The CFA Institute released a
The paper from the financial analyst group pointed out that, in terms of GDP, investments in intangible assets have eclipsed investments in tangible assets in developed markets, and there have been significant increases in price-to-book ratios of major equity indices, partly because of unrecognized intangible assets. The biggest companies in the world now tend to be intangible-intensive, and companies receiving venture-capital financing or going public through IPOs also tend to skew toward intangible-intensive sectors.
“The increasing importance of intangibles is not only a characteristic of listed and VC-backed companies but a hallmark of major advanced economies,” said the report. “In contrast with financial accounting standards that treat most intangible expenditures as expenses, national income accounting rules used to calculate gross domestic product (GDP) treats firms’ expenditures on R&D, software and artistic originals as investments, analogous to the other components of capital investment included in GDP, such as residential structures and buildings, nonresidential structures and buildings, and machinery and equipment.”
The report noted that both FASB and the IASB are broadly re-examining accounting for intangible assets. Under the current accounting rules, intangible assets (such as patents, brands and software) acquired in a business combination are often capitalized as assets, while the costs associated with intangible assets generated internally by a company are expensed as incurred. But beyond the lack of recognition, only minimal disclosures are required — or voluntarily provided — for intangible assets, often leaving investors in the dark about the exact nature of these significant investments.
“The central message emerging from our work is that improved disclosures and better disaggregation are necessary to understand the investments made in the creation of intangible assets before considering their recognition on financial statements,” said Sandra Peters, senior head of global advocacy at the CFA Institute, in a statement. “When we look back at standard-setting over the last 30 years, disclosures are what led the way to productive conversations and finally to recognition for stock-based compensation, fair value accounting, and pension measurement. Without more information, investors do not have insight into the specific intangible assets they know exist, and standard-setters lack insight on how to best approach changes to recognition. Without better disclosures, neither investors nor standard-setters can properly define and scope the issue they are trying to solve.”
The CFA Institute surveyed a group of over 800 investors for the paper and received a variety of responses and comments that are included in the report. Overall, more than 70% of the respondents agreed that for many companies the most valuable assets don’t appear on the balance sheet; the accounting model does not, but should, recognize important intangibles; and the unrecognized intangible assets are a significant driver of the difference observed between the book and market values of equity for many listed companies.
Only 39% of the respondents found current intangible disclosures useful. The biggest level of agreement (more than 80%) in the survey was for better disclosures and for more disaggregation of investments in intangibles across the financial statements. Investors widely agreed with a menu of disclosure improvements, with most receiving over 80% support. Respondents saw improving disclosures as a path forward to achieving better valuation, measurement and ultimately recognition of such intangibles.
Over 70% of the respondents agreed with continuing to separately recognize identifiable intangibles in an acquisition but a similar proportion of respondents expressed concerns with the transparency and timeliness of impairment testing.
Many of the survey respondents would like to see internally generated, identifiable intangibles recognized on the balance sheet. A significant plurality disagreed, however, seeing the potential for earnings management and believing that deferred recognition may not provide any more useful information than expensing. Their comments suggest that this potential for earnings management stems from a lack of transparency regarding the investment in intangibles.
Nearly equal numbers of respondents supported cost and fair value models for measuring internally generated intangible assets, if they were to be recognized on the balance sheet.
Investors see the financial statements as at risk of losing their relevance without action by FASB and the IASB on intangibles, but they don’t have a strong appetite for radical change such as an entirely new balance sheet that shows the fair value of acquired or created intangibles.
“In the current environment, where the prevailing mood tends toward fewer, not more, disclosures, the debate around the accounting of intangibles is controversial, despite clear evidence that financial statements are missing important assets,” said Matthew Winters, senior director of global advocacy at the CFA Institute, in a statement. “Many of the stakeholders — mostly investors — who try to solve this conundrum want broader capitalization of intangibles to properly reflect companies’ sources of value on balance sheets and to treat intangibles more consistently with tangible assets. However, others disagree. They believe that capitalization would not provide more useful information than expensing, and that the conservatism and uniformity of the current rules are good things. Opponents also argue that granting companies more flexibility in capitalization could have the perverse effect of greater earnings management.”
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