By Neil Gross
As any business-school prof can tell you, the value of companies has been shifting from tangible assets--the bricks and mortar--to intangible assets, such as patents, customer lists, and brands. These are the keys to shareholder value in a knowledge economy, but our accounting system does little to acknowledge the shift. You won't find balance-sheet entries for those assets except in rare cases, even though at some companies they may account for the bulk of overall value. For example, at Apple Computer (AAPL), No. 49 in our rankings, brand value equals a huge 80% of market capitalization.
Ignoring those intangible assets may have been fine 30 years ago; not anymore. Investors need a sense of the assets' value and whether expenses to support them--such as advertising--are really productive. If accounting can't take stock of that, boards can't allocate capital intelligently, analysts can't evaluate the companies they cover, and investors can't get a fix on the market. "You end up with the blind leading the blind and being evaluated by the blind," says Jonathan D. Low, senior fellow at Cap Gemini Ernst & Young.
NEW RULES. Now, after years of dithering, architects of accounting rules are finally taking the first steps on the issue. It's a start, but more needs to be done. In June, the Financial Accounting Standards Board issued rules for how companies record assets in a merger. The rules, effective for most companies next Jan. 1, mean that when businesses acquire others using standard accounting, they will no longer have to amortize goodwill. That makes sense because most of those assets don't really depreciate. You don't wear out research or run out of brand power--at least most of the time.
Sometimes, however, those assets can be damaged, and the new rules require companies to recognize that. If your assets become impaired--say, your biggest brand suffers a massive safety recall--then you must account for the damage. To do so, companies will have to assign a value to the intangibles. Crusaders for accounting reform who care about knowledge assets applaud this outcome. "The idea that you will identify acquired intangibles and periodically measure what they are worth--this is definitely a move in the right direction," says Baruch Lev, accounting professor at the Stern School of Business and author of Intangibles: Management, Measurement and Reporting.
So why not go a step further and require companies to account for intangibles on the balance sheet all the time, regardless of whether or not there's a purchase? After all, in places such as Britain and Australia, companies already must, at times, report brand valuations on the balance sheet.
VOODOO ACCOUNTING? First of all, get real. It took the conservative FASB 30 years to make the latest set of changes. A quick, radical overhaul simply isn't in the cards. And that may not be the solution, anyway. When it comes to brands and other intangibles, says FASB Research Director Timothy S. Lucas, "there are very significant measurement and definition problems." Even the reformers seem content to go slow. "To get into the financial statements, information should be reliable," says Paul B.W. Miller, a professor of accounting at the University of Colorado and a longtime FASB watcher and critic. The biggest problem? Valuing intangibles, even using the most rigorous methodology, calls for subjective judgments--something accountants abhor.
There are, however, other ways to balance the need to track the value of intangible assets and the need for easily verifiable financial statements: Simply report the value of the intangible assets elsewhere in the financials--for example, in the footnotes. That way, investors would have at least some sense of whether their investment was gaining or losing value. Intentionally or not, FASB has put the need to value intangible assets front and center. BusinessWeek's new brand ranking will provide good grist for the whole debate. Senior Editor Gross writes about research, patents, and other intangibles.