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International Symposium

Measuring and Reporting Intellectual Capital:Experience, Issues, and Prospects

Amsterdam

Technical Meeting9-10 June 1999

TRANSPARENCY IN INTELLECTUALCAPITAL

(Description of study conducted by Ernst & Young for the final report to the Ministry of Economic Affairs)

COUNTRY COVERED: THE NETHERLANDS

RESEARCH TEAM:

Martin Hoogendoorn RA (Project Manager, Ernst & Young Accountants)Auke de Bos RA (Ernst & Young Accountants)

Frits Krens (Ernst & Young Accountants)Wim Veerman RC (Ernst & Young Corporate Finance BV)Herbert ter Beek (Ernst & Young Management Consultants)

The opinions expressed in this paper are the sole responsibility of the author(s) and do not necessarily reflect those of the OECD,the governments of its Member countries, the co-organisers, or the supporting organisations.

This document cannot be quoted or cited without the express permission of the author(s).

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TABLE OF CONTENTS

INTRODUCTION .......................................................................................................................................... 3

THEORETICAL MODEL: INTELLECTUAL CAPITAL STATEMENT ................................................... 4

Financial overview...................................................................................................................................... 4Overview of performance indicators........................................................................................................... 5

CLIENT APPROACH.................................................................................................................................... 7

AEGON .......................................................................................................................................................... 9

Client profile ............................................................................................................................................... 9Identification of intellectual capital ............................................................................................................ 9Capitalisation of intangible assets in the balance sheet............................................................................. 10Valuation of intangible assets ................................................................................................................... 10Performance indicators for intellectual capital ......................................................................................... 11The Intellectual Capital Statement ............................................................................................................ 11Views on the Intellectual Capital Statement ............................................................................................. 12

DHV.............................................................................................................................................................. 14

Client profile ............................................................................................................................................. 14Identification of intellectual capital .......................................................................................................... 14Capitalisation of intangible assets in the balance sheet............................................................................. 15Valuation of intangible assets ................................................................................................................... 15Performance indicators for intellectual capital ......................................................................................... 15The Intellectual Capital Statement ............................................................................................................ 16Views on the Intellectual Capital Statement ............................................................................................. 18

VNU.............................................................................................................................................................. 19

Client profile ............................................................................................................................................. 19Identification of intellectual capital .......................................................................................................... 19Capitalisation of intangible assets in the balance sheet............................................................................. 20Valuation of intangible assets ................................................................................................................... 20Performance indicators for intellectual capital ......................................................................................... 21The Intellectual Capital Statement ............................................................................................................ 21Views on the Intellectual Capital Statement ............................................................................................. 23

CLIENT COMPARISON............................................................................................................................. 24

Identification of intellectual capital .......................................................................................................... 24Capitalisation of intangible assets in the balance sheet............................................................................. 24Valuation of intangible assets ................................................................................................................... 24Performance indicators for intellectual capital ......................................................................................... 24The Intellectual Capital Statement ............................................................................................................ 24Views on the Intellectual Capital Statement ............................................................................................. 25Conclusion ................................................................................................................................................ 25

SUMMARY AND CONCLUSIONS ........................................................................................................... 26

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INTRODUCTION

1. This report forms part of the draft final report of 27 January 1999, as presented to the Ministry ofEconomic Affairs. This report is confined to the specific study conducted by Ernst & Young. It is intendedfor inclusion in the full final report to be published by the Ministry.

2. The following issues are covered:

• A description of the theoretical model as a basis for the study (Part 2)

• A description of the client approach applied in the study (Part 3)

• A report on the study (Parts 4 to 7)

• Summary and conclusions (Part 8)

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THEORETICAL MODEL: INTELLECTUAL CAPITAL STATEMENT

3. The study conducted by Ernst & Young is based on empirical tests of a theoretical model of anIntellectual Capital Statement for external reporting purposes. The model that we propose integrates afinancial overview and an overview of performance indicators.

Financial overview

4. We propose to include a financial overview in the Intellectual Capital Statement, on the basis thatthis should provide the best possible insight into the value of the intellectual capital, regardless of therelevant legislation. Instead of the term `market value’, we use the more neutral term `fair value’, whichcan be defined as the amount for which an asset could be exchanged, or a liability settled, betweenknowledgeable, willing parties in an arm’s length transaction.

5. The form of the financial overview is as follows:

Fair value of the company: A

- Less the fair value of the tangible and monetary assets, afterdeduction of debts and provisions B

- Less the fair value of the identifiable and separable intangibleassets C

= The fair value of the remaining intellectual capital. D

6. This overview is drawn up on the basis of the idea that the value of the intellectual capital equalsthe difference between the fair value of the company (or the shareholders’ value) and the book value of thetangible and financial assets less debts and provisions. In order to realise an accurate valuation of theintellectual capital, which equals the sum of C and D, we take the view that the fair value of the companyshould be deducted from the fair value of the tangible and monetary assets, less the fair value of the debtsand provisions. If, for example, the cost of property were used instead of the fair value, the differencebetween fair value and historical cost of the property would improperly be attributed to the valuation of theintellectual capital.

7. In this overview, the value of the intellectual capital, i.e. of elements C and D, is divided into apart that related to the intangible assets (the identifiable and separable intellectual capital items that couldbe included in the balance sheet) and a residual part. The residual part consists of the acquired and self-generated goodwill. In accordance with current accounting principles, acquired goodwill can be shown inthe balance sheet (at cost less depreciation), while self-generated goodwill cannot. Generally speaking, it isnot possible to allocate goodwill to individual elements of the intellectual capital.

8. The distinction between elements C and D is important for the assessment of the company’sfinancial position by third parties. The better a company is able to translate its intellectual capital intoidentifiable and separable intangible assets, the less dependent that the value becomes on future profit

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expectations: after all, identifiable and separable intangible assets can be traded independently and cantherefore generate earnings independently, regardless of movements in the profitability of the organisationas a whole.

9. It is important to note the differences between the intangible assets that must be included in thebalance sheet by law, and those that are shown in this overview:

• All identifiable and separable intangible assets at the company’s disposal are shown in thisoverview in C, provided that a fair value can be determined in a reliable manner.

• No distinction is made between acquired and self-generated intangible assets.

• The assets are shown at the fair value.

• It follows from the foregoing that systematic depreciation is not applied to intangible assets.

10. Finally, a comment should be made with regard to the subjectivity of the valuation. In mostcases, determination of fair values will be accompanied by a large number of assumptions. This makes thevaluation subjective to a significant extent. In itself, this need not present any difficulty, providing that thevaluation can be regarded as reliable. If the fair value cannot be reliably determined, other valuationmodels must be applied, such as those based on historical costs. However, it would be a misconception toimagine that valuation at historical costs provides the objectivity that the fair value lacks. After all,historical costs of intangible assets only provide useful information if the future cash flows to be realisedwith the asset at least equal the historical costs. If this is not the case, the lower fair value (or lower presentvalue) provides a better indication of the value of the asset. In other words, a historical cost is a kind ofminimum fair value: lower fair values are taken into account, while higher ones are not. This means,therefore, that even when valuation is based on historical costs, fair values have to be estimated, with allthe associated subjectivity. Only when it is clear that the fair value is higher can valuation at historicalcosts be regarded as more objective. However, in our view, this makes the information less relevant forthird-party professional judgement and decision-making, since only negative movements are madetransparent, while positive ones are not. In weighing up the benefits of objectivity and relevance, we haveopted for relevance in our model. To quote a well-known saying: `It is better to be almost right thanexactly wrong.’

Overview of performance indicators

11. The financial overview is supplemented by an overview of performance indicators, divided intofields. We have given preference to an overview based on a fixed grid of distinct fields to group theperformance indicators. In first instance, we believe that the grid should be completed on a company-specific basis. However, it must be borne in mind that at later stages, a need will arise for a more or lessuniform basic grid for groups of similar companies, in the interest of comparability. The initial company-specific details are more important for the time being, however, since this will guide the choice of keyperformance indicators that must form the content of the matrix. If, for example, a measure expressing therealisation of objectives must be entered in the `human resources’ field, a value that expresses jobsatisfaction could be sought.

12. The selection of relevant performance indicators presents a difficult issue. Even when the grid isdeveloped, the selection of concrete indicators remains far from simple. Clearly, the existence of all sortsof reviews in the literature does not, and cannot provide more than a guide. It is not the intention to drawup long and confusing lists of indicators, but to highlight the key values that form the core of the matter.

13. The fact that this is an overview of performance indicators relating to the intellectual capital thatwill be included in external reports imposes restrictions:

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a) The question of which level of aggregation of information can still provide meaningful anduseful performance indicators in specific areas must be addressed. The same indicatorscannot automatically be used at the business unit level as at the group level.

b) The question of whether information included in reviews intended for internal corporatecontrol, in the form of performance indicators, qualifies for publication in external reportsmust also be answered. Clearly, confidential information and information of strategicimportance to competitors cannot be disclosed.

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CLIENT APPROACH

14. The study was conducted at three clients, that can be described as follows:

1. AEGON: a large insurer that derives a significant proportion of its profitability frominsurance contracts. The value of the key intangible assets is expressed in the ‘embeddedvalue’.

2. DHV: one of the larger international consultants, the main element of intellectual capitalbeing the available know-how.

3. VNU: a publishing and information group active in the markets for consumer andprofessional information. The main intangible asset here involves publishing rights.

15. This selection provided for a spread over both the sectors in which the companies operate andover the most prominent elements of intellectual capital. All the selected companies have more than50 employees. AEGON and VNU are listed companies.

16. The ideas relating to the model outlined in Part 2 were developed on the basis of a study of theliterature and the initial meetings with these clients. In the next phase, we assessed whether elements of thetheoretical model could already be observed among our clients and the extent to which the model could beapplied in full. Various officials of the organisations were interviewed for this purpose. We also consultedthe Ernst & Young audit teams that are involved in the annual audits of the financial statements. Althoughall the meetings were largely of a fact-finding nature, which is a distinguishing feature of a pilot study suchas this, an effort was made to obtain the most concrete answers possible to the potential input for thetheoretical model and the problems that could arise, with the aid of standard questionnaires developed forin-house use. Finally, to supplement the interviews, some of the client’s views were then recorded with thehelp of a written questionnaire.

17. Parts 4, 5 and 6 are devoted to a discussion of each client. Draft reports were co-ordinated withthe clients. It should be noted that, where the reports refer to corporate opinions, this relates solely to theviews of one or more officials in the company: they are not, therefore, a reflection of a more or less officialview. Part 7 provides a review of the issues with an assessment of all three clients together. Parts 4 to 6 aredrawn up under the following standard headings:

1. Client profile.

2. Identification of intellectual capital.

3. Capitalisation of intangible assets in the balance sheet.

4. Valuation of intangible assets.

5. Performance indicators for intellectual capital.

6. The Intellectual Capital Statement

7. Views on the Intellectual Capital Statement.

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18. Under headings 1 to 5, we report on findings at the client. Under heading 6, we describe potentialinput on the relevant client for the theoretical model, taking account of the findings. The client’s views onthis are presented under heading 7.

19. The same format is followed in Part 7 of this report, with the exception of heading 1.

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AEGON

Client profile

20. AEGON is a large listed insurer, its core activities being life insurance and pension andinvestment products. The company is primarily active in the Netherlands and the US, and also in the UK,Hungary, Spain and in Asia. Turnover in 1997 amounted to

NLG 31.3 billion and net profit to NLG 2.2 billion. Shareholders’ equity totalled

NLG 18.1 billion and the market value is NLG 52.3 billion. As at 31 December 1997, thecompany has more than 23,000 employees.

21. We focused part of our study on the Dutch activities, combined in AEGON Nederland, whichaccounts for about one third of the group’s turnover.

Identification of intellectual capital

22. The value of an insurance company, which is the discounted value of the future cash flows(distributable profits), is referred to as the `appraisal value’. AEGON divides the appraisal value into twocomponents:

• The embedded value, the discounted value of the future free cash flows from the existinginsurance portfolio plus the assets and liabilities shown in the balance sheet (the net amountbeing the shareholders’ equity);

• The structural value, which is the discounted value of the future free cash flows from thefuture insurance production.

23. The existing insurance portfolio can be regarded as an identifiable and separable intangible asset.It therefore qualifies for inclusion in the balance sheet. Embedded values relate to life insurance contracts,which have a far longer life than non-life contracts. Share lease contracts, such as those contracted byLegio Lease, are directly comparable with insurance contracts.

24. Some of the intellectual capital included in the structural value can be individually identified andseparated. The elements that can be distinguished here are:

• Databases with know-how information

• Address databases

• Brands and product concepts that can be licensed (the royalties can serve as a basis forvaluation here).

25. These intangible assets could be shown in the balance sheet.

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26. However, most of the determining factors for the structural value are not identifiable andseparable and do not, therefore, qualify for separate inclusion in the balance sheet (unless they are includedin acquired goodwill). The value to be assigned to this element is derived primarily from human creativityand innovative capacities: it is primarily the human resources that must ensure that insurance policies arecontracted. In addition, of course, elements such as infrastructure and brand recognition play a key role. Assoon as a policy is contracted, its profit potential can be reliably determined and the structural valuebecomes embedded value. It should be noted that the term `structural value’ as such is not directlyconsistent with the meaning of the term `structural capital’ in the theoretical considerations.

Capitalisation of intangible assets in the balance sheet

27. As already mentioned, the embedded value, the value of the existing insurance portfolio, could beshown in AEGON’s balance sheet. However, this is not the case, as there is no standard valuation methodyet for determining the embedded value. This could lead to distortions in comparisons between insurersover time. The embedded value is not mentioned in the notes to the financial statements, as is the practicein the UK, for example. If the embedded value is shown in the balance sheet in the future, or is referred toin the notes, this would have to be accompanied by a detailed explanation due to the complexity of theissue. The other identifiable and separable intangible assets are not included in the balance sheet either.Acquired goodwill is not capitalised, but is charged directly against shareholders’ equity. For this reason,the asset side of the balance sheet consists almost exclusively of investments. If the said intangible assetswere to be included in the balance sheet, this would have a substantial impact on the balance sheet picture.

Valuation of intangible assets

28. An embedded value report is drawn up each year, and is reviewed by an external actuary. Todetermine the embedded value, estimates are made of the profits expected in the future from existinginsurance contracts, discounted at a certain fixed rate, the level of which depends partly on the currency inwhich the policies are contracted. Various uncertain factors, for which estimates must be made, can bedistinguished in the determination of embedded values, such as:

• The premium income, which depends on natural and unnatural decline;

• The benefit payments, regarding which there are technical uncertainties (in particular,mortality);

• The returns on investment, which are only partially fixed;

• Movements in costs, including the effect of inflation.

29. The complexity of the calculations also means that they do not become available until a relativelylate stage after the end of the financial year. Because of this factor, as well as the necessary, non-standardised determination assumptions, the embedded values are not made available for external purposes(see above).

30. One can conclude that the method of determining the embedded value entails an approximationof the market value of the insurance portfolio (in addition to the shareholders’ equity).

31. The value of the other identifiable and separable intangible assets is not determined with anydegree of regularity. The same applies for the appraisal value. If appraisal value calculations are made inconnection with acquisitions, these are often based on a time horizon of five years of new production. Inview of the associated uncertainty, a higher discount rate is applied to determine the value of newproduction than for the determination of the embedded value.

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Performance indicators for intellectual capital

32. Internal control of intellectual capital takes place with the aid of a Balanced Score Card (BCS).Control in this form takes place only at the business unit level within AEGON Nederland. The businessunits provide quarterly reports in a standardised form for the central management of AEGON Nederland.An aggregated BSC at the AEGON Nederland level is seen as less meaningful, partly because there are nouseful benchmarks.

33. Each business unit is required to divide the BSC into four fields:

• Shareholders

• Market

• Internal management

• Innovation.

34. Apart from this division, they are free to design the BSCs as they see fit. Concrete measurementvalues are applied in the latter three fields, which improve the transparency of the intellectual capital. Twoexamples are:

• A performance indicator for Internal Management: the number of contact points per clientper year (as a contribution to the strategic objective of keeping loyal clients)

• A performance indicator for Innovation: the number of new products.

35. Social indicators, such as indicators for absenteeism, mobility, training costs in relation to thewage bill and the like are regarded as being more appropriate to the social annual report.

36. Internal reports to the Executive Board consist mainly of financial information, including theembedded value. As a management tool, embedded value is also primarily important in the assessment ofsegments that are in development. No systematic aggregated reporting of non-financial performanceindicators occurs.

The Intellectual Capital Statement

37. Taking account of the foregoing, in our view an Intellectual Capital Statement as an appendix toAEGON’s 1998 financial statements could be drawn up as follows (based on the general model, with somespecific modifications). All figures and performance indicators are accompanied by comparative data forthe preceding year.

Financial overview

Market value of AEGON as at 31 December 1998 A

Appraisal value AEGON as at 31 December 1998 B

Difference between market value and appraisal value A - B = C

Appraisal value: B

Fair value of investments and other assets less fair value of provisions and debts D

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Fair value intellectual capital B - D = E

Embedded value of existing insurance portfolio, if not included in the above F

Fair value of databases G

Fair value of address databases H

Fair value of brands and product concepts I

Total fair value of identifiable and separable intangible assets F + G + H + I = J

= Net total: structural value, if not included above E - J = K


Market

• Indicators that show the importance of AEGON’s market contacts, such as the number ofpolicyholders, the number of agents, the number of insurance contracts, market share etc.,analysed by product and geographical segments.

Internal Management

• Indicators that show the importance of internal processes in the organisation (theinfrastructure), such as the number of contacts per client per year, the average time to processrequests for proposals, average time to process claims etc., analysed by product andgeographical segments.

Innovation

• Indicators showing the importance of innovation, such as the number of new products, thenumber of people employed in product development, the number of hours spent on marketresearch, etc., analysed by product and geographical segments.

Human resources

• Indicators showing the importance of people in the organisation, such as the number of hoursspent on training, training costs, the number of new recruits, the age structure of the staff,absenteeism etc., analysed by product and geographical segments.

Notes

38. Notes could be provided here on the determination method for the fair values in the financialoverview and the assumptions made for this purpose. The determination method for (individual) indicatorscould also be explained. It would also be desirable to include an explanation of any exceptional movementsfrom the preceding year, and of any trends and developments.

Views on the Intellectual Capital Statement

39. AEGON’s Report of the Executive Board 1997 includes the following passage:

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“And we question the practice of routinely charging the goodwill paid for acquisitions against earnings asis the accounting convention under US GAAP rules. In our experience such goodwill is only very rarely adiminishing asset. So, why blur the true and fair view of the results? Moreover, isn’t it inconsistent to onlyrecognise purchased goodwill and to disregard the goodwill a company creates in-house? At the end of theday, like most accounting discussions, this boils down to degrees of conservatism applied in therecognition of profits and equity. Our policy in this regard is to compare on an annual basis our reportedearnings to the value added to our embedded value, i.e. the book equity plus the present value of futuredistributable earnings included in the existing life book of business. We can proudly report once again thatin 1997 this comparison was favourable, which means that our goodwill increased again.”

40. This passage reveals a positive attitude to our theoretical model, focusing on fair values and self-generated goodwill. In AEGON’s view, the market value is not a good indicator of the value of thecompany, because it fluctuates too much. The appraisal value, the term used to indicate the value of aninsurance company, therefore differs from the market value.

41. As explained above, we also asked our primary interviewee at AEGON to complete aquestionnaire with some specific questions concerning opinions on the Intellectual Capital Statement. Theresponses reveal the following views:

• AEGON takes a negative view of providing more transparency on intellectual capital forthird parties, but greater transparency is seen as desirable for internal purposes. Theunderlying reason for this view is that there is not sufficient assurance of comparabilitybetween companies and that therefore disclosure of information on intellectual capital couldlead to misapprehensions among third parties.

• AEGON takes a very positive view of the distinction made in the Intellectual CapitalStatement between a financial overview and an overview of performance indicators.

• With regard to the financial overview, AEGON takes a very positive view of the approachfollowed: the company also believes that it may be possible to apply this approach inpractice, but that this will require further study.

• With regard to the overview of performance indicators, AEGON takes a reasonably positiveview of the approach followed and also agrees with the division into fields applied and theexamples provided.

42. In summary, AEGON can be said to take a very positive view of the approach followed. Thecompany believes that this approach could probably be applied for internal purposes, but that this willrequire further study. However, it sees no need to include an Intellectual Capital Statement in the annualreports until the issue of comparability between companies has been solved.

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DHV

Client profile

43. DHV is a large international firm of consultants, ranking among the world’s top 20 in its field.DHV’s activities focus on the fields of transport, infrastructure, water, environment, physical planning,agriculture, industrial premises and property. Within these fields, DHV provides many services, rangingfrom strategic advice, policy analysis, research and feasibility studies to design and engineering, projectand operational management, general contracting and organisational development. At the end of 1997, thegroup had 2 600 employees spread over more than 50 locations world-wide. Turnover in 1997 amounted toNLG 468 million and net profit to NLG 11 million. Shareholders’ equity totalled NLG 45 million. Thecompany is not quoted on the stock exchange.


44. DHV attaches considerable importance to human know-how and is therefore active in the field ofknowledge management. Know-how is regarded as the determining factor for value. In this context, thefollowing are of key importance:

• The development of knowledge through training

• Embedding human know-how in the organisation in systemised and accessible forms

• Materialising know-how through patents.

• The first two activities are of primary importance at DHV.

45. The most important activity is the embedding of human know-how in the organisation: to thisend, the company has started to record know-how in databases as far as possible. The advantage of this isthat it makes the company less vulnerable, since it becomes less dependent on individual know-how.Database development is still in full swing. External consultants are used for this purpose, in order todevelop procedures for the embedding of know-how. The databases include a confidential section that isconsulted for internal purposes, and a section that is also accessible to DHV clients. The latter containsmore or less publicly available information that clients can consult fast and effectively. DHV is a leadingorganisation in areas including water management, and is currently making particularly heavy investmentsin the databases in this field. The know-how in databases includes e.g. advisory reports, offers, reports,CVs, client information etc. For the future, it is important to monitor the success of the databases, forexample by recording the number of times that they are consulted.

46. In addition to databases, DHV also develops software. This primarily involves simulationmodels, management software and maintenance software. Simulation models can be used to define theeffects of, for example, certain traffic measures. In addition to traffic models, the company has alsodeveloped sewerage models. The management and maintenance software is used for maintenanceplanning. The input for these models is data provided by clients. On the basis of the models, maintenanceplans can be drawn up.

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47. DHV also holds various patents and trade names. The patents (and trade names) relate mainly toknow-how applications. The licences on patents generate a certain sum in royalties each year. This incomeis offset by the costs of maintaining the patents and the internal management costs (namely personnelcosts). Overall, they are moderately profitable. Another advantage, which is not measured in financialterms, is the fact that the patents enable DHV to win certain orders or realise higher margins on projects.

48. As such, the know-how of individuals cannot be identified and separated, and does not, therefore,qualify for inclusion in the balance sheet. In DHV’s view, the same applies for the know-how incorporatedin the databases and the software. The database forms part of a large whole that cannot be regarded inisolation from the organisation as a whole and in particular, from the individuals that make use of it inspecific situations. The software packages also derive their value largely from the people who work withthem and are able to apply them. To the extent that third parties make use of the databases and softwaremodels, and could be charged for this, one could say that valuation is possible. The expenditure on internaldevelopment could also be capitalised. In any event, the know-how materialised in the form of patents canbe valued separately.


49. The patents (and trade names) qualify for capitalisation in the balance sheet. However, DHV hasopted not to capitalise these intangible assets. The databases and software packages are not capitalisedeither, but as such could qualify for capitalisation. Acquired goodwill is charged directly againstshareholders’ equity. No intangible assets are therefore shown in DHV’s balance sheet. The asset side ofthe balance sheet consists largely of receivables.


50. As already mentioned, people and know-how are key assets at DHV. The company does notregard an accurate financial valuation of know-how, human resources and databases as possible. Valuationof patents would be possible, but this is not performed because it serves no purpose. However, cost-benefitanalyses are performed for the purpose of decision-making on patent applications.


51. The company has introduced the Business Balanced Score Card (BBSC) for its subsidiaries. Forthese, 14 indicators must be provided.

52. The indicators from the financial point of view are:

• Growth of value added• Operating result as a percentage of value added• Ratio of value added to personnel costs• Return on invested capital• Funding/net result.

53. The indicators from the market point of view are:

• Ratio of marketing costs to sales• Value added sales/Value added turnover• Provision of start-up costs.

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54. The indicators from the internal point of view are:

• Order percentage• New employees• Staff turnover• Staff flexibility (temporary staff)

55. The indicators from the point of view of innovation are:

• Internal turnover of the DHV companies• Internal purchases of the DHV companies.

56. Each subsidiary can add extra indicators if it wishes.

57. At the group level, management is based primarily on these ratios, which in turn, are basedmainly on financial variables (management from a financial point of view). DHV Beheer is responsible foranalysing the (financial) data from the subsidiaries, and then reports to the Executive Board.

58. Most indicators are of a financial nature. Apart from this, non-financial information on peopleand know-how is seen as particularly important. However, no formalised internal information system onthis area is available as yet. In the development of such a system for non-financial information, adistinction can be made between:

• Creativity. This can be expressed by information on published articles, lectures delivered andcontacts with universities (Chairs).

• Subject matter know-how. This can be expressed by information on educationalqualifications, breadth of training and the number of training hours or days per year.

• Network of business contacts. This can be expressed by providing information on the numberof orders per client, movements in the client files and turnover in the database of regularclients (DHV aims for long-standing client relations).

• Multi-disciplinarity. This can be expressed through a review of projects performed, and todetermine the extent to which different people worked on them (multi-disciplinary projectsinvolving five to ten people, versus `individual’ projects involving one or two people).

59. For internal purposes, targets could be developed, for which those responsible would beaccountable.

60. Specific indicators that provide information on the success of knowledge management includethe number and scale (in terms of value added) of follow-up orders, the number of multi-disciplinaryprojects (co-operation between different ‘groups’ of DHV) and the success rate of proposals.


61. Taking account of the foregoing, in our view an Intellectual Capital Statement as an appendix toDHV’s 1998 financial statements could be drawn up as follows (based on the general model, with somespecific modifications). All figures and performance indicators are accompanied by comparative data forthe preceding year.

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Financial overview

Fair value DHV as at 31 December 1998: A

Fair value of the assets less fair value of provisions and debts B

Fair value intellectual capital A - B = C

Fair value of patents and trade names D

Fair value of databases E

Fair value of software packages F

Total fair value of identifiable and separable intangible assets D + E + F = G

= Net total: fair value of other intellectual capital C - G = H


Human resources

• Indicators that show the importance of human resources within the organisation, such as thenumber of hours spend on training, training costs, information on educational qualifications,number of new employees, age structure within the organisation, extent to which employeeswork in teams, absenteeism, etc., analysed by product and geographical segments.

Know-how

• Indicators that show the importance of know-how and knowledge management in theorganisation, such as the number of hours spend on knowledge management, the number oftimes that databases are consulted internally and by third parties, the number of patents andsoftware packages, the extent to which know-how is communicated through publication ofarticles and the delivery of lectures etc., analysed by product segments.

Network of business contacts

• Indicators that show the importance of DHV’s long-term relationships, such as the number ofclients, number of orders per client, movements in the client database, the number and scaleof follow-up orders, the number of preferred supplier contracts with key accounts, the successrate of proposals, market share etc., analysed by product and geographical segments.

Notes

62. Notes could be provided here on the determination method for the fair values in the financialoverview and the assumptions made for this purpose. The determination method for (individual) indicatorscould also be explained. It would also be desirable to include an explanation of any exceptional movementsfrom the preceding year, and of any trends and developments.

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63. The interviews conducted revealed that DHV does not take a negative view of externalpublication of the relevant performance indicators for know-how and human resources, in the form of anappendix to the annual report. This does not relate to the extent to which targets were met (the internalobjectives), but will primarily be used to demonstrate the importance attached to the development of know-how. At present, however, this does not take place, although knowledge management is discussed in aqualitative sense in individual sections of the annual report.

64. There is no clear consensus within DHV on the desirability of capitalising patents, databases andsoftware in the balance sheet. In DHV’s view, providing transparency with regard to the value ofintangible assets could lead to improved material assessments by financiers.

65. As at AEGON, we also asked our primary interviewee at DHV to complete a questionnaire withsome specific questions concerning opinions on the Intellectual Capital Statement. The responses revealthe following views:

• DHV takes a reasonably positive view of providing more transparency on intellectual capitalfor third parties. In DHV’s view, the balance sheet of a company of its own kind does not infact provide a view of the company’s value, since it has no tangible production assets.

• DHV takes a reasonably positive view of the distinction made in the Intellectual CapitalStatement between a financial overview and an overview of performance indicators.A financial overview alone is less suitable because the intangible production asset of know-how is difficult to express in terms of value, which makes indicators necessary to provideadditional insights.

• With regard to the financial overview, DHV takes a reasonably positive view of the approachfollowed: the company also believes that it may be possible to apply this approach inpractice, but that this will require further study. DHV notes that determining the value of thecompany on an annual basis would present a particular problem since it there is no stockmarket value.

• With regard to the overview of performance indicators, DHV takes a reasonably positiveview of the approach followed. The company comments that the indicators must beaccompanied by notes explaining why the indicator is regarded as important. With regard tothe division into fields, it notes that the `knowledge’ field could be replaced by orsupplemented by `competencies’, showing the organisation of competence management andhow this is translated in terms of personal BSCs.

66. In summary, DHV can be said to take a reasonably positive view of the approach followed. Thecompany believes that this approach could probably be applied for external purposes, but that this willrequire further study. The annual valuation of the (non-listed) company could present a problem here.

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VNU

Client profile

67. VNU is a large listed publishing and information company, which is active in the markets forconsumer and professional information. The company’s most important operations include consumermagazines, professional magazines, regional newspapers, telephone directories and information services,educational textbooks, marketing information services and entertainment. VNU is active in a large numberof European countries, the US, Africa and Asia. It has some 12,000 employees. Turnover amounted toNLG 3.9 billion in 1997 and net profit to NLG 419 million. Shareholders equity totalled NLG 888 millionas at 31 December 1997, and the market value of NLG 10.8 billion.


68. VNU’s main intangible assets are its publishing rights. This term should be broadly interpreted,and in addition to titles increasingly includes databases. These databases, consisting of data and dataprocessing software, are leased to third parties (leasing of rights of use to various users for specificperiods). Sometimes, VNU also makes use of third party databases.

69. Databases, as part of the publishing rights, are acquired both separately and inclusive ofinfrastructure. In the latter case, the company owning the database is in fact taken over (the databasetogether with the employees and the organisation to maintain and upgrade it). Publishing rights in the senseof titles are almost always acquired inclusive of the personnel, primarily the editors of the title. In additionto acquiring publishing rights, VNU generates its own publishing rights.

70. The company also develops software. A distinction is made here between production softwareused for the development of software designed for sale to third parties, and software acquired or producedfor in-house use.

71. Naturally, human resources, know-how, brands, market relations and distribution channels arealso key elements of VNU’s intellectual capital. However, to a large extent, these are embedded in theintangible capitalised publishing rights. The value of a title, for example, is largely determined by thefollowing factors:

• The brand name. A brand (magazine title) can be sold separately and can therefore be valuedseparately, although the value depends heavily on what the buyer plans to do with the brand.Sometimes the name of a title is also used to offer additional products and services, such astraining courses.

• The database of addresses/subscriptions. This is valuable in combination with the product tobe delivered (the magazine). The size of the subscriber database together with individualsales also has strong ties with the scale of the advertising revenues. The address database alsohas a value in itself, with a difference between defined addresses (with distinguishing

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features) and non-defined addresses. In combination with a subscription, however, there isalways a defined address.

• The editorial team. A good editor is extremely valuable, but it is not possible to value aneditorial team separately. An editorial team creates value and this is reflected in the numberof subscribers, the individual sales, etc.

• The market position. This relates to the magazine’s position in the market, for examplewhether it is the market leader. Market leadership improves the chances of survival in adeteriorating market, partly because advertisers then also remain loyal to the magazine.

• The distribution channel. This enables delivery of the magazine to the subscriber’s door andhas a supporting value.

72. It should, therefore, be possible to value certain building blocks of the title, but this would onlyreflect a fraction of a magazine’s overall value.

73. Nevertheless, the publishing rights do not reflect the entire value of the intellectual capital. Thecompany’s value is determined partly by the capacity of the employees to develop new publishing rights,make successful new acquisitions and the like. The management is particularly important in this respect.For this reason, there is an extensive management development programme. The element of self-generatedgoodwill cannot, of course, be identified and traded.


74. Publishing rights are capitalised in the balance sheet as an `intangible asset’. Capitalisation ispossible for both acquired and self-developed publishing rights, in both cases if they exceed a certainminimum level. In practice, no self-developed publishing rights have been capitalised as yet because noneof those developed recently have exceeded this minimum level.

75. Until 1997, acquired goodwill was charged directly against shareholders equity. From 1998,however, it has been capitalised and written down.

76. Production software is also capitalised. However, this is not shown as an intangible asset, but as atangible fixed asset. Software for in-house use is not included in the balance sheet.

77. In the remainder of this section, we confine ourselves to the publishing rights, which accountedfor 25% of the balance sheet total as at 31 December 1997. The main other assets are the tangible fixedassets (15%), the financial fixed assets (13%), receivables (33%) and liquid assets (10%).


78. Publishing rights acquired from third parties (including databases) are included in the balancesheet at value attributed to them on acquisition. This is related to the profitability of the rights, themaximum value being the cost of the total acquisition. The difference between the cost price of theacquired company and the publishing rights valued within it is regarded as goodwill and is directly writtenoff from equity. However, as from 1998, acquired goodwill will also be capitalised.

79. In principle, self-generated publishing rights are valued at an amount relating to their profitabilityin the year that the project is deemed to be completed, the maximum being the project costs. As alreadymentioned, no self-developed publishing rights have yet been capitalised in practice.

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80. Amortisation is not applied to publishing rights if they are not deemed to be subject todeterioration through use or the passage of time. The value of the publishing rights is therefore evaluatedannually using consistently applied principles. If this evaluation reveals a fundamental decline in value,this decline in value is charged to operations as an amortisation expense. Higher values for publishingrights are not taken into account.

81. The profitability of the publishing rights plays a key role in the determination of their value. Thismeans that a calculation is made of the (future) earnings (to be) realised through the publishing rights andthe costs incurred for that purpose. Income elements include subscriptions, individual sales andadvertising, while the cost elements are personnel costs and direct variable costs. Through this valuation,and the absence of systematic depreciation of publishing rights, the balance sheet includes anapproximation of the fair value of the intangible assets, on the understanding that fair values in excess ofthe expenditure on these assets are not taken into account. No mention is made of such higher fair values inthe notes to the financial statements either.

82. A current value or fair value for titles or databases is not determined internally in a systematicmanner. Publishing rights are rarely sold, and there is therefore no need for a regular determination of thefair value on these grounds.


83. Internal control of intellectual capital takes place with the aid of financial variables. In addition tothe financial data shown in the balance sheet and profit and loss account, the management receivesinformation including the following:

• The start-up costs for publishing rights developed in-house (development and marketingcosts) for each title or database.

• Number of subscriptions for each publication.

• Number of advertising pages per publication

84. Non-financial indicators, such as information on markets (market shares etc.) and on personnel(employee totals etc.) are also available. The company considers it desirable to develop more performanceindicators relating to the quality of human resources and management, but this is found to be extremelydifficult. The Business Balanced Score Card is not applied.


85. Taking account of the foregoing, in our view an Intellectual Capital Statement as an appendix toVNU’s 1998 financial statements could be drawn up as follows (based on the general model, with somespecific modifications). All figures and performance indicators are accompanied by comparative data forthe preceding year.

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Financial overview

Market value of VNU as at 31 December 1998: A

Fair value of tangible fixed assets (excluding software), financialfixed assets and current assets, less fair value of provisions and debts B

Fair value intellectual capital A - B = C

Fair value of publishing rights (titles and databases) D

Fair value of software packages E

Total fair value of identifiable and separable intangible assets D + E = F

= Net total: fair value of other intellectual capital C - F = G

Fair value of publishing rights and software packages F

Book value of publishing rights and software packages H

Difference between fair and book value on intangible assets I


Market

• Indicators that show the importance of VNU’s market relations, such as the number of titlesand databases, number of subscriptions per title, the number of advertising pages per title,number of individual sales, market share and market leadership, number of database users,use of brand names for additional products and services, etc.

Human resources

• Indicators that show the importance of human resources in the organisation, such as thenumber of hours spent on management development, the costs of management development,the number of new employees, editorial changes, age structure of the organisation,absenteeism etc., analysed by product and geographical segments.

Innovation

• Indicators showing the importance of innovation, such as the number of and start-up costs fornew titles and databases developed in-house, the success rate for the launch of new titles anddatabases, the number of people employed in developing new publishing rights, the numberof hours spent on market research, etc., analysed by product and geographical segments.

Notes

Notes could be provided here on the determination method for the fair values in the financial overview andthe assumptions made for this purpose. Notes on the difference between the book value and the fair valueof the publishing rights shown in the balance sheet may be desirable. The determination method for

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(individual) indicators could also be explained. It would also be desirable to include an explanation of anyexceptional movements from the preceding year, and of any trends and developments.


86. At VNU, too, we asked our primary interviewee to complete a questionnaire with some specificquestions concerning opinions on the Intellectual Capital Statement. The responses reveal the followingviews:

• VNU takes a very positive view of providing more transparency on intellectual capital forthird parties. In VNU’s opinion, the financial market needs this transparency.

• VNU takes a reasonably positive view of the distinction made in the Intellectual CapitalStatement between a financial overview and an overview of performance indicators. It noteshere that the interpretation of the `value’ of the performance indicators is very personal and,therefore, fairly subjective.

• VNU is not in favour of the input for the financial overview as it regards it as meaningless: itfeels there are too many practical problems to apply the approach in a meaningful way.

• With regard to the overview of performance indicators, VNU takes a reasonably positiveview of the approach followed: the company agrees with the division into fields and theexamples used.

87. In summary, VNU can be said to take a very positive view of providing more transparency forthird parties with regard to intellectual capital. In itself, the company regards the distinction between afinancial overview and an overview of performance indicators as positive, but sees the input for thefinancial overview, based on an approximation of fair values, as meaningless.

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CLIENT COMPARISON


88. Identifiable and separable intellectual capital were distinguished in all three companies:

• At AEGON: the insurance portfolio, the databases, address databases, brands and productconcepts

• At DHV: patents, trade names, databases and software packages

• At VNU: publishing rights (titles and databases) and software packages.

89. Obviously, the remaining intellectual capital is also important for all three companies. Inparticular, human resources, know-how, innovation and market relationships were distinguished here.


90. Only VNU capitalises intangible assets in the balance sheet. VNU is also the only one of thethree companies to capitalise and depreciate acquired goodwill (since 1998), rather than charging thisdirect to the shareholders’ equity.


91. AEGON makes an annual internal calculation of the embedded value, in a way that generates anapproximation of the fair value of the insurance portfolio. This information is used for internal purposes(and for the Insurance Chamber). VNU values its intangible assets only for the purpose of valuation in thebalance sheet. Publishing rights are valued at the value assigned to them on acquisition. Systematicdepreciation is not applied, but permanent diminutions in value are taken into account. The absence ofdepreciation means that an approximation of the fair value is shown in the balance sheet, on theunderstanding that fair values in excess of the costs incurred for this purpose are not included. DHV doesnot systematically value its intellectual capital.


92. Internal control at both AEGON and DHV is based on BSCs. At AEGON, in particular, a cleardivision into four fields is applied at the business unit level and concrete, non-financial variables ofmeasurement are used, that contribute to the transparency of the intellectual capital. At DHV, theindicators on which management is based are largely financial. Non-financial information on humanresources and know-how is regarded as extremely important, but as yet, there is no formalised internalinformation system for this purpose. Internal control at VNU is also based mainly on financial variables.


93. The Intellectual Capital Statement was set up in the same way at each of the three companies, onthe basis of the theoretical model. A number of differences in the set-up were created:

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• At AEGON, an explicit distinction was made between the market value of the company andthe appraisal value: the latter is seen as a better, more stable indication of the company’svalue than the market value.

• At DHV, there is no market value since the company is not listed.

• At VNU, a comparison was included between the fair value of the identifiable and separableintangible assets and their book value in the balance sheet.

94. This comparison does not apply for either of the two other companies, as they do not showintangible assets in their balance sheets.


95. With regard to the provision of greater transparency to third parties, the results show thatAEGON takes a negative view of this (at least as long as there are not enough assurances ofcomparability), DHV takes a reasonably positive view and VNU a very positive view. Opinion on thedistinction made in the Intellectual Capital Statement between a financial overview and an overview ofperformance indicators is unanimously positive: DHV and VNU are reasonably positive and AEGON verypositive.

96. By contrast, opinion regarding the input for the financial overview is divided. AEGON is verypositive and DHV reasonably positive, although both note that further study is needed to develop this inpractice. VNU is clearly negative and regards an overview based on fair values as meaningless.

97. Finally, there is a consensus regarding the overview of performance indicators: all threecompanies regard this as reasonably positive.

Conclusion

98. Taking the three areas together, the following general comments can be made about the threecompanies:

• AEGON is the most advanced in terms of calculations of fair values of intangible assets, andtakes the most positive view of a financial overview based on fair values, but is the leastpositive with regard to disclosure of this information to third parties. The information is seenas valuable for internal control, together with non-financial performance indicators at thebusiness unit level.

• VNU takes the most positive view of making intellectual capital transparent for third parties,and is the only company that capitalises intangible assets in the balance sheet, but sees novalue whatsoever in a financial overview based on fair values. Internal control is basedprimarily on financial performance indicators.

• DHV holds an intermediate position between the two former companies. It takes a reasonablypositive view of making intellectual capital transparent, of a financial overview based on fairvalues and of an overview of performance indicators. However, as yet it discloses little ofthis, does not perform any internal valuations at fair value and does not yet have aninformation system based on non-financial performance indicators.

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SUMMARY AND CONCLUSIONS

99. This report covers a study commissioned by the Ministry of Economic Affairs. Part 2 describesan Intellectual Capital Statement.

100. The key feature of the Intellectual Capital Statement is that a distinction is made between afinancial overview based on fair values, and an overview of performance indicators. The basic form of thefinancial overview is as follows:

Fair value of the company: A

Less the fair value of the tangible and monetary assets,after deduction of debts and provisions B

Less the fair value of the identifiable and separable intangible assets C

= The fair value of the remaining intellectual capital. D

101. The financial overview in no way relates to the statutory requirements regarding intangibleassets. It is intended to lead to greater transparency than that which is possible in financial statementsunder the existing rules. The performance indicators included in the overview relate both to elements thatare included in the balance sheet or the financial overview, and to those that are not.

102. The Intellectual Capital Statement was conducted at three clients: AEGON (insurer), DHV(consultants) and VNU (publisher and information group). The approach to the study is described in Part 3.Parts 4 to 7 contain the results of the study at each client, and a comparison of these. The main conclusionsof the study are as follows:

• Identifiable and separable intangible assets were distinguished at all three clients:

− At AEGON: the insurance portfolio, the databases, address databases, brands and productconcepts

− At DHV: patents, trade names, databases and software packages

− At VNU: publishing rights (titles and databases) and software packages.

• Only VNU capitalises intangible assets in the balance sheet. VNU is also the only one of thethree companies to capitalise and depreciate acquired goodwill (since 1998), rather thantaking it direct to the profit and loss account.

• Only AEGON calculates the value of intangible assets annually, in a way that approximatestheir fair value. VNU takes a restricted approach to the fair value in its balance sheetvaluations, as fair values in excess of the expenditure for the asset are not taken into account.

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• Internal control at both AEGON and DHV is based on BSCs. Although VNU does not applyBSCs, its internal control is also based on both financial and non-financial variables, with acertain emphasis on the former.

• The Intellectual Capital Statement was set up in the same way for all three companies, on thebasis of the theoretical model.

• AEGON took a negative view of providing greater transparency to third parties (at least aslong as there are no sufficient assurances of comparability), while DHV took a reasonablypositive view of this and VNU a very positive one.

• Opinion on the distinction made in the Intellectual Capital Statement between a financialoverview and an overview of performance indicators is unanimously positive: DHV andVNU are reasonably positive and AEGON very positive.

• By contrast, opinion regarding the input for the financial overview is divided. AEGON isvery positive and DHV reasonably positive, although both note that further study is needed todevelop this in practice. VNU is clearly negative and regards an overview based on fairvalues as meaningless.

• Finally, there is a consensus regarding the overview of performance indicators: all threecompanies regard this as reasonably positive.

103. The general conclusion is that in our view, providing greater transparency on intellectual capitalwith the aid of an Intellectual Capital Statement as an appendix to the financial statements, as we propose,must be regarded as possible. The practical study shows that providing an insight through a combination offinancial valuation and performance indicators proves to be particularly attractive. There is a difference ofopinion with regard to the actual input for the financial overview and as to whether this information shouldbe made available to third parties. This requires further study, particularly with regard to the determinationof fair values, the input for the performance indicators, and the analysis and judgement of external usersbased on this information.

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