Business models in many industries have evolved in the last decade to increasingly create economic value from investments in intangible assets, such as brands, technology, and customer relationships. And this intangible-centric approach has been more obvious since the start of the global pandemic. Companies have made and continue to make substantial investments that create or enhance the value of intangibles, which are inextricably linked to their strategy. They may, for example:
research new technologies,
cultivate customer relationships that form the basis for future revenue streams,
foster relationships with partners and service providers that complement in-house capabilities,
run advertising and promotions that enhance product recognition and brand affinity,
identify, hire, and nurture a workforce that can efficiently and effectively deliver on the company’s value proposition, or
develop strong processes, know-how, and trade-secrets that create efficiencies and value.
Since 2009, the implied market value of intangible assets at S&P 500 companies increased 255%, while the book value of tangible assets only increased 97% over the same period.
While this value creation has happened, the accounting model has remained unchanged. Current accounting guidance does not always recognize the value created by intangibles, either on the balance sheet or in the footnotes. Although hard assets, such as property and equipment, appear on company balance sheets, investments in internally-generated intangibles are generally expensed as incurred. As a result, a company’s most valuable assets often do not appear on its balance sheet. The result can be a large gap between the book value of the company and its market capitalization.
To enhance the relevance of financial reporting, we believe it will need to reflect the transition to a knowledge-based economy and provide greater insight into intangible investments. Communicating this information as part of the financial reporting process, rather than through other avenues, subjects it to the rigorous processes and controls in the financial reporting ecosystem that are designed to produce information that is reliable, consistent from year to year, and comparable between companies. This is especially important as investors are increasingly focused on a company’s environmental, social, and governance (ESG) strategy, which highlights management’s stewardship of certain intangibles, such as human capital.
The question is how financial statements can most effectively and efficiently communicate information about intangible assets to stakeholders. Given the wide array of intangibles, there may not be a one-size-fits-all approach. Instead, stakeholders may need to work together to develop a mixed model of recognition and disclosure to communicate the relevant decision-useful information.
Read the full article.