Data assets in corporate governance

According to the Interim Provisions on Accounting Treatment Relating to Enterprises’ Data Resources, data resources used by businesses should be recognised as intangible assets if they meet the definition and recognition conditions in Accounting Standard for Business Enterprises No. 6. That means data assets will be included on the balance sheet.

Adding data as a new asset item to the balance sheet will have a far-reaching effect on corporate governance and bring challenges to corporate management.

The impacts

Corporate finances. The inclusion of data assets on balance sheets will increase total assets and reshape the financial position and capital structure of companies, eventually impacting financial indicators and ratios. For example, inclusion will bring down the liabilities to assets ratio, return on assets and return on equity. Traditional indicators may no longer be applicable when evaluating the value and credit rating of a target company.

Shareholders. Paragraph 2 of article 27 of the Company Law provides that non-monetary property as capital contribution shall be valuated and verified, without any over-valuation or under-valuation. Paragraph 2 of article 28 provides that where a shareholder fails to make contribution as specified in the preceding paragraph, it shall not only make full contribution to the company but also bear the liabilities for breach of contract to other shareholders who have made full capital contributions on schedule.

Because it is difficult to determine the fair value of data assets through valuation, there is a risk of feigned capital contribution when a shareholder contributes capital in the form of data assets.

Moreover, article 30 of the Company Law provides that after the establishment of a limited liability company, if the actual value of the capital contributions in non-monetary form is found to be apparently lower than that in the company’s articles of association, the shortfall shall be paid by the contributing shareholder and other founding shareholders shall be held severally and jointly liable.

Reorganisation. As shown by past experience, it is common for novel assets to be acquired at a premium, especially for listed companies They are usually subject to a valuation adjustment mechanism (VAM) agreement with the transferor.

However, data alone cannot generate income, and needs to be integrated into other business activities. If performance misses expectations, it is difficult to determine which is to blame; is it the data asset itself, or the business activity that exploits the data?

Once a dispute arises from a VAM, the attribution of liabilities and obligations will be a great difficulty.

Asset activeness. Data assets are different from ordinary movables and immovable properties. Theoretically, a change of users does not directly affect the value of movables or immovables. But a data asset is an information set that involves multiple subjects, rather than a single one.

On the one hand, from a commercial perspective, such activities as information collection, sorting, storage, use, processing, transmission and furnishing will generate commercial value, manifesting the activeness of data assets.

On the other hand, the use of information is regulated by the China’s Cybersecurity Law, the Data Security Law and the Personal Information Protection Law, involving the protection of data subjects’ rights and interests.

Data assets that are contributed as capital or externally acquired are not available for use by the parent company due to personal information protection. This renders the data assets inactive or, say, into a retired status, having an adverse impact on both sides of the transaction.

Information disclosure. Regular disclosure of financial statements is a statutory obligation for listed companies. Including data assets on the balance sheet means that data assets will be regarded as part of disclosure.

Listed companies may face a dilemma between ensuring the accuracy and integrity of information disclosures and protecting any personal information behind their data assets. In addition, as it is hard to determine whether the valuation of a data asset is fair or not, data assets may be rapidly depreciated or retired, coupled by the difficulty of accurately measuring the depreciation period.

This dilemma provides an opportunity for listed companies to manipulate financial statements, such as manipulating the current loss through one-off recognition of profits or losses and inventory falling price reserve, which constitutes a financial fraud. This may arouse investors’ doubts over the authenticity of the balance sheet and invoke a lawsuit regarding civil compensation for misrepresentation of securities.

Response and prospects

Improve data asset management. Enterprises should establish valuation, record-keeping, classification and management processes for their data assets to ensure their accuracy, integrity and security. The risk management should be enhanced by data backups, disaster recovery planning and security protection, among others.

Capital base restructuring. Companies should restructure their capital base according to the value and importance of their data assets. They should remain prudent and conservative towards data assets acquired through equity investing or acquisition, and which are included on the balance sheet. In particular, data asset valuation should not be enlarged when there is a lack of benchmarking or before data assets begin to generate profit.

Once data assets fail profitability expectations, it is difficult to make explanations to satisfy creditors, investors and regulators, which will likely give rise to disputes and liabilities. Furthermore, it should be noted that any financial statement manipulation by inclusion of data assets is prohibited.

According to article 27 of the Company Law, assets eligible as capital contribution are those that can be valued in money and transferred in accordance with law. As a for-profit legal person, however, a company decides whether or not to include an asset in the balance sheet based on its ability to create profit for the company in the future, rather than its monetary valuation and transferability.

Undoubtedly, data assets are becoming increasingly important for companies, and society in general. But companies, investors, creditors and regulatory authorities still have a long way to go before thoroughly understanding and using data assets.

Liao Senlin is a senior partner at DOCVIT Law Firm liaosenlin@dtlawyers.com.cn