Academic journal article Federal Reserve Bank of New York Economic Policy Review

Remarks on the Measurement, Valuation, and Reporting of Intangible Assets

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Remarks on the Measurement, Valuation, and Reporting of Intangible Assets

Article excerpt


Intangible assets are both large and important. However, current financial statements provide very little information about these assets. Even worse, much of the information that is provided is partial, inconsistent, and confusing, leading to significant costs to companies, to investors, and to society as a whole. Solving this problem will require on-balance-sheet accounting for many of these assets as well as additional financial disclosures. These gains can be achieved, but only if users of financial information insist upon improvements to corporate reporting.


In a recent paper, Leonard Nakamura of the Federal Reserve Bank of Philadelphia uses three different approaches to estimate the corporate sector's amount of investment in intangible assets. (1) The first approach is based on accounting for the investments in research and development (R&D), software, brand development, and other intangibles. The second uses the wages and salaries paid to "creative workers," those workers who generate intangible assets. The third approach, which is quite innovative, examines the changes in operating margins of firms--the difference between sales and the cost of sales. Dr. Nakamura argues, persuasively, that the major reason for improvement in reported gross margin is the capture of value from intangible assets, such as cost savings from Internet-based supply chains.

Although all three approaches yield slightly different estimates of the value of investments in intangible assets, the estimates converge around $1 trillion in 2000--a huge level of investment, almost as much as the corporate sector's investment in fixed assets and machinery that year. Dr. Nakamura estimates the capitalized value of these investments using a quite conservative depreciation rate. His conclusion is that the net capitalized value is about $6 trillion, a significant portion of the total value of all stocks in the United States.

One way to determine if this estimate of the value of intangible assets is reasonable is to compare the market values of companies with the book values (the net assets) that appear on their balance sheets to see if there is a large unmeasured factor. Data for the S&P 500 companies, which account for about 75 percent of the total assets of the U.S. economy, reveal that since the mid-1980s, there has been a large increase in the ratio of market value to book value, albeit with very high volatility. At its peak in March 2000, the ratio of market value to book value was 7.5. At the end of August 2002, it was 4.2, and it may still go down. However, even if the ratio fell to 4 or even 3, it would be sufficiently higher than it was in prior periods, and high enough to confirm that an amount of value equal to between one-half and two-thirds of corporate market values reflects the value of intangible assets.

Recently, Federal Reserve Chairman Alan Greenspan has been discussing what he calls "conceptual assets." In testimony to the House of Representatives in February 2002, he noted that the proportion of our GDP that results from the use of conceptual, as distinct from physical, assets has been growing, and that the increase in value-added due to the growth of these assets may have lessened cyclical volatility. However, he then argued that physical assets retain a good portion of their value even if the reputation of management is destroyed, while intangible assets may lose value rapidly. The loss in value of intangible assets by Enron was noted by Chairman Greenspan. Two weeks later, a major article in the Wall Street Journal asked where all the intangible assets have gone, mentioning Enron and Global Crossing specifically.

To investigate this issue, I asked one of my Ph.D. students to review the financial reports of these firms. The result was astounding: these companies did not spend a penny on research and development. …

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