1

Does Accounting Account for Knowledge

Presenters: William Caputo Ryan BarrMatthew Piatko

2

Presentation OverviewIntroductionKnowledge Accounting AccountabilityReliability vs. RelevanceAccounting for AssetsIssues with Financial StatementsBusiness IssuesSix Alternative MethodsThe Future of and Prospects for Knowledge

AccountingConclusion / Q & A

3

IntroductionKnowledge Management, and how

accounting is failing at recognizing this resource in businesses today.The driving force in the economy today is no

longer physical capital, it is knowledge.Accounting still places physical capital as the

primary focus of productivity for businesses.

4

Knowledge Accounting AccountabilityCurrent system has little to no accounting for

knowledge management, although there are two ways.Externally created assets, such as intangibles

that will be expenses over their useful lives.Internally created knowledge is expensed as

incurred. (often undervalued)Investing in knowledge type physical assets

appear more beneficial in financial statements in the short term than investing in intangibles.

5

Reliability vs. RelevanceThere is a give and take of reliability and

relevance when it comes to Knowledge Accounting.Reliability – is verifiable, neutral, and faithful.Relevance – timeliness of information available

to decision makers before it loses its capacity to influence decisions.

Knowledge Accounting emphasizes reliability at the cost of relevance.

6

Accounting for AssetsAssets are property obtained by arm’s length

transactions that expects to have a future economic benefit.

Human resources, employees, who provide knowledge management are not seen as assets. They are also not accounted for in KA, which critics claim is problematic.

Assets purchased are considered in KA to be more reliable than internally created assets due to the verifiability from market transaction.

7

Issues with Financial StatementsFinancial statements are created to be

reliable and comparable to other entities and is done so by quantifying information in monetary terms.

Although financial statements do have some qualitative information, many KM activities are lost in KA.Effects of KM activities are only apparent when

they effect financial statements, which is often not immediate.

8

Business IssuesWhile KA focuses on the reliability of

information, business incentives persuade managers to focus on relevance.

One issue of increasing relevance in KA is manager’s incentive to misreport based on their bias.

KM information is relevant to investors but auditors do not accept management’s assertions because they may be held responsible if the KM fails to materialize.

Six Alternative Methods•Total Value Creation (TVC)•Accounting for the Future (AFTF)•Balance Scorecard•Scandia Navigator•Intangible Asset Monitor•Value Chain Scoreboard

Total Value Creation (TVC)Value-creating VS value-realizing activitiesFinancial and non-financialDiscounted cash flow frameworkSupplement to financial reporting

Accounting for the Future (AFTF)Assets, liabilities, and equities reported at

present value of expected future cash flowsReplaces existing financial reporting systemAll financial information

Balanced ScorecardSpecific measurable objectives:

• Financial performance• Customers• Internal processes• Learning and growth

Supplement to financial reportingIncomparability of companies’ KM initiatives

Scandia NavigatorSimilar to Balance Scorecard ModelFocus areas:

• Financial • Customer • Human• Process• Renewal and development

Lack of comparability between companiesSupplement to financial reporting

Intangible Asset Monitor“The Invisible Balance Sheet”Builds on Skandia NavigatorDistinction between:

Individual capitalStructural capitalCustomer capital

Supplement to financial reporting

Value Chain ScoreboardTen step model by which process creates

valueSupplement to financial reportingThree criteria for choosing process measures:

QuantitativeStandardizedEmpirically confirmed

16

The Future of and Prospects for Knowledge Accounting

The unique Economic Characteristics of knowledge include:Non-Scarcity,High fixed and low marginal costs,Increasing returns to scale,Net Benefits to increasing numbers of

users,Difficulty in excluding other’s use, and High Development risks.

Accounting for knowledge is tightly bound with economic characteristics of knowledge.

17

Should We Replace the Existing Accounting Model?

None of the proposed models call for replacement, but they do call for supplementing existing accounting reporting with additional information about intangibles and knowledge assets.

The fundamental knowledge asset issue is the timing of the recognition of knowledge management initiatives, not to economic substance.

18

Comparing Knowledge Accounting Methods

TVC & AFTF are based on discounted present value models of management’s organizational plans.

The CICA’s proposes TVC disclosures be supplemental.

Nash’s proposes AFTF data replace existing financial statements.

The Balanced Scorecard, Skandia Navigator, and the Intangible Assets all indentify focal areas of organizational concern.

19

Should Knowledge Management Reports Supplement Financial Statements?

According to Occam’s Razor, simpler explanations are preferred to complex ones. Also, in economic terms the benefits of KA must exceed its disclosure costs.

This would pose a major obstacle to the TVC & AFTF methods, because they require a discounted cash flow analyses of company assets and liabilities.

It is important to consider whether the information being used is valuable or not. The author utilized heroin use and psychics as examples.

20

Prospects and Possibilities for Knowledge Accounting

All existing and proposed solutions to KA are imperfect. None meet the goals of a perfectly objective, reliable, relevant system of KA.

KA is closely bound with the economics of knowledge, and with the institutions, social forces, and political realities of financial reporting.

Hopefully in the future, KA will be better integrated with the economics of knowledge and better reconcile the conflicting demands of relevance and reliability.