2.4 D IFFICULTIES IN FINANCIAL ACCOUNTING FOR ICT INVESTMENT
2.4.1 Difficulties of justifying the capitalisation conditions
Previously, the literature review identified the capitalisation conditions from the accounting literatures that could impact the capitalisation of the investment. The definition of ICT investment has also been discussed from the IT literatures. The following discussion focus on the issue related to the application of each capitalisation conditions for ICT investment.
a) Future economic benefit
An expenditure items can be capitalised if and only if the organisation can prove the future economic benefit of that item. It is difficult for some of the ICT asset. For IT, there is normally the time lag before the organisation can realise the benefit from the investment. Evidence suggests that the lag is between 2 to 6 years. This is relatively
long and the benefits from IT investment are therefore less certain.(Bharadwaj et al., 1999, Brynjolfsson and Yang, 1997, Dewan and Min, 1997, Im et al., 2001, Tam, 1998, Shin, 2006, Weill, 1992). The difficulties of justifying the future economic benefit from ICT investment could leads to fewer capitalisations and more expense of ICT investment.
b) Controllability
In the perception IT or IS literatures, the asset arising from IT investment are more than computer machine. Those asset such as knowledge and new improved business process, also contribute to the economic growth of firm and are considered by IS/IT practitioner as the intangible asset (Yang et al., 2002, Corrado et al., 2007). Yang et al., (2002) concluded that investor and stock market give value to the firm’s intangible asset arising from IT investment more than other assets. Corrado et al., (2007) pointed out that intangible such as the knowledge capital has been ignored by the financial accounting practice at firm level.
In financial accounting, intangible asset such as knowledge asset cannot be capitalised due to the lack of the organisation controllability over this type of assets.
For instance, there can be training going on in the IT project investment. According to IAS38 and AASB 138, the expenditure on the training activities cannot be capitalised. This is because the organisation does not have control over the future economic benefit from skill is trained to staff. The skilled worker can leave the organisation anytime.
c) Reliability measurement
To measure the value of asset, the accounting standards recommend the historical cost method and fair value method. For the historical costing method, the assets are
valued by the sum of cost of the transactions that are directly attributable to create the asset. However, the value capitalised and reported in the financial statements shall reflect its market value, which is also its fair value.
Stressing deeper into the accounting standards about the value of asset, the organisation shall also be able to quantify the future benefit of the assets into the monetary unit. In the accounting standards, the value of the asset reflects the future economic benefit of the asset. The future economic benefit defines in the accounting standards is the reduction of the outflow of cash or cash equivalent, and the increase of the inflow of the cash or cash equivalent to the organisation. The asset with $300 value report on the balance sheet would give the organisation $300 if it is being sold at the time of reporting.
Either with historical cost or fair value, it is still difficult to provide the reliability measure over the value of ICT assets. The difficulty of being able to quantitatively measure the benefit from IT investment has been in debate of IT Literatures. Early researches in ITBV use the traditional method such as ROA and ROI to quantify the value of IT investment (Strassmann, 1997). Later, researchers suggested the value of IT investment can be intangible and cannot be measured with just the financial measure (Hitt and Brynjolfsson, 1998, Jon-Adrild Johannessen, 1999, Willcocks and Graeser, 2005).
It is sometimes difficult to quantify the value of IT investment economically because IT sometimes has indirect impact to the organisation financial performance. Base on (Lee, 2001), there is an indirect and complex causal relationship between IT and the organisational profitability. Rivard et al., (2005) showed that IT increases the profitability of the organisation by supporting the organisational asset. Wu et al
(2005) found that IT alignment and advancement positively mediating by supply chain capabilities increase the market performance and financial performance of the organisation. (Shin, 2006) indicated that IT doesn’t have direct impact on gross margin but through organisational strategic direction.
It is also problematic to measure the value of ICT asset during its useful life. The organisations need to perform the revaluation of the asset overtimes after the asset has been capitalised. The value of asset with the finite useful life will be depleted overtimes, therefore, the asset need to be depreciated or amortised. Traditional methods spotted in the accounting standards are straight line method, diminishing and unite of production. This is indicated in IAS 38 and AASB 138. (IFRS, 2011c, CPA, 2008, CPA, 2010, CPA, 2009)
The use of the traditional method for the revaluation of software overtimes is not right (Mordechai and Ilanit, 2007) . Instead of losing its value over time, software is enhanced through time of use, and its value becomes more enhanced accordingly.
Consistently, different studies have suggested that the value from IT investment become stronger overtimes along with the organisations adjustments and learning (Willcocks and Lester, 1996, Hitt and Brynjolfsson, 1998).
Mordechai and Ilanit, (2007) suggested a model for calculating value of software overtimes. The value is referred to as the “intrinsic value” or “fair value” preferred by accounting. The concept behind the model is that software, also a system, may contain a lot of modules. Those modules can be used to fulfil different business transactions, for example, calculating the interest rate. Therefore, each software modules has its own benefit of use and contributes to organizational economic benefit differently. These modules may be replaced or changed overtimes, therefore
the value of the whole software would be different overtime accordingly. It is not always increased or decreased in value. Thus, the traditional amortization method in financial accounting cannot reflect the value of the software.
d) Identifiability
Section 1 suggests “separable” is an important criterion for asset capitalisation. In accounting standards, asset is identifiable when it is separable. Implicitly, the asset should still deliver the economic benefit reported on the balance sheet after being separated from the organisation. It is hard for IT asset to keep delivering the benefit or value consistently after being separated from the organisation that owned it.
The benefit of IT investment is quite depends different organisational factors. (Lee, 2001) IT will not make a positive impact on the organisational profitability if there are not any favourable complementary conditions. It needs well management and planning; and not every company is able to deliver that. (Yu et al., 2006) and (Shin, 2006) have shown that the organisation get different level of benefits base on different complementarity of IT investment and the organisation strategy. For instance, ITBV is higher for multi focus firms than single focus firms(Tallon, 2007).
It requires time for the organisation to create and adjust different organisational factors to gain the benefit from IT. For instance, it would take 2.71 years for ERP adoption to release the value (Aral et al., 2009). This is because the organisation needs times to make adjustment on the organisation complementary factors, for example human resource, organisation capabilities and business strategy(Aral and Weill, 2007). It is impossible that the value of ICT investment is the same after being separated to its new owner.