Accounting for Intangible Assets

The Australian Accounting Standards Board recently published an interesting discussion paper here on “Initial Accounting for Internally Generated Intangible Assets.”  Comments on the paper will be accepted here through May 15, 2009.

The paper addresses the peculiar state of affairs that exists in accounting today: that intangibles (the knowledge assets that largely drive corporate operations in the knowledge era) exist only as expenses and not as assets.

For example, if a company like Fedex were to invest a $1 million in internal software implementation for a new bar code tracking system software, this “investment” would be treated as an expense in the year in which it occurred even though the company would benefit from the investment for a number of years. In contrast, if they were to buy $1 million in equipment, this would be treated as an investment and its cost amortized over the useful life of the equipment.

The Australian paper endeavors to lay out the alternatives for how to account for “investments” in internally-generated intangibles such as the bar code tracking example above. The two major approaches are to account for the cost of the investment or the fair market value of the product of the investment.

The writers do a good job of summarizing the two cases, although they have a bias toward fair value (which is a big debate in accounting today). In the end, they recommend that companies disclose both cost and fair value.

It’s too bad this paper is so technical in nature. This is an issue that needs to be on the radar of all accountants. And I would like to see a broader discussion, especially of the need to understand the cumulative cost/investment in intangibles. Macroeconomic data suggests that the annual investment at a national level in the U.S. is at least as large as capital/tangible investment (see references to Nakamura calculations here and here). If you sit on a board, invest in or manage a company, shouldn’t you be looking at this number?

While I also agree with the theoretical soundness of value versus cost, I know that the practice of creating such values is far from scientific. In all but a few rare cases (such as clearly identified patents or trade names), there is not an efficient market for these intangibles, so value is going to be determined using a discounted cash flow, which can be easily manipulated.

I think that, to start out, cost would be an amazingly powerful way to measure intangible investment (see my previous discussions of this here). Today, most of this investment is expensed on the income statement. That means that very few companies even know how much they spend on intangibles. Let’s start with a firm metric–cost–before we graduate to sophisticated valuations of intangibles that we are only now beginning to understand.