ARTICLES

By Jiang Hong
Management College of Jinan University-CNAO

I. The Operation of Intangible Assets

Enterprises operate strategically and design their intangible assets, such as patent-right, trademark-right, copyright, land-access-right and commodity credit, etc, in order to maximize their value and profit.

The operational strategy of intangible assets mainly includes:

1. Intangible assets development

When developing intangible assets, an enterprise should compare its intangible assets’ developmental and operational capacity with its international competitors or the leading companies of the same industrial sector and find out the advantages and competitiveness of its own development method. Besides, an enterprise can also learn advanced experiences on intangible assets development from its competitors, so as to maintain its competitiveness and progressiveness.

2. Added value

In comparison with tangible assets, the most significant value increment a company gains from intangible assets is the extension value of intangible assets. Take the trademark, for example. A company can promote different products with one established trademark, which can not only help the introduction of new products to the market, but also reduce promotion costs and add value to the established products.

3. Intangible assets financing

Financing through various intangible assets at different development stages of an enterprise is a new way to absorb financial resources. In carve-out stage, a company could attract venture capital with a promising and feasible “idea” or “blueprint”. In the durative operational stage, a company could get loans by mortgaging its intangible assets. If an enterprise receives financial resources under a franchise, the concessionary could obtain intangible assets, such as the advanced management experiences, formula, trademark, etc., with a comparatively low initial investment.

4. Intangible assets expansion

Enterprises could take advantage of their intangible assets, such as brand name, technical skills and management experiences, to activate their tangible assets, expand their business through association, share holding and merging and finally actualize the optimal resource allocation.

5. Intangible assets distribution

In modern enterprises, the work of technical and management staff should not only be accounted according to the tangible value they created but also be capitalized, which means that the intangibles should be a part of the profit distribution. In recent years, special human resources participation of in profit distribution has become a trend in hi-tech enterprises.

Intangible assets audit must be carried out, in order to strengthen the management of intangible assets and reduce the inherent risks relating to intangibles operation. Such audits should cover intangibles identification, evaluation and investigation. Auditors should also put forward recommendations on improving the operation of auditees. Through monitoring, evaluating and consulting, intangible assets auditing will play the roles of pre-operation strategic guide, operation supervisor, after-operation evaluator and forecaster.

II. Professional Judgement---The Basis of Intangible Assets Operation Auditing

1. Audit identification

Identifying auditable elements is a prerequisite of intangibles auditing. Although a commonly accepted definition of intangible assets has not yet been established, the significant importance of intangible assets in enterprises development strategy is already widely recognized, no matter how they are defined. Unfortunately, the accounting identification to the intangibles is quite limited. As the first stage of the business accounting circle, only identified transactions and items could be included in the accounting system, and be documented, calculated and reported according to their characteristics. As a result, only the items incorporated in accounting system will be identified as auditable elements. Conventional accounting by emphasis mainly on identifying and reporting tangible assets, leaving the accounting for intangibles incomplete. Statistics show that 29 economic concepts involve intangible assets. Since 1960, economic resources have transformed from unitary tangible resources to dualistic resources comprising physical resources and intangible resources. However, the concept of assets identified in accounting system has remained unchanged. In China, 12 intangible assets are commonly recognized but only half of them were listed in the accounting system, namely, patent right, non-patent technique, trademark right, copyright, land-access-right and commodity credit. Many existing intangibles are not taken into account. Human resources, with no exception, were excluded from the accounting system. Thus, the accounts do not objectively reflect the assets scale of economic entities, affecting the profit distribution system.

2. Evaluation in intangible auditing

The value of intangible assets fluctuates frequently and dynamically. The inputs for creating intangibles do not balance with the value of excessive-profit brought to enterprises by intangibles. The core of economics is wealth, which is represented by natural resources. Natural resources, featured by their usefulness and scarcity, make up the major tangible resources of a industrial society. Accordingly, the traditional accounting system was built on the measurement of tangibles. Basically, the existing accounting module follows the ‘historical costs’ principle. And the tangible assets in static state could be measured according to original vouchers. The knowledge economy has made a tremendous impact on the traditional accounting system. In the context of the knowledge economy, accounting prioritizes on intangibles, which change dynamically with less stability but greater profitability, and the historical costs principle can hardly apply. As auditing is the re-assurance of accounting identification, measurement, documentation and reporting, the reasonable evaluation of intangibles will definitely influence the efficiency and effectiveness of the operational strategy of intangible assets.

With the above-mentioned two aspects, we can set the following criteria for intangible assets audit identification:

• The channel of intangible assets transaction must be traceable. That is the intangibles could be acquired separately by entities, or through business merger or government subsidy.
   
• The transaction cost of intangibles must be computable. As an international practice, intangibles should be calculated precisely according to their initial costs. The costs of intangibles include purchasing price and the expenses paid directly for the scheduled application of intangibles, like costs related to legal affairs. When carrying out specific audit identification, auditors should decide: whether expenses directly accounted for intangibles or expenses for the scheduled application of intangibles could be amortized on a fair and consistent basis into intangibles. For instance, whether the physical material consumed and labor services used for intangibles, salaries paid for staff directly involved in the creation of intangibles, registration fee of intangible assets, depreciation of fixed assets, amortization of insurance and rent and their interests should be accounted as costs of intangible assets. However, some could not be recognized as costs of intangibles, like distribution expenses, management expenses and other indirect expenses.
   
• The intangible assets under research and development should only be identified if they are:
  a) technically assured, developed for application and sales, and the company possesses the evidence of outputting and selling of these assets
  b) proved to be available and useful within the company
  c) supported by sufficient financial resources.

Despite those intangibles with the above-mentioned characters, the commodity credit and trademark, customers list and sales network generated within enterprises should not be identified as auditable elements of intangible assets operation.

III. Analysis and Evaluation---- A Way of Improving Performance

As the operation of intangible assets is a dynamic and continuous process, new audit methods must be introduced in supervision and evaluation. Intangible assets auditing is focused on the potential value and creation process of intangibles, which is to carry out audits with considerations of market, laws, economic environment and technical factors. Auditors should prepare a practical audit plan according to their audit objectives, and with the help of established audit evaluation standards, analyze and evaluate the rationality, economy, efficiency, effectiveness and risks of intangibles operation, as well as reliability of the internal control system of intangibles operation.

Auditors should compare the data and information possessed, and determine the rationality of intangibles operation using the methods of comparative analysis, ratio analysis, system analysis and regression analysis. Then auditors could affirm whether the effect and profit of intangibles are achieved through means of essential evaluation, comprehensive evaluation and system evaluation. Furthermore, auditors should also explore the way and methods of improving intangibles’ performance. The objectives of analysis and evaluation include:

1) Authorization agreements

If a company develops intellectual property with an intention to earn profits through authorizing other enterprises and organizations to operate on its behalf, the implementation of authorization agreements has to be audited to detect and eliminate any possible “Credit Gap”. In practice, a third party must be allowed to audit all authorization agreements and review all related documents, rather than standing merely on sales volume. Further, the implementation process must be reviewed on a regular basis, in order to avoid any changes to the agreements made unilaterally by authorized party and any operation beyond agreements.

2) Investment return

The investment return and value of intangible assets are actualized in two manners: a) intangibles assets exchange; b) transformation of intangible to tangible assets.

The identification methods of investment return also vary with different types of intangibles. For example, the rewards from patent investment belong to direct income, but the proceeds from trademarks are extra profits not be identified as auditable elements of intangible assets operation.

IV. Analysis and Evaluation---- A Way of Improving Performance

As the operation of intangible assets is a dynamic and continuous process, new audit methods must be introduced in supervision and evaluation. Intangible assets auditing is focused on the potential value and creation process of intangibles, which is to carry out audits with considerations of market, laws, economic environment and technical factors. Auditors should prepare a practical audit plan according to their audit objectives, and with the help of established audit evaluation standards, analyze and evaluate the rationality, economy, efficiency, effectiveness and risks of intangibles operation, as well as reliability of the internal control system of intangibles operation.

Auditors should compare the data and information possessed, and determine the rationality of intangibles operation using the methods of comparative analysis, ratio analysis, system analysis and regression analysis. Then auditors could affirm whether the effect and profit of intangibles are achieved through means of essential evaluation, and methods of improving intangibles’ performance. The objectives of analysis and evaluation include:

1) Authorization agreements

If a company develops intellectual property with an intention to earn profits through authorizing other enterprises and organizations to operate on its behalf, the implementation of authorization agreements has to be audited to detect and eliminate any possible “Credit Gap”. In practice, a third party must be allowed to audit all authorization agreements and review all related documents, rather than standing merely on sales volume. Further, the implementation process must be reviewed on a regular basis, in order to avoid any changes to the agreements made unilaterally by authorized party and any operation beyond agreements.

2) Investment return

The investment return and value of intangible assets are actualized in two manners: a) intangibles assets exchange; b) transformation of intangible to tangible assets.

The identification methods of investment return also vary with different types of intangibles. For example, the rewards from patent investment belong to direct income, but the proceeds from trademarks are extra profits


3) Legal costs

The amount of expenses on intellectual property protection are rather huge, especially for worldwide patent registration and protection. Management of intellectual property is regulated by a special law. It should be carried out by patent registration and protection agencies. Some enterprises, have set up their own intellectual property bodies and patents protection bodies. Audits at this stage should review the efficiency and effectiveness of intellectual property management through evaluating investment and rewards for legal costs occurred.