Accounting for Non-Physical Assets in Commercial Operations
In the dynamic world of business, intangible assets have become a significant factor in shaping the financial landscape. These assets, such as brands, patents, and customer lists, often go unnoticed in traditional financial statements but play a crucial role in a company's value and performance.
Two competitors may have different balance sheet and income statement results if one purchases a customer list and records it as an asset, while the other develops it internally and expenses the costs. This discrepancy highlights the importance of recognising intangibles as assets, as it can provide a more accurate representation of a company's true worth.
A recent book argues that financial accounting needs to record more intangibles as assets to make it relevant to investors. This call for change is supported by the fact that intangibles now account for a substantial portion of a company's market value. For instance, up to 84 percent of the market value of S&P 500 entities is intangible, an increase from 32 percent 30 years ago.
Companies like Google, Alphabet Inc., Apple, and Microsoft have created significant intangible assets in recent years, such as brand value, proprietary software, patents, and customer data. However, due to accounting rules, these assets often are not fully listed on their balance sheets. Instead, they present these values to investors through detailed disclosures in financial reports, management commentary, investor presentations, and estimated metrics such as brand valuation or R&D capitalisation.
Take Google, for example. Interbrand values the Google brand at over $120 billion, implying substantial unrecorded intangible assets. Yet, Alphabet Inc.'s 2015 balance sheet lists Property, Plant, and Equipment (PPE) at $29.0 billion and intangible assets at only $3.8 billion. Similarly, The Coca-Cola Company's value stems from its brand and secret formula, not from its bottling plants or other PPE. The company's 2015 balance sheet records trademarks at $6.0 billion while PPE is $12.6 billion.
Despite the importance of intangibles, the accounting for these assets can be complex. Intangibles can be impaired if they lose their value, but the accounting for intangible assets may not matter much because most intangibles aren't recorded as assets to begin with. Moreover, the FASB requires internally generated intangibles to be expensed, not recorded as assets, due to the lack of a purchase price and difficulties in determining future benefits and measurability.
However, this doesn't mean that the value of intangibles is irrelevant. Managers are increasingly attempting to communicate how their activities are creating value since the financials, in the view of many capital market participants, are not reflecting entities' economic performances. By providing detailed disclosures and emphasising intellectual property and user base growth, companies are trying to convey the economic value beyond the recorded book value.
Articles comparing financial statements to intangible asset economic activities may garner an interested readership, shedding light on the hidden wealth that lies within these intangible assets. As the world continues to evolve, it is essential to understand the role of intangibles in shaping a company's value and performance.
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