The Intangible Personality Drivers

COVID-19 pandemic is a real challenge for the economy at macro level and to our jobs, health and our lives, at micro level. On the flip side it is also allowing all of us a good opportunity to reflect on various matters including our aspirations, skills, career path and so on. One of the common thing that one might be doing, is to be spending more time on Internet. Talking about the two sets of accounting standards – Accounting Standards (AS) and IFRS as converged and adopted in India i.e. Ind AS. One of the area that always attracts attention is Intangible Assets that is covered by Accounting Standard (AS) 26 for a long time and now by Indian Accounting Standard (Ind AS) 38.

When we start reflecting on this, a natural question comes to mind that before standard was issued, were there no intangible assets that entities possessed? Definitely, entities had these assets, but there were no set principles for identification, recognition, measurement and disclosure in the form of an accounting standard.

Now let us explore some interesting elements of the concept “Intangible”. In general parlance, it is understood as something “unable to be touched; not having physical presence”. Going by the dictionary meaning the term intangible means, “something that does not exist as a physical thing but is still valuable to a company”. In comparison to intangible assets, tangible assets are easy to identify, recognise and measure as we can see and touch them. Tangible assets includes all things on this earth that can be physically possessed and their ownership be established.

Human Cognitive Evolution and Personality Substratum

One of the greatest differentiators human beings have when compared to other animals is the ability to use their mind to a different level. Evolution tells us that living in society, forming an association, doing some commercial activity, etc. are some of the things human (rightfully called “Homo Sapiens”) learned and established over a very long period of time covering thousands of years.

Mental ability, power of thinking, is something natural to humans and is influenced by the surrounding circumstances, education at home (called “Sanskaras” in Indian culture), learnings from school, colleges and work environments. These factors vary from person to person and therefore, these factors impact differently to each person in terms of nature, timing and extent. This leads to each one of us having a unique personality. This uniqueness gives an edge to some persons to acquire superior position over others. For example, one with higher mental ability would try to do some new things, bring innovations, establish new businesses, write new legislature, create art or music, etc.

“Generally, humans want some purpose, a cause for their existence, wish to use their skills and abilities, possess physical goods or money and have emotions and empathy.”

Generally, humans want some purpose, a cause for their existence, wish to use their skills and abilities, possess physical goods or money and have emotions and empathy. Humans want to define their personality by deliberately doing or avoiding certain activities. These things in a way form a substratum of the personality.

Suppose a person has worked in a multinational company at a very senior position for say 20 years, what all “Intangible” things are likely to be associated with his / her personality? Knowledge and experience about the industry, processes, systems, work culture, handling people at various levels, handling multiple crisis situations and so on. These are knowledge elements that sets him apart from others. It is easy to comprehend that these abilities are innate qualities that are over and above the educational and professional qualifications and enable a person to make quality decisions, lead the organisation, innovate and perform better than others.

Accounting, auditing and management practices are essentially imperfect sciences and are called behavioural sciences and hence, one rule cannot apply to every situation. That creates the challenge of valuing these intangibles. Now let us see how ‘intangible’ factors are inherent to few factors of any organisation that an accountany professional ends up dealing with, daily.

Corporate Governance

Corporate Governance: It is a very broad term which deals more with behavioural and ‘soft’ aspects like trust, fiduciary capacity, surveillance, ethics, enterprise risk management, internal controls, succession, value creation and preservation, brand, sustainability, etc.

We know that all the above terms cannot be cardinally quantified, i.e., one cannot assign a number to it. Like it is difficult to say that X organisation’s governance is at seventy percent level. This is because there cannot be a definition of what constitutes hundred per cent.

“A careful look at the developments in Corporate Governance requirements, disclosures across the globe reveals that more and more entities are moving beyond traditional financial statements, i.e., number crunching.”

A careful look at the developments in Corporate Governance requirements, disclosures across the globe reveals that more and more entities are moving beyond traditional financial statements, i.e., number crunching. This is because studies have proved that there is a positive correlation between the good governance and the long term ROI / value creation by the entity. The human mind (rather brain) always thinks of safety, risk, surety, returns, cash flow timings, ethics, transparency which cannot alone be addressed by the financial statements. Hence, we end up having sections in the annual report on management discussion and analysis, risk management, sustainability reporting, social responsibility and environmental reporting, etc.

So going forward, Chartered Accountants will be required to deeply understand the cognitive and behavioural aspects, the importance of emotional quotient, curiosity quotient in order to work on the engagements like enterprise risk management, certifying corporate governance, framing sustainability reporting systems, and so on.

The novel form of assurance in future, could include cultural audit, mandatory governance audits, sustainability certification and much more.

Financial Reporting

Financial Reporting: Financial statements are an outcome of processing business transactions in a disciplined manner and in compliance with the applicable regulatory framework. Chief Financial Officer’s role has undergone a sea change in terms of areas they contribute. It includes business enabling role in the areas of strategy, MIS, risk management, internal controls, compliances and various other things.

Coming back to our ‘intangible’ discussion, for a peculiar organisation the hygiene or quality of financial reporting depends on organisational governance and culture, organisation structure, roles and responsibilities of a CFO, level of internal controls invoked through an ERP system and supporting manual internal controls, level of documentation of processes, adoption of internal control framework, internal audit system, skillsets of people involved in the financial reporting, involvement of third party service providers like outsourced accounting/ shared service centres, payroll processing, etc. All these things create a unique understanding about the financial reporting system of an entity and is often termed as ‘Control Environment’.

So any change in above variables will impact the level of experience that financial reporting team members will gain over a period, thereby creating different level of ‘intangible assets’ for each of them.

“Another important area for finance function is application of judgement in making reasonable estimates and in interpretation of statutes, agreements and contracts.”

Another important area for finance function is application of judgement in making reasonable estimates and in interpretation of statutes, agreements and contracts. With technology advancement, more and more activities are performed by machines. So there is good amount of accuracy and predictability possible for certain accounting estimates. For example, warranty provision. Unlike traditional methods of provisioning, one can have a clear trail of parts fitted into a machine, i.e. specification, make year, supplier name, batch name, plant code, etc. and therefore easy to arrange for a product recall and thereby estimate warranty expenses using defined matrices. However, the judgement is required in establishing reliability of this data and factoring the level of innovation planned to reduce defects and similar prospective actions in determining the warranty provision amounts.

Suppose an entity in India is planning to acquire another entity in a different geographical area. It requires contextual application of valuation models, applicable corporate laws, transfer pricing laws, land laws of entity being acquired, accounting standards, so on and so forth. These combinations are not readily available and hence, are intangible skills.

So from the skillset point of view, an entity needs people who are good at processes, people having good grip on numbers, aggregators, risk managers who can challenge the obvious, those who know the accounting standards, etc. A Chartered Accountant is well positioned to assume these roles and serve the entity, either internally or externally in form of assurance engagements or audit engagements. But a conscious investment is needed to understand comprehensive business perspective around financial reporting and not be confined only to the debit/credit, accounting standards and disclosures. Also experience of dealing with experts like valuation specialists, lawyers, etc. would be an icing on the cake.

“A conscious investment is needed to understand comprehensive business perspective around financial reporting and not be confined only to the debit/credit, accounting standards and disclosures.”

Auditing and Professional Judgement

Auditing: It is one of the most complex and onerous jobs wherein auditors’ main duty is to opine on the financial statement’s truth and fairness. Knowingly or unknowingly we are continuously judging people, situations, scenarios and are forming opinions. The process behind formation of personal opinions is invisible and largely driven by our subconscious mind. But when it comes to forming a professional opinion, the auditors have scope of work mandated by the law/ customer, audit work governed by the auditing standards and various accounting standards and pronouncements.

Though large amount of efforts have been put nationally / internationally on codifying the standards by a logical division of the audit steps and technology helping auditors in a big way to analyse huge amount of data, forming an audit opinion will continue to be a matter of professional judgement.

Consider a context of auditing a large listed IT company which has 10,000 plus employees, ERP systems and sub-systems, 2 foreign entity acquisitions completed recently, has got 30 subsidiaries across geographies and publishes its audited results on a quarterly basis as per I-GAAP, IFRS and US GAAP. The revenue register consists of 650,000 line items and similar are the line items for procurement and employee reimbursement data put together.

In the above context, the typical audit will start with understanding the entity’s business, do a risk assessment, identify internal controls that mitigate these risks, support that effort with substantive testing, and then form an opinion on the fairness of the financial statements.

It may sound simple, but when it comes to applying these things to a complex situation as stated above, there cannot be one correct way of doing the audit. There could be multiple ways of gathering the required evidences and thereby an assurance though underlying auditing framework is common. Largely factors like audit team skillsets, availability of experts, documented audit methodology, its enforcements and on top of everything, experience of the person in-charge of an audit play a role.

Let us take a small example of assessing employees’ risk of committing a fraud in the above stated entity. It requires an auditor to consider frauds happened so far, going through past internal audit reports, level of enforcement of ethics, related internal controls in respective processes wherever human intervention is involved. Before getting into the risk assessment per se, an auditor has to define a canvas in his mind that he is talking about an entity having more than 10,000 people, i.e., so many minds. Statistically, there would be some percentage of people who will be trying to exploit gaps in the internal control systems, have negative intentions. Then the auditor will put a likelihood to these possible risks and try to see controls built by the entity.

Likewise, an auditor is always connecting the dots of his experience, auditing framework and client context in mind which is an invisible process. That is ‘intangible asset’. The beauty is, an intangible asset ‘put to use’ as above, instead of getting amortised actually gets appreciated - audit by audit.

So in near future a shift will happen to include more qualitative and soft aspects in the audit. Naturally, skillsets which would be required to perform these audits would be different and would have to be achieved by the Chartered Accountants.