Why IAS 38 is Hindering South Africa’s Growth: A Call for Change

In an era where innovation, intellectual property (IP), and intangible assets drive economic success, South Africa finds itself at a critical crossroads. Our financial statements reveal a stark reality—South Africa has one of the lowest representations of intangible assets compared to other countries. This is not just an accounting issue; it’s a symptom of a broader problem that threatens our ability to compete in the global economy.

At the heart of this issue is IAS 38, the international accounting standard for intangible assets, which may be doing more harm than good for South Africa’s economic ambitions.

The IAS 38 Problem

In his article “Discussion of ‘Accounting for intangible assets: suggested solutions’ Niclas Hellman Stockholm School of Economics discuss IAS 38, which deals with intangible assets, and the criticisms from both practitioners and academics. IAS 38 is often viewed as overly conservative, and critics suggest that it fails to fully capture the value of intangible assets, particularly in industries where such assets are critical to value creation.

IAS 38 dictates how companies account for intangible assets like patents, software, brands, and research and development (R&D). While seemingly neutral on paper, in practice, this standard heavily favours capitalising acquired intangible assets—those bought from another company—while making it far more difficult to capitalize internally generated intangibles, such as self-developed software or in-house R&D.

For a developing country like South Africa, this is a devastating flaw.

We are not a country with massive amounts of capital to throw around to acquire readymade intangible assets. What we do have is the potential to develop these assets ourselves. But IAS 38 largely prevents companies from capitalizing these self-developed intangibles, forcing them to expense them immediately. This conservative approach means that the true value of these innovations never shows up on the balance sheet, which distorts a company’s financial health and makes it harder to attract investors or secure funding for further innovation.

Intellectual Property and Economic Growth: South Africa’s Struggle

In the global knowledge economy, intangible assets are everything. They drive productivity, enhance competitiveness, and provide the foundation for long-term economic growth. Countries with strong IP portfolios are the ones leading the pack. Unfortunately, South Africa lags far behind.

Our financial statements reflect a glaring underrepresentation of intangible assets, which signals two worrying possibilities: either we aren’t investing enough in IP, or we’re investing in it but not accounting for it properly. Either way, we have a problem, and it’s one that has significant implications for our economy.

Why is this important?

Because without the ability to properly account for the value we are creating through innovation, South Africa is depriving itself of economic growth. Investors, both local and international, rely on financial statements to make decisions. If we are not showing the true value of our innovations, we lose out on investment that could drive future development.

Is IAS 38 Too Conservative for South Africa?

In South Africa, we seem to apply IAS 38 with extra caution—thanks in part to our regulatory environment, where bodies like the Independent Regulatory Board for Auditors (IRBA) enforce stringent controls on audit firms that forces them to favour conservatism over practical considerations to avoid fines and penalties from the IRBA. While regulation is critical for ensuring transparency and preventing fraud, we may be shooting ourselves in the foot by being too conservative. Similarly the South African Financial Reporting Standards Council (FRSC) has adopted a blanked adoption approach to IFRS and IAS with very little effort to consider if the standards will contribute to local economic growth and employment.

If audit firms are excessively cautious, out of fear of the IRBA, in how they interpret IAS 38, it could be contributing to the undercapitalization of intangible assets. Companies may be discouraged from capitalising internally developed assets due to fear of regulatory overreach, leading them to expense innovations that could, and should, be seen as long-term investments.

This overly conservative approach does not suit a country like South Africa. As a developing nation, we cannot afford to stifle our innovation. If we continue down this path, we risk permanently hindering the development of sectors critical to our future, such as technology, pharmaceuticals, and renewable energy.

The Unintended Consequences: A Stagnating Economy

The low representation of intangible assets in our financial statements creates a dangerous feedback loop. When companies cannot capitalize their innovation, their financial health appears weaker than it really is. This makes it more difficult for them to secure the funding needed for further R&D or expansion. In turn, this discourages investment in innovation, creating a self-fulfilling prophecy of stagnation.

What’s worse is that in an increasingly digital and knowledge-driven world, economic growth is synonymous with IP growth. Without fostering and properly valuing our intangible assets, we risk being left behind on the global stage, where developed countries with robust IP portfolios will continue to outpace us.

This issue is made crystal clear in an exclusive interview with Dr. Daan Steenkamp, CEO of Codera Analytics, hosted by Leana van der Merwe CBA(SA), CA(SA) of the Chartered Institute for Business Accountants (CIBA) and the CFO Club. The interview, which dives deep into South Africa’s underperformance in intangible assets, reveals that IAS 38, the international accounting standard for intangible assets, could be the very thing stifling our economic development.

A Call for Change: Adapting IAS 38 for South Africa’s Future

South Africa cannot afford to simply follow international standards blindly, especially when those standards are designed for developed economies with different challenges and resources. We need to adapt IAS 38 to our unique context.

Here’s how:

Advocate for Change in IAS 38: We need to push for an adjustment in the international accounting standards to allow for more flexible capitalisation of internally developed intangible assets, particularly for developing countries. IAS 38 could be reformed to reflect the economic realities of nations like South Africa that depend on internal innovation rather than acquisition.
Regulatory Flexibility: IRBA and other regulators must reassess how IAS 38 is applied in South Africa. Rather than a blanket conservative and restrictive approach, there needs to be room for professional judgment, allowing auditors to recognize the value of intangible assets that are crucial for long-term growth.
Government and Policy Support: The South African government can play a significant role by providing tax incentives, grants, and subsidies to companies investing in R&D and intellectual property. This can encourage businesses to innovate locally and capitalize on their own developments, boosting our intangible asset value as a nation.
Raising Awareness: South African businesses, accountants, and auditors need to be more aware of the importance of accurately reflecting intangible assets in financial statements. This requires education and a shift in mindset about how we view innovation and value creation in the knowledge economy.

The Road Ahead: South Africa Must Value Its Innovation

South Africa is at a turning point. The path we take now will determine whether we rise to become a knowledge-driven economy or remain trapped in a cycle of underdevelopment. IAS 38, as it stands, is hindering our progress by devaluing the innovation and intellectual property that are essential to our growth.

We must challenge the status quo, rethink how we apply IAS 38, and adopt a more progressive, innovation-friendly approach. The future of South Africa’s economy depends on it.