It is a fallacy to believe that companies cannot be appraised or valued if their balance sheets do not contain every possible value-creating investment, says Jane Fuller
This article was first published in the February 2018 UK edition of Accounting and Business magazine.
I picked up the book Capitalism Without Capital by Jonathan Haskel and Stian Westlake with enthusiasm. The subtitle spoke of the ‘intangible economy’ and it promised an analysis of the intangible assets ‘hidden from company balance sheets’.
But while illuminating the current business zeitgeist, the book ends up on the side of the head-shakers who think that something is broken. At least it is rather more temperate than diatribes against accounting standards from the likes of accounting academic Baruch Lev.
The idea that companies cannot be valued if their balance sheets do not contain every potentially value-creating ‘investment’ (a euphemism for spending, in this case) is nonsense. As disciples of the economist Benjamin Graham would say to the accountants: ‘Give me information I can anchor on, but leave the speculation to me.’
Modern accounts include plenty of information that can help with the speculative activity of forecasting future cashflows. For ‘new economy’ companies, it can be found in the income and cashflow statements, and the notes. Even measures of indebtedness for non-financial companies have become more cashflow-orientated, with net debt:ebitda replacing net debt:net assets in many cases.
Haskel and Westlake actually set out the reasons why internally generated intangible assets are difficult to value (see also page 58). Market prices are not readily available and the assets are typically business-specific, making them hard to separate from a unique blend of activities. There are often no comparable standardised units.
While patents and licences carry rights that can be traded and enforced, it is another matter to control who benefits from many intangible investments, such as training a skilled workforce. IAS 38, Intangible Assets, calls for assets to be identifiable, separable and controlled by the entity – including the future economic benefits.
On that basis, intangibles can be capitalised at cost. But how much benefit is there to a user of accounts in seeing a steady stream of spending – on research for instance – capitalised and amortised rather than expensed as incurred? The sums would be similar and the latter is simpler.
If a young company is ramping up investment in its brand, technical know-how and marketing, its income statement would be flattered by capitalisation of the expenses. But it is cash burn that will determine when it will run out of money if no more funds can be raised.
So I wish the UK’s Financial Reporting Council and others luck in considering, yet again, whether more intangible assets can be credibly added to the balance sheet. Enhancing narrative disclosures would be easier. But neither approach will tell us for sure whether the ‘investment’ will prove to be gold dust, or sand through the fingers.
Jane Fuller is a fellow of CFA UK and serves on the Audit and Assurance Council of the Financial Reporting Council
"How much benefit is there in seeing a steady stream of spending capitalised and amortised, rather than expensed as incurred?"