=Paper=
{{Paper
|id=Vol-34/paper-18
|storemode=property
|title=Recognition and Measurement of Intellectual Resources: The Accounting-Related Challenges of Intellectual Capital
|pdfUrl=https://ceur-ws.org/Vol-34/odonnell_et_al.pdf
|volume=Vol-34
|dblpUrl=https://dblp.org/rec/conf/pakm/ODonnellOO00
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==Recognition and Measurement of Intellectual Resources: The Accounting-Related Challenges of Intellectual Capital==
https://ceur-ws.org/Vol-34/odonnell_et_al.pdf
Recognition and Measurement of Intellectual Resources:
the accounting-related challenges of
Intellectual Capital
Dave O’Donnell Philip O’Regan Veronica O’Regan
Chief Knowledge Officer Lecturer in Accounting Lecturer in German
Intelllectualcapitalireland.com University of Limerick University of Limerick
Ireland Ireland Ireland
dolan.odonnell@oceanfree.net philiporegan@eircom.net veronica.oregan@ul.ie
Abstract Those charged with the financial management of
commercial resources concur. The International
The key to competitive success is likely to Federation of Accountants (1998), for instance, notes
be the ability to create, leverage, and that knowledge is the primary competitive factor in
develop specialised knowledge and business; that it is a non-traditional intangible resource;
and that the accumulation, transformation, creation and
intellectual resources. This new reality valuation of this resource lies at the heart of intellectual
presents both challenges and opportunities capital management (IFAC, 1998).
for accounting, a discipline which has However, industrial era managerial paradigms,
traditionally found it difficult to deal with based on the tangible sources of value (land, labour and
the recognition and measurement issues financial-capital) and the predict-direct-exploit-control
bureaucratic machine metaphor are proving
surrounding intangible assets. This paper increasingly incapable of dealing with the emergent
makes two contributions to the emerging complexities of visualising, creating and leveraging this
literature on intellectual capital. Firstly, it resource. Furthermore, little is known about how these
offers some preliminary results of a study intellectual resources, structures, institutions, processes
of the drivers and generators of intellectual or dynamics actually develop, or how they should be
managed, utilised, valued or accounted for. A concept
capital. Secondly, it posits a theoretical/ such as intellectual capital, even with the accumulated
methodological approach to intellectual tools of the philosophy of consciousness and the recent
capital based upon Habermas’ concept of move to the philosophy of language, cannot be
communicative action, a concept that precisely defined. This should not, however, prevent us
from using it at a time when the intangible is rapidly
allows the premium attaching to the
gaining economic and social supremacy over the
human and dynamic elements of tangible (O'Regan & O'Donnell, 2000).
organisations to be accentuated. This paper proceeds in six sections as follows:
Section 1 briefly summarises the emerging literature on
Intellectual Capital. Section 2 identifies a number of the
Introduction
issues of relevance to financial and management
Drucker’s (1994) claim that knowledge is becoming the accounting raised by the emergence of an intangible
only meaningful economic resource is complemented asset such as ‘intellectual capital’ as a primary driver of
by Quinn’s (1992) assertion that the ability to manage corporate wealth. Section 3 introduces a conceptual
this resource is the critical skill of the modern era. framework within which this dynamic can be imagined.
Adopting the Habermasian (1984) notion of
The copyright of this paper belongs to the paper’s authors. Permission to copy
‘communicative action’, an action-theory allowing for
without fee all or part of this material is granted provided that the copies are the exploration of the role and nature of relationships
not made or distributed for direct commercial advantage. amongst employees as the main drivers and repositories
Proc. of the Third Int. Conf. on Practical Aspects of of corporate wealth, this section challenges a literature
Knowledge Management (PAKM2000) which already leans heavily towards systems-theoretic
Basel, Switzerland, 30-31 Oct. 2000, (U. Reimer, ed.) approaches which facilitate the colonisation of this
http://sunsite.informatik.rwth-aachen.de/Publications/CEUR- space by the owners of capital. Section 4 outlines a very
WS/Vol-34/ preliminary analysis of data collected in a survey of
O’Regan, O’Donnell and O’Regan 17-1
CEOs of thirty indigenous, knowledge-intensive firms per employee functional Customers
operating in the IT sector in Ireland, and presents some teams Index
of the accounting issues which this raises. Section 5 Rookie ratio Database use Frequency of
discusses some of these issues in the context of frequency repeat orders
Habermas’ theory of communicative action. Section 6 Level of Investment in Brand loyalty
offers some indications of future research possibilities. education IT
Training and Proportion of Customer
1. Current Approaches to Recognising and Education cost support staff complaints
Measuring Intellectual Capital Years of R&D expense Customer
experience satisfaction
In the absence of any accounting-specific methods to Reputation Age of Profitability
recognise and measure intellectual capital, various with agencies organisation per customer
templates have been developed by others to facilitate its Sources: Dzinkowski 2000; Sveiby 1997.
identification and management. Although there is
substantial variation as to how each dimension is These approaches are supplemented by various
conceptualised, theorised or measured, and a glaring methods developed to enable inter-firm comparison.
dearth of good empirical studies, a broad consensus is Among the more common approaches facilitating this
now emerging in which most intellectual capital models relative assessment of the existence and valuation of
assume a three way distinction between People, intellectual capital are:
External, and Internal dimensions (Bontis,1998;
Edvinsson & Sullivan, 1996; Roos et al., 1997; von 1. Market-to-book ratios: the simplest of the
Grogh & Roos, 1996; St. Onge, 1996; Stewart, 1997; calculations, this takes the difference between the
Sveiby, 1997; Kaplan and Norton, 1997). This is book value of a company as represented by its
indicated in Table 1 which provides an outline of three balance sheet and the market value, whether from
of the more developed intellectual capital models. stock exchange or internal market to be equal to the
level of intellectual capital in the business;
Table 1: Emerging Intellectual Capital Templates 2. Tobin’s ‘q’: ‘q’ is the ratio of market value to
replacement cost of a company’s assets and can be
People Internal External used as a comparative base between firms;
Sveiby People’s Internal External 3. Calculated Intangible Value (CIV): using industry
Competence Structures Structures
norms to establish rates of return for tangible
Kaplan Learning Internal Customer
and growth processes perspective assets, this measure calculates the level of
and
perspective perspective intellectual capital by attributing to it any return in
Norton
excess of the industry norm.
Edvinsson Human Organisat- Customer
capital ional capital capital 4. ‘Colorised’ reporting: proposed by SEC
Source: Sveiby http://www.sveiby.com.au commissioner Steven Wallman, this approach
places the emphasis on additional narrative reports
In this scheme the ‘People’ dimension refers to people (the ‘colour’) which supplement the more
competencies, knowledge, know-how and experience - traditional (the ‘black and white’) financial
the ‘traditional human resource’. The ‘Internal’ refers to statements, with information which helps to
the set of inner organisational structures, routines, identify and classify intellectual capital in a relative
processes, management systems and so on. The context.
‘External’, often referred to as ‘customer capital’ refers
to external constituencies and structures such as links to While all of these can be faulted on a number of
customers, suppliers, and various other external grounds, their primary usefulness is that they provide a
networks. common measure allowing firm performance to be
Common measures or indicators of these benchmarked, thus enabling comparative measures of
dimensions have been identified and developed intellectual capital to be established (Dzinkowski,
Examples are listed in Table 2. Significantly, several of 2000).
these are already produced by accounting-based internal 2. Accounting for Intellectual Capital
management and information systems (IFAC, 1998;
Roslender, 2000). Accounting has traditionally focused its attention on
capturing and representing items which can be fully
Table 2: Intellectual Capital Indicators objectified. Underpinned by a system of historical cost
accounting which ascribes ‘value’ to transactions
People Internal External involving tangible entities, generally accepted
Employee Number of Sales per accounting practices (GAAP) have been developed
satisfaction patents customer which reflect accounting’s fundamental stewardship
Value Added No of multi- Satisfied role, that is, of accounting for and informing company
O’Regan, O’Donnell and O’Regan 17-2
management and its various stakeholders of the In recent years some attempts have been made
existence and progress of its resources, activities and by accounting regulators to redress this deficiency.
investments (Power and Laughlin, 1996; Lodh and Accounting standard setters, for example, have begun to
Gaffikin, 1997; O’Regan and O’Donnell, 2000). review the conceptual scaffolding that has seemed to
Reflecting this historical emphasis upon its preclude the discipline from addressing issues of
stewardship role in relation to tangible items, relevance in the modern commercial milieu.
accounting has found it much more difficult to deal with Hermannson (1964) and Brummet et al. (1968) were
items which its limited conceptual framework neither seminal figures in the attempt to advance the
recognises nor values. In fact, since such intangible recognition and measurement of human resource costs
resources can never be fully objectified, accounting’s under the term Human Resource Accounting
cognitivist paradigm is incapable of embracing them (Flamholtz, 1985). The accounting profession has,
within its worldview. One of the principal catalysts in however, largely ignored HRA, citing the traditional
causing the efficacy of current financial reporting and objections put forward by those aware of the challenges
management accounting concepts and procedures to be posed by accounting for such resources (Grojer and
revisited has been the gradual realisation that intangible Johanson, 1998; Guerrero, 1998). Furthermore, while
assets can no longer be dismissed as the incidental and there have been efforts to address some of the more
troublesome offspring of activities undertaken by troublesome intangible assets such as goodwill and
relatively few, albeit large, entities. The dawning brands, the solutions proposed have disappointed,
awareness that intellectual capital in its various guises particularly in failing to deal at a fundamental level with
now forms a major part of the resource base of not only the conceptual and epistemological challenges posed. In
individual firms, but also entire industries, has essence, while some progress has been made, the
challenged accounting regulators to review the manner opportunity to critically reconsider the nature and role
in which these are treated. In an environment in which of accounting in this context has been largely eschewed.
international trade in the knowledge sector is growing
five times faster than in natural resource-intensive 3. Communicative Action
industries, where the costs of information long ago
surpassed the costs of equity (Strassman 1996), and The traditional accounting model is one which views an
where tangible assets often represent less than one-third individual being as capable of gaining knowledge about
of corporate value (Van Buren, 1999), an accounting a contingent environment and using this knowledge
system designed to satisfy the needs of ‘financial’ effectively by intelligently adapting to and manipulating
capital is incapable of embracing the measurement and that environment (O’Donnell, 1999a). This perspective
reporting needs of knowledge-based entities (IFAC, assumes that this world is pre-given and that the goal of
1998). As Lev (1997, p.35) puts it: any cognitive system is to create the most accurate
representation of this world. Representations can be
‘In recent decades the usefulness of financial stored in and retrieved from individual schemata, and if
reports of public companies has steadily the events represented occur frequently they can be
declined, despite their increased gloss and stored in scripts; these schemata and scripts are often
girth. One indicator: In the 1960s and 1970s, referred to as knowledge structures (von Krogh and
about 25% of the differences in stock price Roos, 1996). At a general level, most contributions in
changes could be attributed to differences in this vein assume that managers and organisations create
reported earnings. But by the 1980s and early representations of their environments through
1990s, this figure had dropped to less than processing information available to them in this
10%. That's a lot of lost relevance. Everybody external environment (see Lyles and Schwenk, 1992 for
in this economy ought to be concerned. a seminal example). The phenomena in need of
Reliable financial reporting guides capital to explication in intellectual capital research, however,
the most promising investments. But bad or may not be simple facets of objective nature but the
outdated information can lead to an inefficient inter-subjective dynamic processes of understanding
allocation. This leads to volatile markets and and agreement at both the interpersonal and intra-
investors who demand higher-risk premiums to psychic levels. Processes of knowing grow when they
cover the increased uncertainty. That's why, are shared (Baumard, 1999; Bontis, 1998; Nonaka,
for capital markets to function best, financial 1994; von Krogh and Roos, 1995; Spender, 1998;
statements need to be as informative as Sveiby, 1997), whether these be individual or
possible. Conventional accounting performs collective, tacit or explicit. Knowledge workers are idea
poorly with internally generated intangibles and revenue creators, not mere reified cost factors of
such as R&D, brands, and employee talent— production.
the very items considered the engines of We claim that a more suitable point of departure
modern economic growth’. for exploring this emergent dynamic, with implications
for people management and accounting professionals, is
the set of symmetric and reciprocal relations
O’Regan, O’Donnell and O’Regan 17-3
presupposed in Jürgen Habermas’ (1984, 1987a, people element) is such that it can never be completely
1987b) Theory of Communicative Action (O'Donnell, observed by either participants or observers: intellectual
1999a, 1999b; O'Donnell et al., 2000; O’Regan and capital embraces not only what is known or stocks, but
O’Donnell, 2000). Communicative action theory also the processes of knowing, or flows. (Bontis, 1998;
provides an ontological and epistemological foundation Nahapiet and Ghoshal, 1998; Roos et al., 1997; Sveiby,
that has yet to be adequately developed in intellectual 1994; Van Buren, 1999).
capital research. The dynamic intellectual capital- In this worldview, the nexus of intellectual
creating process of knowing that can be leveraged into capital creation may be viewed as residing in the set of
market value can be viewed as existing in the interactional social relations that exist between people
communicative relation between human beings. whose ‘value’ is greater than the sum of their individual
Through communicative processes people continuously parts. Moving beyond traditional concepts of human
learn, develop, unlearn, relearn and apply common capital (Becker, 1964), which refer to an individual’s
understandings by which to exchange, combine, create, acquired knowledge, skills and abilities, intellectual
renew and transfer tacit, implicit, explicit and codified capital refers to the knowledge and knowing capability
processes of knowing from blueprints, ideas, emotional of a social collectivity (Nahapiet and Ghoshal, 1998).
states and fuzzy hunches into problem definitions, This collective phenomenon represents both a key
solutions, added value and markets (O'Donnell et al., resource and a capability for action based on knowledge
2000). The universal communicative relation between and knowing that can be leveraged into value. People
human beings, which satisfies the scientific and action are given some priority over system and
requirements of objectivity in a specific sense structure as it is people through the process of
(Habermas, 1984, p137), is suggested here as the germ- communicative interaction who define situations, define
cell of intellectual capital creation. Nahapiet and problems, capture know-how, share insights, and
Ghoshal (1998) cite Edith Penrose’s (1959, p.53) innovate. Intangible values are created by people;
observation that the communicative experience: money and technology are merely the tools that people
use and are themselves expressions of knowledge. The
... develops an increasing knowledge of the emerging system dynamic is based more on
possibilities for action and the ways in which informational and telecommunications structures with
action can be taken by ... the firm. This increase probable new lifeworld-system relationships
in knowledge not only causes the productive experiencing their genesis at the moment. We know
opportunity of a firm to change... but also very little about what an economy and society based on
contributes to the ‘uniqueness’ of the the economics of intangible values would look like, or
opportunity of each individual firm. how those aware of the shifting sands could possibly
attempt to steer it.
Roos and his colleagues (1997) note that most strategic
contributions on knowledge focus on two main issues; 4. Research
the way knowledge is created and the way it is
leveraged into value, although there is no definitive One of the persistent obstacles confronting managers
boundary between the two. As customer relations in and, indeed, accountants as they struggle to develop
knowledge-intensive businesses are no longer seen as measurement and management techniques appropriate
one-way driven, but, rather, partnerships in which to the dynamics of the knowledge economy is the lack
solutions are co-created and knowledge flows both of empirical data. Thus, while considerable work has
ways (Sveiby, 1997), both internal architecture and been done by individual companies such as Skandia and
external architecture should be considered in any Dow Chemicals to develop indicators of intellectual
comprehensive analysis. We are dealing with people capital, little is known about the changing internal
and/or systems, with action theory and/or systems dynamics within firms and, indeed, economies, that
theory. parallel the knowledge era. A joint research programme
Kogut and Zander (1993) argue that the firm undertaken by the University of Limerick, the Irish
may be viewed as a social community that specialises in Management Institute and the University of Maryland
the creation and internal transfer of knowledge, and that involving the collection of detailed and extensive
this productive knowledge defines the firm’s perceptual data from Chief Executive Officers, Top
competitive advantage. From this perspective, which Management Team members and Core Employees in
complements Edith Penrose's (1959) seminal work on indigenous Irish firms operating in the knowledge
the growth of the firm, competitive advantage may be economy is, however, yielding considerable insights
viewed as a sufficient condition governing firm trade, into these dynamics. Supplemented by internal and
direct investment, and growth, and it is probable that external data on the financial performance of these
the ability to both create and leverage intellectual firms this research may provide some early indicators of
capital is becoming its primary source. Nevertheless, the extent of the challenges posed for managers,
the partly tacit and socially unconscious nature of accountants and national planners by the ‘new
intellectual capital embedded in various lifeworlds (the
O’Regan, O’Donnell and O’Regan 17-4
1 this corporate value not only commonly remains off the
economy’. More specifically the perceptual data
derived to date from interviews with CEOs of thirty of balance sheet, but is absent from internal management
these indigenous Irish firms provides empirical reporting processes intended to facilitate decision-
evidence of the significance of intellectual capital in making. It is imperative, therefore, if it is to retain its
terms of company value, the principal drivers of that traditional information supplying role, that accounting
value, and the extent of the challenge facing develops new internal and external measurement
accountancy as it attempts to grapple with the concepts and reporting methodologies that recognise
recognition and measurement issues associated with the central role of knowledge as a source of wealth.
intellectual capital. These will need to be supplemented by new financial
The Irish software/telecoms sector provides an management techniques that incorporate information
ideal research framework for any such investigation. In resources and knowledge into investment appraisal
recent years it has established itself as the largest techniques. This can only be achieved initially by
software exporter in the world and been one of the focusing on relative, indicative disclosures rather than
primary engines of growth in an economy that has on the development of objective recognition criteria and
experienced real growth of 37% in 5 years, a rate measurement techniques. Such an approach allows the
unparalleled in the developed world. It also provides a possibility of building upon existing techniques such as
‘new economy’ environment in which the scope to those management accounting approaches that already
develop new managerial practices is greater than in recognise quality and strategic management issues or
traditional industries. Within this sector indigenous reporting practices which recognise the usefulness of
Irish firms play an increasingly significant role, ‘softer’ disclosures in narrative form (Roslender, 2000).
employing over 20,000 people in more than 900 firms The interviews are also significant in
(OECD, 1999). confirming that the greater part of this intellectual
As one part of the interview process CEOs capital can be traced to the people element in these
were asked to provide perceptual data as to the extent businesses. CEOs perceive that almost fifty per cent of
of intellectual capital as a source of corporate wealth. this intangible value links directly to the people
This involved indicating the percentage of company employed in these knowledge-intensive firms. This
value deemed to derive from ‘intellectual capital’. In challenges the traditional accounting model which
line with existing typologies, intellectual capital was classifies labour as an expense. The knowledge
presented as consisting of people, internal structure and economy views employees as assets whose primary
external structure and CEOs were also asked to indicate function is to generate revenue by converting
the degree to which the drivers of this wealth can be knowledge into a marketable form. The extent to which
traced to these factors by distributing 100 points people are perceived as assets rather than costs suggests
between them. Finally they were asked to estimate any that one way in which intellectual capital may be better
increase or decrease in company value over the course accommodated is by revisiting the whole concept of
of the preceding twelve months. Table 3 provides a Human Asset Accounting and developing templates and
summary of this feedback. new conceptual approaches which will result in the
recognition of employees as the principal asset of a
Table 3: Results of CEO Interviews business. It should also lead to the development of new
tools to better assist in the management of, and
% % IC % IC in % IC in investment in, people (O’Donnell et al, 2000; Van
value in Internal External Buren, 1999).
in IC People Structures Structures This links to another related consequence of
Average the new dynamics of the knowledge economy – the
(n=30) 66.07 49.80 18.68 31.52 changes being induced in corporate governance models.
The existing corporate model strongly favours the
The most striking finding is that Chief providers of financial capital. However, in an
Executive Officers in the fastest growing sector of the environment in which the primary resource is seen as
fastest growing economy in Europe believe that, on knowledge embedded in people, together with their
average, almost two-thirds of their company value is relationships both to one another and to knowledge and
attributable to intellectual capital. This crystallises the ways of knowing, then the existing governance model
extent of the challenge for accounting in that currently will be challenged to embrace a stakeholder approach
which recognises the claims of employees to a share of
1
The data set developed here forms part of the joint ownership reflecting the fact that they provide the
Irish Management Institute-University of Limerick primary value creating resource. Nor is this likely to be
research programme on knowledge-intensive Irish satisfied by stock option schemes which are predicated
companies. A collaborative arrangement is in place with upon notions of reward. A governance model which has
the University of Maryland at College Park in the USA. traditionally linked ownership to provision of capital
This programme is directed by IMI-UL Professor may be forced to recognise the consequences of this
Patrick Flood and Tony Dromgoole of the IMI. paradigm in an economy in which intellectual capital is
O’Regan, O’Donnell and O’Regan 17-5
provided by other than financial capitalists. It is also However, the real significance of Habermas’
likely that as part of this process the attempts of notion of communicative action lies in the fact that at a
financial capitalists to capture and establish ownership time when accounting is being forced by commercial
by means of patents or its physical expression in the realities to reconsider its ontological and
form of recipes and manuals will be resisted by epistemological framework, it offers a theoretical,
employees. The nature of relationships internally will substantive and real platform on which a paradigm
also be affected with power correlating more closely to shift, as called for by Spender (1998), might be
knowledge and knowledge networks than to hierarchy explored (O’Donnell, 1999b). We claim that applying
within a traditional organisation structure. Habermasian theory from a lifeworld perspective has
Furthermore, in an economy in which the the potential to facilitate a broadening in the conceptual
importance of teams, knowledge flows, processes and discipline of accounting, a broadening which is capable
collegiality are commonly seen as facilitators of value of providing insight into the intangible nature of
creation, the traditional predict-direct-exploit-reward intellectual capital. It may offer the means by which the
paradigm which underpins the agency view of firm colonisation by the system of accounting technology
organisation may be increasingly challenged by models and regulatory bodies of the accounting ‘lifeworld’, that
which emphasise notions of trust, empowerment, is the social, cultural and communication context within
alliance and transformation. These will require the which the accounting system is located, may be
development of internal management techniques which renegotiated (Burrell, 1994; Laughlin, 1987; O'Regan
recognise and encourage the accommodation of these & O'Donnell, 2000; Power and Laughlin, 1996).
concepts as well as reporting methodologies which
distinguish between entities in which these traits are 6. Conclusion
increasing and those in which they are decreasing.
These techniques will also need to recognise the often As confirmed by this research, by creating competitive
chaotic and intuitive process of creativity and advantage intangible assets such as intellectual capital
‘knowing’. are playing an increasingly important role in the wealth-
creating dynamic of the knowledge economy. If it is to
be properly managed, however, information systems
5. Discussion
appropriate to intangible resources and to the needs of
The challenge for accounting therefore becomes one of an increasing range of users and stakeholders will need
a fundamentally ontological nature: continue with and to be satisfied. Accounting has traditionally been the
modify a positivist model which has traditionally had principal supplier of such information, gathering and
difficulty with either recognising or measuring assets presenting it in a manner such as to allow timely and
which cannot be fully objectified, or contemplate a new informed decision-making by management and
model in which the insights provided by Habermasian stakeholders. But accounting’s capacity to continue to
theory, or others, could inform the nature of the new function as a primary information provider has been
paradigm. compromised by its inability to respond more rapidly to
In fact, there has been a willingness on the part the demands of a new economy in which intangible
of some accounting academics to consider the relevance resources have emerged as the principal catalysts for
of Habermas to managerial accounting practices and growth, with consequent radical changes in
financial statements that are proving increasingly organisational structure and knowledge flows.
incapable of meeting the requirements of their principal The information revolution, therefore, offers a
users (O’Regan and O’Donnell, 2000). Thus, Laughlin number of challenges for accounting, and this research
(1987), Arrington and Puxty (1991), Broadbent and project is being extended to investigate ways in which
Laughlin (1994) and Power and Laughlin (1996), have existing accounting methodologies and paradigms are
attempted applications of Habermas’ notion of being adapted by firms operating in this new economy.
communicative action within accounting and have Significantly, these challenges may be best met by those
sought to extend beyond the traditional who learn to apply traditional collection, valuation,
technical/objectivist paradigm to include both reporting and auditing skills in developing new ways of
interpersonal and subjectivist dimensions (Power and facilitating the creation, integration and management of
Laughlin, 1996). However, their main focus has been knowledge in a transparent manner. This will involve
on identifying and exploring the implications of the the development of new accounting concepts and
self-legitimating role of the ‘expert’, to ‘question who approaches which not only identify, evaluate and
can monopolise public dialogue opportunities’ and to classify, but which are sensitive to the novel
explore how Habermas’ idea of ‘internal colonisation’ stakeholding and knowledge-creating dynamics of the
might be applied (Power and Laughlin, 1996; Collins, new economy.
1979; Fischer, 1990).
O’Regan, O’Donnell and O’Regan 17-6
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