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Intellectual Capital: Measurement, Recognition and Reporting Dr INTELLECTUAL CAPITAL: MEASUREMENT, RECOGNITION AND REPORTING DR. S.ARAMVALARTHAN MBA, PhD, FCA, ACMA, ACS, 1 INTRODUCTION The present day economy is knowledge based. In a knowledge economy, the drivers of competitive advantage and value creation are knowledge resources such as human capital, organizational processes and external networks. The success of organizations depends more on their ability to exploit and manage their intangible resources than their tangible assets. As intangibles such as knowledge and innovation have become an increasingly important part of corporate value, measurement, recognition and reporting of intellectual capital assumes great significance. MEANING OF INTELLECTUAL CAPITAL Intellectual capital is intellectual material—knowledge, information, intellectual property, experience—that can be put to use to create wealth (Stewart, 1997). A company’s intellectual capital is the sum of its human capital (talent), structural capital (intellectual property, methodologies, software, documents, and other knowledge artifacts), and customer capital (client relationships) (Stewart, 2001). “Intellectual capital is the possession of knowledge and experience, professional knowledge and skill, good relationships, and technological capacities, which whwn applied will give organizations compettive advantage (CIMA, 2001). It is a combination of human capital—the brains, skills, insights, and potential of those in an organization—and structural capital—things like the capital wrapped up in customers, processes, databases, brands, and IT systems. It is the ability to transform knowledge and intangible assets into wealth creating resources, by multiplying human capital with structural capital (Edvinsson, 2002) NEED FOR MEASURING INTELLECTUAL CAPITAL Companies may want to measure intellectual capital for a variety of reasons. Holmen (2005) identified the following five specific main reasons for measuring intellectual capital: • To help organizations formulate their strategy. By identifying and evaluating intellectual capital an organization may gain a competitive advantage. • To assist in diversification and expansion decisions. Intellectual capital may be measured to assist in evaluating mergers and acquisitions, particularly in respect of the purchase price of the acquisition. • To assess strategy execution. Measuring intellectual capital may lead to the development of key performance indicators that will help evaluate the execution of any strategy employed. • For use as a basis for compensation. The measurement of intellectual capital may be linked to an organization’s incentive and compensation plan. • To communicate with external stakeholders. The value of the intellectual capital will communicate to external stakeholders the true value of the organization. 1 Professor , Amrita School of Business, Coimbatore, Tamil Nadu, India NEED FOR REPORTING INTELLECTUAL CAPITAL External reporting of intellectual capital can: (1) close the gap between book value and market value, (2) provide improved inf ormation about the “real value” of the organization, (3) reduce information asymmetry, (4) increase the ability to raise capital by providing a valuation on intangibles, and (5) enhance an organization’s reputation. (Holmen, 2005). INTERNAL REPORTING OF INTELLECTUAL CAPITAL Two important attempts to measure and report intellectual capital internally are Skandia’s Navigator and Kaplan and Norton’s balanced scorecard. Skandia Navigator Skandia documented its approach to measuring intellectual capital supplements to its interim and annual reports (Skandia, 1996). Figure 1 shows the company’s hierarchy of intellectual capital. The overall market value of the firm can be split into two parts: the financial capital and intellectual capital. Skandia breaks intellectual capital into several components of human capital and structural capital. Human capital is defined as the knowledge, skills and experience that employees take with them when they leave. Structural capital is defined as the knowledge that stays within the firm. It can be split into customer capital and organizational capital. Customer capital is the value of the organization’s ongoing relationships with the people or organizations to which it sells Organi zational capital can be broken down further into process capital (how things get accomplished) and innovation capital (protected commercial rights and intellectual property). Figure 1 Skandia’s Hierarchy of Intellectual Capital MARKET VALUE OF FIRM INTELLECTUAL FINANCIAL CAPITAL CAPITAL STRUCTURAL HUMAN CAPITAL CAPITAL ORGANIZATIONAL CUSTOMERCAPITAL CAPITAL CUSTOMER CUSTOMER INNOVATION CUSTOMER BASE PROCESS CAPITAL RELATIONS [POTENTIAL CAPITAL Source: Skandia, Intellect ual Capital —Value Creating Processes, a supplement to Skandia’s 1995 Annual Report The Skandia Navigator measurement tool has five main components that are shown in Figure 2: financial, customer, process, human, and renewal and development. At the heart of these is human focus, which drives the whole model. Edvinsson says that navigator can be “viewed as a house. The financial focus is the roof. The customer focus and process focus are the walls. The human focus is the soul of the house. The renewal and development focus is the platform. With such a metaphor, renewal and development become the critical bottom line for sustainability.” (Edvinsson, 2002). Figure 2 Five Components of Skandia’s Intellectual Capital Measurement Methodology Each of the five components focuses on critical success factors that are quantified to measure change. The indicators used for the financial focus are largely represented in monetary terms. Customer focus concentrates on assessing the value of customer capital to the organization and makes use of both financial and non-financial indicators. The measures used for the process focus emphasize the effective use of technology within the organization. They tend to monitor quality processes and quality management systems but also include some financial ratios. The renewal and development focus attempts to capture the innovative capabilities of the organization, measuring the effectiveness of its investment in training and its expenditure on R&D. Finally, the human focus includes measurements that reflect the human capital of the organization and how the resources are being enhanced and developed. Balanced Scorecard Kaplan and Norton’s balanced score card approach (Figure 3) is similar to Skandia’s Navigator in its use of multiple perspectives (Kaplan and Norton, 1996). The balanced score card uses four 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?), and learning and growth (How will we sustain our ability to change and improve?). The learning and growth perspective includes categories for employee capabilities (human capital), information systems capabilities (information capital), and motivation, empowerment, and alignment (organizational capital). Figure 3: Balanced Scorecard Source: Robert S. Kaplan and David P. Norton, The Balanced Scorecard: Translating Strategy into Action, Harvard Business School Press, Cambridge, Mass., 1996 In their book Strategy Maps: Converting Intangible Assets into Tangible Outcomes , Kaplan and Norton attempt to demonstrate how the intangible assets of human, information, and organizational capital can be measured. Human capital includes the skills, training, and knowhow of employees. Information capital includes systems, databases, and networks. Organizational capital 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 organization. Intellectual capital is measured by evaluating how well assets contribute to achieving organizational strategy. (Kaplan and Norton, 2004) A comparison of the meaning of intellectual capital with the four perspectives of the balanced score card highlights how the balanced score card can be used to measure intellectual capital:“Intellectual capital is a combination of human capital—the brains, skills, insights, and potential of those in an organization [learning and growth perspective: human] — and structural capital—things like the capital wrapped up in customers [customer perspective], processes [internal business processes perspective], databases, brands, and IT systems [learning and growth perspective: information capital]. It is the ability to transform knowledge [learning and growth perspective: organizational capital] and intangible assets into wealth creating resources, by multiplying human capital with structural capital. ” ( Edvinsson, 2002) EXTERNAL REPORTING OF INTELLECTUAL CAPITAL INTERNATIONAL FINANCIAL REPRTING STANDARDS Intellectual capital is an intangible asset. IAS 38 Intangible Assets outlines the accounting Requirements for intangible assets (IASB, 2012). It requires an entity to recognize an intangible asset when specified criteria are met. The standard also outlines ways to measure the carrying amount of intangible assets and requires disclosures relating to intangible assets. Critical Attributes of an Intangible Asset The three critical attributes of an intangible asset are: • identifiability • control (power to obtain benefits from the asset) • future economic benefits (such as revenues or reduced future costs Recognition Criteria IAS 38 requires an entity to recognise an intangible
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