Comprehensive Review Required for Recognition of Intangible Assets for Keeping Pace with Expansion of Digital Economy: CII
Intangible assets have long been the engine for value creation in the world’s developed economies. As India is transitioning towards a Digital Economy, importance of intangible assets in today’s business models (e.g. Software as a service (SaaS), Platform as a service (PaaS), Infrastructure as a service (IaaS), block chain-based platform, Advanced Manufacturing, Emission Rights) are increasing manifold. Investment in intangible assets, both internally generated and through acquisition, is critical to an enterprises’ capital allocation process. Despite the importance of intangible assets to the capital markets, only those obtained via acquisition are recognised on balance sheets despite economic benefits being received also from internally generated intangible assets.
Emphasising on sharing a comprehensive set of recommendations to harness India’s potential of Digital Economy, Mr Chandrajit Banerjee, Director General, CII said “while the relevance of intangible assets has evolved over decades, the standards to report on these have not. Inability to recognise internally generated intangibles means that such investments are largely excluded from the governance, financial reporting, and auditing ecosystems. Therefore, such investments are less likely to have corresponding disclosures or be included in the management discussion and analysis (MD&A), and are less likely to receive scrutiny from auditors, visibility to investors and comparability of financial statement. Further, Mr Banerjee stated that there are concerns that at least some of the differences between market capitalisation and book value is due to non-recognition of internally generated assets.
Existing Indian Financial Reporting Standard Ind As 38, which is based on ‘IAS 38-Intangible Assets’, prohibits capitalization of internally generated intangibles. In this context, there are six areas of concern that need attention and deliberations:
First, New-Age companies, particularly those engaged in technology, e-commerce, Consumer Tech, Web-3, social media etc, are spending significant resources in brand building. Companies are deriving substantial value from new and unique forms of brand related intangibles such as proprietary algorithms, user engagement, database propriety, and developer and partner network that impact the companies' market value and competitive advantage. It is recommended that in case of brand building expenditure, distinction needs to be drawn in terms of expenditure for developing the brand vs expenditure for selling the product. Brand building expenses which are of enduring nature and enhances future revenue earning capabilities of the company, may be permitted to be capitalised.
Second, in a digital economy, accounting for SaaS cloud arrangements needs a review especially where under service contract, entity has power to obtain the future economic benefits including guidance on other cloud arrangements such as PaaS and IaaS and hybrid cloud models. Presently development costs for SaaS cloud enabled business initiatives, some of which are of enduring nature are required to be fully charged off in the year of incurrence. These assets directly and indirectly add value to company and generate far reaching economic and non-economic benefits. It is recommended that exclusive configurations rights and development of bridging modules between SaaS solutions may be identified and treated as separate assets, if they meet the asset criteria.
Third, India is set to become pharmacy of the world. India’s Pharma Sector is attaining scale through organic and inorganic growth. Investors are showing strategic interest in Indian active pharmaceutical ingredients (API), contract development and manufacturing organisation (CDMO) etc. In case of Pharma Industry, intangibles are acquired as a basket of assets, along with other assets and acquisition cost includes share of contingent consideration, payable at future date. It is recommended for recognition of intangibles as assets, in case of basket acquisition, based on economic value, especially where a reliable valuation methodology exists.
Fourth, India is becoming a manufacturing hub in Automotive space. Companies are making significant expenditures in launching new product platforms. For development projects, the visibility is only for usage on first lead model and thus at times may not pass the economic viability test. It is recommended to capitalize development costs of new product platform of Automotive Industry, based on management judgment and not subjecting it to economic viability tests. This is based on the industry’s view that short-term visibility of new product platforms may not be economically feasible but in the long run economic viability will be achieved, as the product becomes popular.
Fifth, Carbon Credits/Certified Emission Reductions (CERs) are extensively finding relevance given the potential of generation of such credits in Global South, and a ready market for such credits in developed economies, especially Europe. Enhanced guidance is needed for recognition of these assets. Significant amount of expenditure and intellectual capital is incurred by entity with respect to a specific project that enable generation of CERs over potentially a long period of time. It is recommended that Government and Reporting Standard Setting Bodies need to revisit recognition criteria for CER and considering that Indian economy is moving towards Net Zero, CER may be permitted to be considered as asset.
Sixth, IAS 38 is restrictive about use of revaluation model for subsequent measurement of the recognised intangible assets. This is important especially considering that the difference between the market and book value is increasing significantly. It is recommended for an ease in regulatory architecture for revaluation and subsequent measurement of the recognised intangible assets especially where the difference between the market and book value of enterprise is significant and is increasing with time.
To sum up, CII requests for a comprehensive review of accounting and recognition of Intangible Assets, as India is transitioning towards a digital economy, and intellectual capital is becoming a key determinant of entities’ value creation process. Addressing these challenges will help the Indian industry in disclosure and reporting of true economic value of intangibles, which would facilitate attracting global capital and investors to the country. This would act as a catalyst for growth of Indian Industry by harnessing the potential of digital ecosystem, making India competitive in the global landscape.
22 January 2025
New Delhi