considered assets (Woolworth Limited, 2012). In addition, goodwill can also be the intangible assets owned by an organization that have the ability to enhance its competitive advantage such as brand image and reputation. Just like in any company, Woolworth has separated the goodwill from the rest of the intangible assets due to its unidentifiable and indefinite nature. Over the last year, the company has acquired several companies that have given rise to goodwill assets (Horngren et al., 2012). For instance, Woolworth acquired Tasman Stores in order to prosper in Tasmanian market. The market value of Tasman Store’s assets and liabilities were approximated to be about $9 million and $1 million respectively. Woolworth paid $10 million for Tasman Store generating $2 million for goodwill (Horngren et al., 2012). The treatment of goodwill should conform to the Australian Accounting Standards. Woolworth allocates its goodwill to the respective cash-generating units and its impairment is directly recognized in the financial report but is not reversed. Brand Names Woolworth considers its brand name as intangible assets and includes them in the financial report. Woolworth is considered one of the most recognized and trusted brand in the world. It has created a world class experience for customer in different countries making it an important company entity (Horngren et al., 2012). The brand names primarily relate to the New Zealand stores. Woolworth considers its brand names as part of their intangible assets since they are not physical in nature and customers are willing to pay more for products as a result of it. The brand names have created significant value to the company and have contributed significantly to the company’s growth potential. Woolworth treats its brand as indicated by the AASB (AASB, 2005). The company does not amortize its brand names due to their indefinite nature. It also reviews its brand names annually before reporting in order to establish whether circumstances continue to maintain an indefinite nature for the brand names. Liquor and Gaming Licences The last years have seen Woolworth transferring liquor and gaming licences from different companies across the globe. These licences have given them the right to sell their own and exclusive liquor and gaming products to its customers (Woolworth, 2010). The acquired liquor licences have led to the formation of Woolworth Liquor Group Limited that serves customers across all segments. This has increased its sales reflecting on the success of the liquor business. Woolworth recognizes liquor and gaming licences as intangible assets since the company has paid a guarantee for the privilege that is measurable and can therefore be included in the balance sheet (Woolworth, 2010). As intangible assets, the liquor and gaming licences have played a major role in improving the competitive position of Woolworth. Liquor and gaming licences are indefinite in nature and are therefore not amortized. However, Woolworth tests these assets annually for any impairment which are evident in the income statement. Unrecognizable Intangible Assets There are intangible assets that are unrecognizable by Australian companies such as Woolworth. These assets fall under two categories; human capital and relationship capital. Human Capital Human capital is considered primary intangible asset. Many companies realize the value that comes with these assets and yet, the ability to measure and monitor them prevents them from recognizing them and reporting them in the annual financials report (Lev, 2003). Woolworth recognizes the productivity and efficiency that result as a result of human capital. This asset can only be measured if “labor” can have the ability to conduct defined task at specified time. Changes in the business environment have made this difficult, making these assets difficult for Woolworth to monitor and measure (Lev, 2003). The recognisability of human capital is important since experienced and engaged workforce creates competitive advantage and adds value to an organization. Relationship Capital Just like human capital, relationship capital creates value for a company. This category of intangible assets can be quantified if they are in the form of a client list. Recognition of relationship capital is important to Woolworth since it can predict the level of customer satisfaction and client turnover (Lev, 2003). Woolworth has strong relationship with customers, and suppliers which contribute to effective supply chain management. The organization’s community can be considered as asset since it leads to enhanced operating effectiveness. Although Woolworth recognizes that relationship capital contribute to smooth operation, it has not included it in the balance sheet due to the restrictions from AASB (AASB, 2010). Accounting Treatment of Intangible Assets There are numerous rules that have been put in place by Australian Accounting Standard Board (AASB) for companies to apply when reporting intangible assets. Initial Recognition According to AASB 138, companies should recognize an intangible asset if it is possible for the future economic benefits to flow to the entity and if its cost can be measured reliably (AASB, 2010). The future economic benefits should be founded upon reasonable suppositions about the situation over the life cycle of the asset. If an intangible asset does not meet these criteria, companies are expected to recognize the expenditure as an expense (AASB, 2010). Amortization of Intangible Assets According to AASB (2010), it is important for companies to determine whether the lives of their intangible asset are indefinite or finite. When an intangible asset has finite life, an organization is expected to amortize it. The amortized amount is the recorded cost less the residual value. If the asset is impaired, one needs to adjust the amortization level in order to possibly reduce the useful life. For assets with indefinite life, companies should not amortize them but should evaluate them regularly to determine whether their value has become impaired or have determinable useful life (AASB, 2010). For goodwill assets, amortization should not be done under any circumstances. Impairment Testing AASB necessitate companies to test for impairment loss in the event that an asset may be unrecoverable (Ramanna and Watts, 2009). Circumstances that necessitates impairment test include when there is a decrease in the market price of the asset, excessive cost incurred in acquiring an asset, adverse change that affects asset value and when asset is likely to be sold. In the event of impairment, an organization should recognize an impairment loss. Changes to be made in the Current Accounting Standards The regulations and laws provided in the Australian Accounting Standard Board make organizations scrutinize intangible assets by revealing them in the financial report. The adoption of AASB 138 has resulted into derecognition of many intangible assets such as human capital and relationship capital (Nigel, 2006). The current accounting standard makes it hard for companies to recognize internally generated intangible assets. Nevertheless, some changes can be made to improve the recognition and measurement of intangible assets. For instance, the AASB should ensure companies recognize internally generated intangible assets such as customer lists, relationships due to their importance (Ghamari et al., 2012). In addition, the criteria put in place by AASB to warrant asset recognition has contributed to reporting omission of valuable intangible assets. Therefore, the accounting standards should warrant any intangible asset that offers value to organization permission for recognition. Recommendation Due to the ability of intangible asset to increase value of an organization, it is vital for Woolworth to invest in improving intangible asset reporting. Internally produced intangible assets such as human capital, customer list and research and development design can be paramount sources of success (Lev, 2003). Woolworth should be involved in voluntary disclosure of these intangible assets in order to determine the value they bring to the company and inform the shareholders. Voluntary reporting can be done in narrative sections, outside the financial statement but be part of the overall reporting practice (McNicholas, 2001). According to legitimacy theory, the society has expectations about how an organization should act which affect its future survival. Businesses should therefore show that they are operating in line with these expectations found in the social contract (McNicholas, 2001). In regards to accounting disclosure and legitimation, legitimacy theory necessitates companies to disclose any information that may affect the relationship they have with the society. Therefore, public reporting of intangible assets can be effective in showing that an organization meets its responsibility. Legitimacy theory supports voluntary disclosure of financial information since it demonstrates accountability. Therefore, Woolworth should voluntary disclose the value of all its intangible assets in the narrative sections as a way of being accountable to the public and shareholders (McNicholas, 2001). Conclusion The Australian Accounting Standard Board has established regulations governing recognition and reporting of intangible assets that are seriously flawed since they fail to recognize many important intangible assets. Due to these restrictions Woolworth only recognize few intangible assets such as brand name, goodwill and liquor and gaming licences. The AASB restrict the company from recognizing internally produced intangible assets such as human capital and relationship capital. These restrictions cause the company to lose relevant information on intangible assets that go unreported. Therefore, several changes need to be implemented in the current accounting standard in order to improve financial reporting. Woolworth can also improve its reporting by conducting voluntary disclosure of unrecognized intangible assets. References AASB 136. (2005). Impairment of assets, Australian Accounting Standards. AASB 3 (2010). Business Combinations. Viewed 16th August 2017 http://www.aasb.gov.au/admin/file/content102/c3/AASB3_03-08_ERDRjun10_07-09.pdf AASB. (2008). Initial Accounting for Internally. Generated Intangible Assets. Viewed 16th August 2017 http://www.aasb.com.au/admin/file/content105/c9/ACCDP_IGIA_10-08.pdf Ghamari, M., Saeidinia, M., Hashemi, M. & Aghaei, M. (2012). Intangible Assets Reporting. Australian Journal of Business and Management Research, 1(11): 70-73. Horngren, C., Harrison, W., Oliver, S., Best, P., Fraser, D. & Tan, R. (2012). Financial Accounting. Pearson Higher Education AJ Lev, B. (2003). Remarks on the measurement, valuation, and reporting of intangible assets. FRBNY Economic Policy Review, 4(22): 17-22. McNicholas, M. F. (2001). Analyst coverage and intangible assets. Journal of Accounting Research, 39: 1-34. Nigel, F. (2006). Intangible Assets and Creative Impairment - An Analysis of Current Disclosure Practices By Top Australian Firms. Viewed 16th August 2017 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=957188 Ramanna K. & Watts R.L. (2009). Evidence from goodwill non-impairments on the effects of using unverifiable estimates in financial reporting. working paper 09-106, Harvard Business School, March 17. Woolworth Limited. (2012). 2012 Annual Report. Viewed 16th August 2017 https://www.woolworthsgroup.com.au/page/investors/our-performance/reports/Reports/Annual_Reports/ Woolworths. (2010). Annual Report 2010. Viewed 16th August 2017 www.woolworthslimited.com.au Read More