Intellectual capital (IC) Advanced Financial Accounting

In the beginning, under knowledge economics, intellectual capital occupied a special importance
on the part of professional writers and researchers in the field of accounting thought, in terms of
its concept, representatives, goals and methods of the measurement. Intellectual capital, with its
elements, has become one of the purposeful matters, taking it into account when determining the
economic value of its assets, measuring its intangible assets, and evaluating its economic
performance that believes in dependency on its share prices and increasing competition between
these institutions, as well as providing information that is appropriate and reliable on its head.
Some investors see the growth process in the intellectual head, which leads to the rise in the value
of the intellectual head. From this standpoint, focus must be placed on intellectual capital as a
strategy of transformation from general employment to distinguished employment, even if wages
and operating expenses differ for the desired benefits in developing the organization’s business and
products. So I will discuss in this research three important points which are the extent Intellectual
Capital is accommodated in the financial statements via accounting of Intellectual Capital
Standards (IAS 38) intangible assets, the extent intellectual capital is accommodated via
mandatory narrative reporting requirements, and the benefits and expenses that are associated with
the voluntary disclosure of intellectual capital information in the narrative sections of corporate
annual reports.
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THE EXTENT INTELLECTUAL CAPITAL IS ACCOMMODATED IN THE
FINANCIAL STATEMENTS VIA ACCOUNTING OF INTELLECTUAL
CAPITAL STANDARDS (IAS 38 INTANGIBLE ASSETS
Intellectual capital was defined as the possibilities available to the management of the organization
related to the capabilities and competence of employees and the intimate relationships with
customers, whose use is combined with other material resources. The study also made clear that
the intellectual capital is a function of creating value and one of the main pillars of contemporary
performance appraisal systems. It is group of unique and dependent knowledge assets based on
creative human minds, work requirements and systems, and the relationship with clients that lead
to the continuous production of new ideas and methods that achieve added value for the
organization and support its competitive capabilities. Daniel Zeghal, Anis Maaloul, (2010).
The importance of the study stems from the necessity of accounting for intellectual capital in order
to provide information that improves the quality of the accounting information provided to both
current and potential investors and creditors and other stakeholders to make sound decisions, in
addition to that accounting for intellectual capital contributes to managing its components
efficiently and effectively and contributes to evaluating the overall performance of the facility and
maximizing the real wealth of the owners. A problem of the study was represented in ambiguity
and lack of agreement on a clear and comprehensive definition of intellectual capital and its various
components, the difficulty of measuring its components using traditional financial measures, and
the effectiveness of accounting for intellectual capital in improving the quality of accounting
information. The study aimed at presenting and discussing the concept of intellectual capital and
its main elements, demonstrating the importance of accounting for intellectual capital and
identifying methods of disclosure in the financial statements, in addition to proposing a template
for the list of intellectual capital and its impact on improving the quality of accounting information.
The study used the descriptive approach, the case study method, and suggested a list of the
elements of intellectual capital. The study reached conclusions, including the lack of agreement
on a clear and comprehensive definition of intellectual capital and its components, the difficulty
of measuring and showing it in the financial statements, due to the traditional accounting system’s
reliance on financial and historical indicators and measures that give a view of past events and not
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future ones. The proposed list of elements of intellectual capital achieves the ultimate goals of the
establishment As profitability, providing excellent services, assisting the management in carrying
out its duties efficiently and effectively, providing information for users to make appropriate
decisions, the proposed list is considered the elements of intellectual capital a list that is
complementary to the traditional financial statements and is not a stand-alone list, contributing
with other lists to provide an integrated picture of the facility for all elements of wealth that you
own. Indra Abeysekera, (2007).
The Intangible Assets Monitors Model:
Some researchers (Zaghloul, p. 26) state that (Sereby 1997) presented this model by classifying
the intangible assets into three basic groups:
❖ The first group: the group of intangible assets extending from the external structure, and
it consists of public relations with customers and suppliers, and the reputation of brands as
invisible assets. Sirinuch Nimtrakoon (2015).
❖ The second group: intangible assets derived from the internal structure and consists of a
broad sector of concepts, models, and automatic and administrative systems that have been
formed by individuals and are owned by organizations in general, in addition to internal
business networks, organizational culture, and work spirit within the organization.
Dipankar Ghosh, Anne Wu (2007).
❖ The third group: intangible assets derived from the eligibility of individuals: it refers to
the human force that works in various situations and is known as Individual Competence,
and it refers to the energies consisting of human resources that work in various situations,
and this matter includes education, experience, skill and values, and it is believed that
individuals are only agents. The real people within business organizations, and that all
assets and structures, whether tangible or intangible, are the product of the action of human
power, and ultimately depend on human power for its continued existence. Jan Mouritsen,
(2003).
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There is a similarity between the balanced performance measure perspective and the intangible
assets observer perspective, so both perspectives emphasize the necessity of integrating nonfinancial measures with financial measures, and both perspectives emphasize the need to classify
intangible assets and associated non-financial measures into three types that differ from Terms of
the term are consistent with the content. Norhayati Mat Husin, Keith Hooper, Karin Olesen (2012).
The perspective of controlling intangible assets is based on the assumption that individuals are the
only income generators within the organization, and that the actions of manpower transform into
knowledge structures that may be tangible and may be intangible, at a time when the balanced
performance measure is not based on this assumption. Vivien Beattie, Sarah Jane Smith, (2010).
The perspective of controlling intangible assets is based on a triangular group of these assets, which
requires trying to develop some metrics or design some indicators that are associated with the
growth of these assets, their renewal rates, and the efficiency of their use. As for the balanced
performance measure perspective, it mainly depends on the insufficiency of financial performance
measures alone to measure performance for internal and external purposes. Rather, it must be
supported by the other three-axis measures, which are relationships with customers, internal
processes, learning and the growth of human assets within the organization. Vivien Beattie, Sarah
Jane Smith, (2010).
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THE EXTENT IC IS ACCOMMODATED VIA MANDATORY NARRATIVE
REPORTING REQUIREMENTS (this question is still not answered through
your essay)
The intellectual capital is grouped into three large blocks:
Relational capital: It includes all the relationships and ties that link the tourism company to its
environment represented by suppliers, competitors, shareholders, customers, partners, etc.
Human capital: It is the set of skills possessed by employees who perform their duties in the
company, such as: talent, knowledge, skills, ability to innovate, and values. Md Habib-Uz-Zaman
Khan, Md Mohobbot Ali, (2010).
Regulatory capital: It is a set of systems on which the company has been based since its inception
and has been developed through experience and professionalism as a series of knowledge acquired
over time, which led to achieving significant improvements in performance and providing added
value to the company. It is also called the root of the internal structure, and it is a dimension that
integrates organizational knowledge and skills and includes: each of: the organizational structure,
methods and procedures used in work, software, databases, research and development systems,
company culture and management and direction systems. Vivien Beattie, Sarah Jane Smith (2010).
Where human capital is the specialized knowledge preserved in the mind of the distinct human
element that is not owned by the organization, rather it is linked to the individual personally. As
for intellectual capital: it is the intellectual assets and knowledge which is independent from the
personality of the individual and is owned by the organization, that is, what the organization
obtained from the element. Human rights have become within the property of the organization,
which in the end contributes to the continuous development of the organization’s performance and
maximizes its competitiveness. Vivien Beattie, Sarah Jane Smith (2010).
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The importance of intellectual capital:
1- Intellectual capital contributes to developing the current situation of the organization, by
producing and investing in new ideas and innovations. Catherine A Usoff, Jay C
Thibodeau, Priscilla Burnaby (2002).
2- Intellectual capital is the main source of competitive advantage and the factor affecting the
success of institutional performance. It also enhances the competitive position of the
organization by introducing new products, while reducing costs and the possibility of
selling at competitive prices, not to mention improving productivity. Catherine A Usoff,
Jay C Thibodeau, Priscilla Burnaby (2002).
3- It works to maximize the intellectual value of the organization, by developing knowledge
of the human element in it and making it highly valuable. Catherine A Usoff, Jay C
Thibodeau, Priscilla Burnaby (2002).
4- It is considered a scientific force capable of introducing fundamental adjustments to
everything in the work of the organization, and keeping pace with the rapid and renewed
developments. Catherine A Usoff, Jay C Thibodeau, Priscilla Burnaby (2002).
5- It helps the growth and survival of the organization, by exploiting ideas and opinions,
harnessing them for their benefit, and increasing the creativity, in developing products and
services that attract customers, and enhancing their loyalty to the organization. Catherine
A Usoff, Jay C Thibodeau, Priscilla Burnaby (2002).
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THE BENEFITS AND COSTS ASSOCIATED WITH THE VOLUNTARY
DISCLOSURE OF IC INFORMATION IN THE NARRATIVE SECTIONS
OF CORPORATE ANNUAL REPORTS
The department has been interested in studying the impact of the disclosure of intellectual capital
on the performance of companies and the decisions of the owners, especially the touch, and has
allocated the value of the importance of intellectual capital when defending their investment
decisions. There are many types of species, one of the types of different types of species, and the
alternative disclosure of intellectual funds is considered low. Nick bontaist (2003).
An index is constructed to disclose the information of intellectual capital, which is suitable as a
nucleus for a criterion, especially so that there are no shadows of separation. Thousands of
misdemeanors of thousands of people who have relied on field investigation. Ousama
Abdulrahman Anam, Abdul Hamid Fatima, Abdul Rashid Hafiz Majdi (2011).
Performance evaluation is a prerequisite for making decisions about resource allocation within
Companies, and also to address areas of weakness that emerge as a result of performance appraisal.
There are several metrics associated with measuring performance. The evaluation and
measurement of financial performance is one of the axes of performance evaluation, and it will
remain the most important evaluation of the extent of the companies’ success and sustainability,
despite the existence of other measures of performance are complementary to financial
performance. Gregory White, Alina Lee, Greg Tower, (2007).
Despite some opposition to the optional disclosure of intellectual money, because of the
competitive dysfunction, and the reservation of the regulators and the regulatory regulations and
the cost of disclosure. Gregory White, Alina Lee, Greg Tower, (2007).
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The change in the nature of the global economy to focus on intellectual knowledge and technology
has not changed to change the nature of corporate work and the method they are only administered,
but also changing the nature and quality of information. Traditional financial reporting has been
criticized for non-dependence on its own, for failing to accommodate the elements of knowledge
and intellectual corporate. Due to restricting accounting standards, intertwined in financial
statements, which appears through the widening gap between market value and the carrying
amount of companies. Concrete materials have also become the main factor to achieve growth and
create wealth. Helen H Kang, Sidney J Gray (2011) Reference has to be included as last name and
year (Kang and Gray, 2011). Make sure this is applicable across the document.
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CONCLUSION (Make reference to the essay question and include your views
on it by using the information given in the essay)
In the end, The human capital of the organization is represented by an elite group of workers who
possess a set of cognitive and organizational capabilities and not others. These capabilities enable
them to produce new ideas or develop old ideas that enable the organization to expand its market
share and maximize its strengths and make it in a position to seize the appropriate opportunity.
The intellectual capital is not based on a specific administrative level alone, and the availability of
an academic certificate is not required for whoever is characterized by it. It is used in all the
principle of the accounting and the model also, because it impact on the value of the financial
information in the company and its standards.
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REFERENCES
1. Nick Bontaist (2003). Intellectual capital disclosure in Canadian corporations, Journal of
Human Resource Costing and Accounting 7 (1/2), 9-20.
2. Helen H Kang, Sidney J Gray (2011), Reporting intangible assets: Voluntary disclosure
practices of top emerging market companies, e international journal of accounting 46 (4),
402-423.
3. Gregory White, Alina Lee, Greg Tower, (2007), Drivers of voluntary intellectual capital
disclosure in listed biotechnology companies. Journal of intellectual capital.
4. Ousama Abdulrahman Anam, Abdul Hamid Fatima, Abdul Rashid Hafiz Majdi (2011).
Effects of intellectual capital information disclosed in annual reports on market
capitalisation. Journal of Human Resource Costing & Accounting.
5. Catherine A Usoff, Jay C Thibodeau, Priscilla Burnaby (2002). The importance of
intellectual capital and its effect on performance measurement systems. Managerial
Auditing Journal.
6. Md Habib-Uz-Zaman Khan, Md Mohobbot Ali, (2010). An empirical investigation and
users’ perceptions on intellectual capital reporting in banks: Evidence from Bangladesh.
Journal of human resource costing & accounting 14 (1), 48-69.
7. Vivien Beattie, Sarah Jane Smith (2010). Human capital, value creation and disclosure.
Journal of Human Resource Costing & Accounting.
8. Daniel Zeghal, Anis Maaloul, (2010). Intellectual capital reporting between a developing
and developed nation. Journal of Intellectual Capital.
9. Sirinuch Nimtrakoon (2015). The relationship between intellectual capital, firms’ market
value and financial performance. Journal of Intellectual Capital.
10. Dipankar Ghosh, Anne Wu (2007). Intellectual capital and capital markets: additional
evidence. Journal of Intellectual Capital.
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11. Jan Mouritsen, (2003) Intellectual capital and the capital market: the circulability of
intellectual capital. Accounting, Auditing & Accountability Journal.
12. Norhayati Mat Husin, Keith Hooper, Karin Olesen ,(2012). Analysis of intellectual
capital disclosure–an illustrative. Journal of Intellectual Capital.
13. Sarah Jane Smith, (2010). Human capital, value creation and disclosure. Journal of Human
Resource Costing & Accounting.
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Table of Contents
1.
Introduction ………………………………………………………………………………………………………………………… 2
2.
Components of Intellectual Capital ………………………………………………………………………………………… 2
2.1.
Human capital ………………………………………………………………………………………………………………. 3
2.2.
Structural capital …………………………………………………………………………………………………………… 3
2.3.
Relational capital ………………………………………………………………………………………………………….. 3
3. Narrative section in annual report …………………………………………………………………………………………….. 4
4. Reasons of ICD in narrative section …………………………………………………………………………………………… 4
5. Conclusion ………………………………………………………………………………………………………………………………. 7
6. References ……………………………………………………………………………………………………………………………… 8
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1. Introduction
Today’s corporate economy is characterized by large amount of intangible assets (Andersson &
Folkare, 2015). The intangible assets such as knowledge, talent, customer relationships and
others provide more value than tangible assets like building and land in marketplace (Ferreira,
Branco & Moreira, 2012; Guthrie, Ricceri & Dumay, 2012; Singh & Kansal, 2011). In the
middle of the 1980, the gap between market value and book value has rose and because of that
the International Accounting Standard Board developed a new standard saying that companies
must report intangible assets in their annual report (Petty & Guthrie, 2000). However, not all
intangible assets can be recognized in the financial statements, so the stakeholders where not
satisfied (Branswijk & Everaert, 2012; Lev, Cañibano & Marr, 2005). The one way that the
companies can show their value is voluntary disclosure of intellectual capital that can appear in
narrative section or integrated section of annual report (Branswijk & Everaert, 2012; PWC,
2017). According to Alexander, Britton & Jorissen (2005) the intellectual capital is ‘the process
of knowledge, applied experience, organizational technology, customer relationship, and
professional skills that provide an enterprise with a competitive edge in market’ (p180). It
considered an important source to gain a competitive advantage. Akpinar & Akdemir, (2000)
stated that the values of the companies can grow or decrease depending on how they create,
leverage and capture their knowledge. Therefore, IC can improve the performance of the
business and grow the economy of the country by positive impact on the innovativeness and
creativity level (Khalique, Shaari, Isa & Ageel, 2011). The purpose of this essay is to provide
the reasons why the companies prefer to disclose the information of IC in the narrative parts in
their annual reports.
2. Components of Intellectual Capital
Many researches tried to describe the main IC components to bridge the gap of the lack of
the required direction of the IC specific elements (Williams, 2000). According to Edvinsson and
Malone (1997) human and structural capital considered a value of company’s IC. Other
researchers such Skyrme & Associates (2000) developed a third category of IC which was
customer capital. This category was later alter and expanded to relational capital (Birari, 2015).
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2.1.
Human capital
It indicates to knowledge, experience, skill and capability of an employee (Akpinar & Akdemir,
2000). When the employees leave the company, they take those with them and that can affect
that company (Beattie & Thomson, 2010). It considered source of innovation and strategic
renewal such developing new sales leads (Bontis, 1996). Moreover, all the results of the assets
and structure whether tangible or intangible are from humans and their continuity ultimately
depends on the employees (Sveiby, 1998).
2.2.
Structural capital
It considered a critical element of IC and considered as glue for the companies (Khalique et.al,
2011). It comprises infrastructure, system policies, strategies, routines and procedures. SaintOnge (1996) illustrated four components of the structural capital as follows:
a) Systems: the method an organization performed its process and outputs such information,
communication, decision-making
b) Structure: the arranging of responsibilities and accountabilities that identify the situation
of and relationship between company members.
c) Strategy: the company goals and how it will achieve them
d) Culture: totality of employee opinions, shared mindsets, values, and standards within the
company.
Structure capital helps to achieve optimum intellectual performance by support employees’
quests and that leads to optimum business performance. If the company has poor process and
system, the IC will not reach its fullest possibility (Bontis, 1996).
2.3.
Relational capital
It means communication with people outside the company and have with them loyalty, the
market share, similar issues and the level of back orders. It involves knowledge of customer,
supplier relationships, market channels, industry associations and the effects of general
government policy (Akpinar & Akdemir, 2000). Improving relationships helps to win the trust of
customers, suppliers and other stakeholders and thus increase the value of the company.
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3. Narrative section in annual report
Annual reports have several parts: financial statements and narrative parts, as well as some
company declarations or/and some governance statements (Lee and Tweedie, 1977; Balata and
Breton, 2005). Narrative report which is also knows management commentary explains the
information of financial position, financial performance and cash flows of the company (IFRS,
2010). The financial statement is not enough to understand well, so the existence of narrative
section can report a different message that can be more understandable for the users
(Abrahamson and Amir, 1996). In 2004, IAS 38 developed a standard that says that all
companies must disclose intangible assets in their annual report. Although there are accounting
standards on the subject of intangible assets, the standards do not accommodate many IC
components (FRC, 2015a; European Commission, 2010). Additionally, Since 2006, the
companies requiring to prepare a directors’ report that contain basic information and strategic
report that contain a review of the company’s operations, and in listed companies in FRC
required to involve more information in directors’ report (Deloitte, 2017). In several companies,
all narrative information combines in annual report into strategic report and governance report
that include directors’ report (FRC, 2015b). The strategic report involves what the company
does, its strategy and objectives, and how performance is measured against these, as well as
business model like how it generates value and the key relationships of the company, resources
and other inputs that enable its successful process. According to the report done by PWC (2007)
perfect narrative report includes each of market overview, strategy and structure, managing for
value and performance. The demand of the narrative information increases to better illustrate the
quality and sustainability of company performance, enhance business understanding, build the
relationships between company and its stakeholders (PWC, 2007).
4. Reasons of ICD in narrative section
The importance of traditional annual reports is seems to be decline (Lev & Zarowin, 1999). The
Accounting Standard Board (2002) and Canadian Institute of Chartered Accountants (2001)
argue that the financial reporting system is unable to explain new resources such relationship or
knowledge. Several studies indicate the existence gap between firms and its stakeholders because
of the difference between the information appearing in firms’ annual report and the information
required by market (Beattie & Pratt, 2002; Mouritsen et.al, 2004). The only way for bridge the
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gap is voulentry disclosure of IC information. Intellectual Capital Disclosure is defined as a
report prepared to meet and satisfy all of users information needs (Kamath, 2014). By use
voluntary disclosure of intellectual capital the firm may reduce the perceived risks (Williams,
2000). One more, at the present, the comprehensive theory of voluntary disclosure does not exist
(Verrecchia, 2001). The incentives to information of voluntarily disclose can be explained in
terms of some theories (Beattie & Smith, 2012). They are legitimacy theory, stakeholders theory,
agency theory, signaling theory and capital need theory.
Under legitimacy theory, the companies ensure that they operate within norms and limits for the
society they are in (Neysi, Mazraeh & Mousavi, 2012; Kamath, 2014). When the company adopt
this theory, it will be able to voluntary report on activities that expected by the community in
which it operates. Furthermore, this theory is like social contract between the company and its
community (Magness, 2006). The information about this subject helps the users in decisionmaking (Shehata, 2014). It helps to explain the question of what, why, when and how some items
are dealt with by the corporate management in their contact with the external audience (Magness,
2006). Moreover, companies by disclose this information can get good reputation and change its
external users’ opinion (Cormier & Gordon, 2001; Toms, 2002). Shareholders are more likely to
assist reputable companies; also companies are more likely to win customer loyalty (Doughty
Center, 2011).
Stakeholders theory means that the company management is expected to take and report an
activities expected by its stakeholders include shareholders , suppliers , customers , leaders
employees,
government and community ( Guthrie, Petty, Yongvanich &
Ricceri, 2004).
Overtime, the theory suggests that stakeholders must be informed about the company’s activities
that impact on them whether they use the information or not (Neysi et.al, 2012). This theory and
Legitimacy theory are two close and related to managerial theories (Beattie & Thomson, 2010).
Since the growth of intangible assets in companies, they felt that the annual report should include
IC to give stakeholders the right picture of true company’s value and performance and make
them more understanding of company’s competitive position (Kamath, 2014). Without provide
IC information, company’s annual report will be ineffective for stakeholders to make decision
(Unerman, Guthrie & Striukova, 2007). For example, the investors use company’s report to
make decision about buy, hold or sell shares. Voluntary disclosure of IC is a response to the
stakeholders in order to survival of the company and its continuation especially who have more
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important in relation to company’s activities (Beattie & Thomson, 2010). Additionally, voluntary
disclosure of IC helps to give the stakeholders clear view of business’s long-term sustainability
(Healy & Palepu, 2001; Boesso & Kumar, 2007). IC information includes the strategies and
other information that help the stakeholders to know if the company is going concern or not.
Agency theory defined as a contract under which one or more persons (the owner) run another
person (the agent) to implement some service on their behalf which grant the agent some
decision-making authority (Jensen & Meckling, 1976). Shehata (2014) mentioned that agency
relationship leads to the existence problem because the fact that directors can arrival information
more than investors. Voluntary disclosure is one of the methods that reduce agency problem by
decrease information asymmetry and problems between managers and investors (Healy &
Palepu, 2001; Boesso & Kumar, 2007). Managers are supposed to make a decision on the
reduction or theft of owners’ wealth that can lead to create agency cost (Beattie & Thomson,
2010). Disclosure of IC information helps the shareholders to monitor the managers and keep an
eye on company’s activities and that leads to decrease the agency cost (Barako, Hancock & Izan,
2006). The presence of information asymmetry between managers and shareholders leads to
increase market uncertainty, as well as increase the information risk of the cost of capital
component (Beattie & Thomson, 2010). Voluntary disclosure leads to a lower capital cost and
raise share price and liquidity by given the chance to the managers to increase their transparency
to capital markets (Verrecchia, 2001).
Other economic theory is known as signaling theory. The theory of signaling relates to how
problems emerging from information asymmetries are treated in any public environment
(Kamath, 2014). This theory also used to discuss voluntary disclose in company’s annual report
(Shehata, 2014). Signaling theory supposed that company with a high quality must indicate its
advantage to the market in order to reassessing the company value and reduce capital cost
(Kamath, 2014; Neysi et.al, 2012). One more, Verrecchia (1983) said that the result of
information asymmetries problems is that the companies show some information to the investors
to make them ensure that they are better than others in market in order to attract investment and
enhance reputation. Voluntary disclosure of IC helps the companies to provide more information
that attract investors to increase the sales (Campbell, Shrives, & Saager, 2001).
Other theory supports voluntary disclosure is capital need theory. Companies need to attract the
external finance whether equity or debts and this theory supposed that voluntary disclousure of
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IC assist to grow the capital but in low costs (Choi, 1973). The common belief that the
company’s capital cost includes a premium for investors’ uncertainty about the sufficiency and
accuracy of information available related to company (Shehata, 2014). According to (FASB,
2001) the existence of voluntary disclosure assists to reduce company’s capital cost due to the
investors will be able to explain the company’s economic prospects.
IC voluntary disclosure
leads to increase shareholders’ confidence and that lead to improve risk-sharing and productive
efficiency (Cheynel, 2012).
Other reasons of IC voluntary disclosure are to improve internal communication as well as
improve internal understanding of the company’s value drivers (Mourtisen et.al, 2004). ICD
creates a transparency that let the manager to run company’s intangible assets better. Create
transparency assists the Company’s management to locate resources, to check development and
to create strategy, in summary: it helps the company to make decisions (Neysi et.al, 2012).
5. Conclusion
The importance of intangible assets increases as they have more value than tangible assets,
where tangible assets provide value between 50% and 25% while the remaining value depends
on intangible assets (Petty, Cuganesan, Finch & Ford, 2009). Since the issuance of IAS 38, the
companies require