Intellectual Capital

A Brief Overview of Intellectual Capital and Analysis of the Edvinsson/Malone Framework
A Brief Overview of Intellectual Capital and Analysis of the Edvinsson/Malone Framework
II. Definition of Intellectual Capital (pg. 4-6)
III. The Importance of Intellectual Capital (pg. 6-7)
IV. Analysis of the Edvinsson/Malone Framework (pg. 7-13)
V. General Arguments Lodged Against Intellectual Capital (pg. 13-14)
Accounting is a science based on observation. As companies change, the way accountants observe companies must change. Traditional balance sheets, income statements, and statement of cash flows no longer adequately describe a company due to the rapid growth of knowledge-based companies, especially in technological sectors. The Internet and a growth in service industries are also accelerating the need for a change in the way we analyze a firm. Financial statements are failing to adequately describe “corporate vital signs” by ignoring the importance of ideas, brands, ways of working, and franchises. Intellectual Capital (IC) is important to the growth of a company, and investors need to know how a company maintains and evolves the IC within the organization, and how it channels the IC into its products and services.

It is believed that the economic boom of the last two decades is due to recent scientific breakthroughs and new information technology. A constant stream of innovations and productivity gains have enhanced the performance of the economy and driven up stock prices. There is a link between the IC of a firm and its ability to contribute to the economy.
The commissioner of the Securities Exchange Commission claims that it is because of lack of good measures that we see tremendous volatility in the knowledge sector . The investor demands higher return because of higher perceived risk, leading to an increases the cost of capital. Moreover, the market becomes inefficient because investors are allocating funds with limited information.

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This paper is designed to outline the current state of the IC. The importance of IC and compatibility with current accepted accounting principles will be discussed. The Edvinsson and Molone proposal for a “knowledge balance sheet” will also be analyzed.

The terms “Intellectual Assets” and “Intellectual Capital” are both used to define intangible assets which are not reported in corporation’s balance sheets but are a driving force in the creation of corporate wealth. The definition of Intellectual Capital (IC) is elusive. Since the study of intangible assets is a relatively new field, varying definitions appear.

Steven Wallman, commissioner of the Securities and Exchange Commission, defines IC as the value of brand-names and the customer base of a firm, as well as the brainpower of the employees and the Research and Development of the firm.
Similarly, according to Leif Edvinsson, co-author of the book Intellectual Capital, IC is broken into two main categories :
1. Human Capital: The combined knowledge, skill, and the ability of the company’s individual employees to meet the task at hand. It also includes the company’s values, culture, and philosophy. Human capital cannot be owned by the company, but the company’s training, support programs, and hiring policy contribute to human capital.

2. Structural Capital: The hardware, software, databases, organizational structure, patents, trademarks, and everything else of organizational capability that supports the productivity of the employees. In a sense, structural capital is knowledge-based assets left at the office when the employees go home. Structural capital also includes customer capital, the relationships developed with key customers. Unlike human capital, structural capital can be owned and thereby traded.

Thomas A. Stewart, author of Intellectual Capital, The New Wealth of Organizations, sees three main components of IC: Human Capital, Structural Capital, and Customer Capital . Stewart defines Human Capital as “the capabilities of individuals required to provide solutions to customers.” His definition of Structural Capital is “the organizational abilities of the organization to meet market requirements . . . to codify bodies of knowledge that can be transferred, to preserve the recipes that might otherwise be lost . . . to connect people to data, experts, and expertise–including bodies of knowledge–on a just-in-time basis.” Finally, Stewart adds Customer Capital, which is the value of the business relationships forged by a company.

Stewart further narrows the definition by stating that IC must be:
1. “Knowledge that exists in an organization that can be used to create differential advantage.” Therefore, any knowledge in the company

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