The IASB/FASB recently affirmed an earlier decision not to rewrite standards on inventory cost accounting as part of its revenue recognition project.  Other than the limited guidance already covered in the proposed new standard (on topics such as setup costs for service contracts, precontract costs, and inventory of a service provider), the boards have left untouched the issue of inventory accounting. As a result, many obscure, albeit long held and traditional practices of accounting for costs will continue.

As an example, the practice of spreading the upfront costs of developing a new line of aircraft across the expected number of airplanes that will be built over the production run will continue under the new standard. This method of inventory accounting is often referred to as program accounting, but was never an officially approved Statement of Position. Instead, a draft SOP was created in 1981, and so many airline manufacturers began (or continued) following it that it became part of US GAAP because of its widespread use. Today, it is only referred to in passing as part of FASB ASC 912-20-25-5A. Still, it is widely used by airline manufacturers to defer large upfront development and so-called learning curve costs across the entire expected production run for a particular aircraft. (For a good description of this accounting, read the IASB Revenue Recognition Board Memos for May 31, 2011 covering this topic.)

Some will cry foul because they think many of these deferred costs are nothing more than accounting “watchamacallits” used to smooth earnings over time. But I wonder if the deferred costs (sometimes called know-how assets) aren’t simply a way of recognizing an intangible asset that standard setters are otherwise unwilling to recognize in other industries. If so, why do standard setters allow the recognition of this intangible asset for airline manufacturers, but are loathe to do so in other industries?

We may not be able to answer that question, but maybe as academics we can ask whether these know-how assets for airline manufacturers are predictive of or correlated with the value of the company. Is there prior research that examines how predictive of future cash flows these know-how assets are? How are market returns correlated with changes in the value of know-how assets? If there is not prior research, maybe some enterprising doctoral student or faculty member could look into this relationship and post some preliminary results.

My point here is not to criticize the boards’ decision not to pick up the issue of cost accounting as part of the revenue recognition project. Instead, I want to entertain the possibility that these deferred costs in the airline manufacturing industry are actually intangible assets worth reporting, even though many financial statement users probably understand that the underlying estimates are very subjective. These know-how assets likely provide decision useful information in that they are helpful in predicting the timing, amount, and uncertainty of future cash flows, and we as academics may be able to shed some light on that question. Any takers?