People Who Don’t Get the Intangible Shift

Thanks to Presto Agitato here for pointing to the CATO Institute briefing paper here called, “FASB: Making Financial Statements Mysterious.”

The paper, by T.J. Rodgers, CEO, of Cypress Semiconductor Corporation expresses extreme frustration with the current state of financial statements. I share his frustration but don’t agree at all with his conclusions.

Rodgers says that Sarbannes Oxley was supposed to make accounting more transparent and it hasn’t. I would counter that it was supposed to make accounting more reliable and it has. One of the great accomplishments of Sarbox has been the increased focus on process and controls. These were changes that needed to be made (with plenty of room to go–as I said here many of the failures of the financial institutions involved failure to follow their own processes and standards). My recent post here on the IFAC survey about corporate reporting provides a good counterpoint to his view.

He specifically singles out guidelines that require booking of intangibles in certain circumstances (usually M&A) on the balance sheet as adding to the confusion regarding financials. He maintains that intangible assets “do not exist.” They certainly don’t exist in traditional accounting so I agree that it is confusing to put them on the balance sheet in some circumstances but not in others.

But knowledge-based intangibles are the core of corporate value in today’s economy. The first hint that something has changed is the gap between book value and stock market value. Book value only explains a small fraction of the total market valuation of companies today (See the graphs in this Ocean Tomo white paper). This is also the reason that companies regularly pay prices for companies that exceed the value of their tangible assets. To date, the accounting solution is to put the knowledge portion on the balance sheet as an intangible. If you want background on this, see my recent presentation “Accounting in the Knowledge Economy” here.