In August 2024, the European Commission published a set of frequently asked questions on how to interpret the Corporate Sustainability Reporting Directive (CSRD) requirements, to aid companies with their implementations. It also contains interpretations of certain provisions of the European Sustainability Reporting Standards (ESRS), where legal interpretation from the Commission was deemed necessary.

Among the many topics covered, there are three questions pertaining to disclosures of ‘key intangible resources’. An intangible asset is a subset of the term intangible resources, and is a recognised asset category in financial accounting, providing an interesting use case to better understand the connectivity between sustainability and financial information.

The first question relates to the scope of intangibles. It discusses whether the requirement to report information on key intangible resources includes those intangible assets recognised on the balance sheet. The short answer is yes.

The second question relates to the scope of companies, ie which entities are required to provide information on key intangible resources. The short answer is all companies in scope of the CSRD.

Both the second and third questions refer to the location of information, ie where to place information on key intangible resources. The short answer is in the management report or the sustainability statements (while not specified, we also assumed this to include the financial statements for any intangibles meeting the financial accounting criteria).

What are intangible resources?

The CSRD defines ‘key intangible resources’ as “resources without physical substance on which the business model of the undertaking fundamentally depends and which are a source of value creation for the undertaking”.

Why do we need to disclose them?

The preamble to CSRD further explains:

What you need to know (and why it matters)

To better understand how the CSRD’s consideration of intangibles connects with financial reporting and the conditions under which intangibles are reflected in financial disclosures in Europe, we need to look to the IFRS International Accounting Standard 38 - Intangible Assets (IAS 38).

Defining intangibles

IAS 38 defines intangibles as “an identifiable non-monetary asset without physical substance”.

Intangible assets, under IAS 38, are defined using two basic concepts, and recognised only when two additional criteria for each of those concepts are met:

We can begin to understand why so many intangibles fail to qualify as an asset to be included in the financial statements.

In practice, the challenges around control may include an absence of legal rights to protect, or otherwise control. For example, relationships with customers (also known as customer loyalty) is a resource for which the organisation lacks sufficient control over the expected economic benefits attributable to the quality of relationships. Therefore, while they are a source of value, customer relationships fail to satisfy the definition of intangible assets for accounting purposes.

Additionally challenges around separability of the intangible assets arise when a company continues to spend (or invest) in things like its brand, customer lists or publishing titles. It effectively becomes impossible to distinguish spend on the intangible asset from spend to develop the business. For instance, if a company invests in a brand campaign, how would it objectively determine its distinct brand asset from its overall business? In most cases, it cannot.

Generally, internally generated intangible assets tend to hold low or no value on the balance sheet, while acquired assets tend to be recognised at cost. This is because the probability recognition criterion in paragraph IAS 38 par.21(a) is always considered to be satisfied for separately acquired intangible assets. Additionally, the cost of a separately acquired intangible asset can usually be measured reliably. This is particularly true when the purchase occurs in cash or using other monetary assets.

So it becomes easier to understand that intangibles may not be reflected in financial statements because of limitations of existing standards, either those of recognition or measurement.

For example, money spent to develop new technology in-house must be expensed (through the income statement) rather than capitalised (on the balance sheet) until it’s commercially viable, whereas money spent to acquire pre-commercial technology can generally be capitalised as an intangible asset.

You cannot have intangible liabilities

While you can have intangible assets, but never intangible liabilities. There is no magic as to why this is, really. All liabilities are intangible, meaning there is nothing physical about them. Liabilities are important in the context of sustainability management, and currently covered by financial accounting standard IAS 37 - Provisions, Contingent Liabilities and Contingent Assets (which we will cover further in a future article).

Back to sustainability

The explanation in CSRD’s preamble illustrates that information on sustainability-related intangibles extends beyond monetary information. It serves to describe, in quantitative and qualitative terms, characteristics of a company’s assets that are deemed to have value, even if this value cannot be expressed in currency terms because it does not meet accounting standard requirements for recognition as an asset in the financial statements.

The European Commission’s response to the first question specifically refers to the holistic approach of considering all intangibles. This allows users to understand how a company may depend on key intangible resources to operate and how these may be relevant for the company’s future value creation, irrespective of whether they would meet the recognition and measurement criteria of the applicable accounting framework. For example, ethical business conduct and data security in the I industry are two essential considerations that directly contribute to a company’s ability to maintain its client relationships and obtain new clients to grow its revenues.

Connecting sustainability to financial information

In Connecting sustainability and finance: information, performance and disclosures, we explain how different types of performance information will be reflected in different locations within the general-purpose financial statements, which are increasingly understood to include three components:

• financial statements,
• sustainability statements, and
• the management commentary (or MD&A).  

We also refer to ‘sustainability information’ or ‘sustainability performance information’ as non-financial information about sustainability matters. We refer to ‘financial information on sustainability matters’ as financial information about sustainability matters that fails to satisfy an existing financial reporting measurement or disclosure requirement. Finally, we refer to ‘financial performance information’ as financial performance information that satisfies the existing financial reporting measurement or disclosure requirement, the latter of which must be included in the financial statements (or the notes thereto).

When it comes to intangibles, here’s what that might look like:

In its response to frequently asked questions, the European Commission specifies that information on intangibles [that do not meet financial accounting requirements] does not necessarily have to be included in the sustainability statement and may be provided in a different section of the management report as previously noted.

Understanding the different types of information should not only help reporting practitioners to determine the appropriate location in which to disclose it, but also to articulate an insightful narrative that explains the connection between sustainability and financial.

Conclusion

Intangible resources are a classic example of the innate challenges in recognising the natural connection between sustainability and finance. Companies undertake investments in a multitude of areas that do not result in an asset being immediately recognised on the balance sheet.

The topic of intangible assets has been the subject of much discussion over the years, in fact the International Valuation Standards Council has undertaken a series of whitepapers tackling the very issue of including more intangible items within the financial statements.

In addition, the IASB launched a comprehensive review of accounting for intangibles in April 2024. Any standard setting move towards making “intangibles more tangible” will help immensely not only with the accounting for intangible resources but also with the connectivity between sustainability and finance.