FASB Statements 141/142 and the Business Economist—Where, oh where, have my intangibles gone? - Forum on Emerging Issues - Financial Accounting Standards Board

Business Economics, Jan, 2002 by Perry D. Quick, Mary T. Goldschmid

Although business economists seldom involve themselves in accounting details, recent changes in accounting rules provide fertile ground for economists to make productive use of their analytical skills in the valuation of intangible assets. Choices of what to report and how to value intangibles have important strategic as well as financial reporting implications. Helping management "get it right" can be an important role for the application of economics in business.

Last year at this time, new millennium accounting was all the rage. Academics such as Baruch Lev (2001), think-tanks such as Brookings (Blair and Wallman, 2001), accounting practitioners such Holman and Kahn (2001), and regulators such as the SEC (2001) and FASB were all advocating more disclosure about intangible assets and other "non-financial value drivers" in corporate financial reports. Recognition of the rising value of intangibles was going to explain why stock market prices had risen so far above book values and driven the success of the information-intensive "new" economy. "Get on the bandwagon," urged Eccles, et al. (2001) to their business clients; have a say in the accounting revolution by voluntarily disclosing internal metrics for "the leading indicators of financial performance," like brand value, innovativeness, customer satisfaction, management quality, and employee motivation and competency.

That was the season of springtime promise; but now, in the winter of corporate discontent, much has changed. With stock prices even lower, investors have grown impatient with unconventional measures and are clamoring for "hard" data on earnings and conventional financial ratios. Instead of seeking reasons why market values vastly exceed book values, investors are now more interested in the opposite: how stock prices could have fallen so much more than book values or any apparent erosion in a company's "knowledge capital." In the post-September 11 world, management is turning to accountants more for ways to express tangible losses than for speculation about intangible gains. In the post-Enron world, investors are asking whether some of those intangible values ever really existed.

But even if the "new" economy had continued to soar, many corporate executives would have resisted additional intangibles disclosures. After all, it does seem like giving away the crown jewels. To the degree that a company's intangible assets represent its intellectual secrets--the reasons it is able to compete effectively--why would anyone voluntarily go public with more financial data about how these secrets were created and valued? Wouldn't that just invite duplication from rivals and the erosion of competitive advantage? Moreover, wouldn't more disclosure about hard-to-measure intangibles invite shareholder lawsuits if that subjective disclosure proved misleading? If regulators were having difficulty with the idiosyncratic nature and non-comparability of pro forma earnings, what would they think about the ad hocracy of valuing intangibles?

Corporate executives' resistance increased with the June 2001 issuance of two new Statements from the Financial Accounting Standards Board--FAS 141 on Business Combinations and FAS 142 on Goodwill and Other Intangible Assets. (1) These two statements channel hope for what might have been a voluntary and open-ended reporting "revolution" into marching orders for narrowly defined financial drills. Like all FASB directives, FAS 141 and 142 call for only those changes in accounting practices that are objective and verifiable, and conducive to comparable standards and procedures across all enterprises and industries.

Effective July 2001, FAS 141 calls for greater identification of and separate accounting for intangible assets that were formerly treated as goodwill (i.e., when the purchase price of an acquisition exceeds its book value). It has a lengthy list of intangible assets that must be assigned dollar values for each of the company's "reporting units" or business segments. The intangible assets also must be given economic lives so that those values can be amortized as periodic operating expenses against the future income of the acquiring company. The list includes twenty-nine subcategories of intangibles in five main categories--marketing. customer-related, artistic-related, contract-based, and technology-based. The unifying characteristic of all the entries is that they either "arise from a contractual or other legal right" or are "capable of being separated...and sold, transferred, exchanged, rented or licensed." Thus, entries like "noncompetition agreements," "advertising jingles," and "secret formulas, processe s, and recipes" meet the contractural-legal criterion; while entries like "noncontractual customer relationships," "unpatented technology," and "databases" satisfy the capable-of-separated/sold criterion. It will take an enormous effort for most companies to determine how the new rules expand current accounting for intangibles; and there will doubtless be both internal and auditor-client disagreements over what deserves separate recognition, especially if it is not expressly on "The List" (such as brand value, interestingly enough). Another prime area for controversy is whether an intangible has an "indefinite" life or a "definite" life, and if so, what that definite life is. Other squabbles may arise over how asset values are assigned to relevant "reporting units" or business segments within a company.