As previously announced, we will be having our first Round Table Discussion hosted by a preparer this week when Bob Laux (Microsoft) joins us on Wednesday at 11 am ET.  Given Bob’s wide-ranging interests and expertise, Wednesday’s discussion promises to be engaging and informative!

As if there weren’t already enough to discuss given Bob’s tentative agenda, CEASA recently put out a new occasional paper by Stephen Penman on accounting for intangible assets.  In the paper, Penman argues that the balance sheet omits many valuable assets by failing to pick up intangibles.  Rather than concluding that this necessarily detracts from the usefulness of financial statements, Penman argues that the income statement can be used to extract information about intangibles and that it can, under certain conditions, conceivably do a better job than the balance sheet in conveying the value of intangibles to financial statement users.

This argument (that the income statement can substitute for the balance sheet in conveying information about assets) is somewhat provocative and would seem to be at odds with the balance-sheet perspective adopted by the FASB when developing its conceptual framework.

I mention the Penman paper here because the issue of intangibles is highly relevant to Microsoft.  Penman even uses Microsoft as a case study in the paper.  Below, I quote from the conclusion of the paper:

The examples with Microsoft and Dell, two companies to whom “intangible assets” are often attributed, demonstrate that accounting, handled appropriately, is not backward looking, but reports forward looking information from which value can be estimated.

Of course, income statements may not always be as rich as those for seasoned firms like Microsoft and Dell. Indeed, for a start-up reporting losses, the accounting can be quite uninformative. But one has to ask whether there is an accounting solution that solves the problem. A start-up is the most speculative of firms, possibly with no product developed yet from its R&D, no government approval for its drug, and no sales. Guessing the likely outcome for these firms and putting it into the balance sheet (or even capitalizing expenditures) would be very speculative accounting. I tell my students who ask how to value a start-up biotech: Go and get a PhD in biochemistry; it is not an issue that accounting can solve.

The paper aims not to discourage research into accounting for intangible assets, but to put it in perspective. As with any accounting research, the researcher needs to start with an understanding of how accounting works to indicate value, and focus on the balance sheet alone is misconceived. The issue of capitalization and amortization of expenditures on intangible assets is very much alive, but developing amortization schedules that improve rather than damage earnings is a challenge.

I, for one, am interested in getting Bob’s perspective on the role of balance sheet measurement in measuring performance and also what he thinks about the issue of intangibles assets given his experience at Microsoft.

Be sure to join us for what promises to be a fascinating discussion!

Disclaimer: The views expressed here are my own and do not represent positions of the Financial Accounting Standards Board. Positions of the FASB are arrived at only after extensive due process and deliberations.