Presenters: William Caputo Ryan Barr Matthew Piatko 1

Presentation Overview Introduction Knowledge Accounting Accountability Reliability vs. Relevance Accounting for Assets Issues with Financial Statements Business Issues Six Alternative Methods The Future of and Prospects for Knowledge Accounting Conclusion / Q & A 2

Introduction Knowledge 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. 3

Knowledge Accounting Accountability Current 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. 4

Reliability vs. Relevance There 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. 5

Accounting for Assets Assets 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. 6

Issues with Financial Statements Financial 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. 7

Business Issues While 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. 8

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 activities Financial and non-financial Discounted cash flow framework Supplement to financial reporting

Accounting for the Future (AFTF) Assets, liabilities, and equities reported at present value of expected future cash flows Replaces existing financial reporting system All financial information

Balanced Scorecard Specific measurable objectives: Financial performance Customers Internal processes Learning and growth Supplement to financial reporting Incomparability of companies’ KM initiatives

Scandia Navigator Similar to Balance Scorecard Model Focus areas: Financial Customer Human Process Renewal and development Lack of comparability between companies Supplement to financial reporting

Intangible Asset Monitor “The Invisible Balance Sheet” Builds on Skandia Navigator Distinction between: Individual capital Structural capital Customer capital Supplement to financial reporting

Value Chain Scoreboard Ten step model by which process creates value Supplement to financial reporting Three criteria for choosing process measures: Quantitative Standardized Empirically 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.

Should We Replace the Existing Accounting Model? 17 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.

Comparing Knowledge Accounting Methods 18 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.

Should Knowledge Management Reports Supplement Financial Statements? 19 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.

Prospects and Possibilities for Knowledge Accounting 20 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.