Accounting for Intangible Assets: There Is Also an Income Statement

Accounting is often criticized for omitting intangible assets from the balance sheet. With value in firms of today flowing less from tangibles assets and more from so-called intangibles -- brands, distribution systems, supply chains, "knowledge capital," "organization capital" -- accounting is seen as remiss, with high price-to-book ratios as evidence. The remedy often proposed involves booking these intangible assets to the balance sheet. This paper makes the point that accounting is not necessarily deficient in omitting intangible assets from the balance sheet: there is also an income statement, and the value of intangible (and other) assets can be ascertained from the income statement. For example, although The Coca-Cola Company does not report its brand asset on its balance sheet (and trades about five time book value), earnings from the brand flows through its income statement. Thus the firm is readily valued from its earnings; the income statement remedies the deficiency in the balance sheet. Accordingly, accounting that calls for the recognition of "intangible assets" on the balance sheet may be misconceived. The paper explores the case where the income statement perfectly corrects for a deficient balance sheet, and the case where it does not. It then explores whether, in the latter case, accounting in the balance sheet -- by capitalization and amortization of intangible assets or carrying them at fair value -- could remedy the deficiency in the income statement (or makes it worse). The investigation involves an analysis and valuation of Microsoft Corporation and Dell, Inc., two companies presumed to possess a good deal of "intangibles assets." The paper is instructive, not only to those concerned with accounting issues, but also to analysts attempting to value firms with assets missing from the balance sheet. It shows how to handle the accounting information in valuation and how to deal with the perceived deficiencies, real or imagined, with respect to intangible assets. In the case of Microsoft and Dell, the reader can observe at how close one comes to their market valuation by using valuation techniques that use accounting information currently provided by GAAP

Fair Value Accounting in the Banking Industry

This paper studies the application of fair value accounting in bank holding companies in the United States with the purpose of evaluating the effects of expanding fair value accounting in the banking industry. The paper documents the current application of fair value accounting in the industry, showing what proportions of recognized assets and liabilities of bank holding companies are at or close to fair value on the balance sheet, have related unrealized gains and losses in income, or have fair values disclosed in the footnotes. In each case, it evaluates the advantages and disadvantages of the current treatment and makes an assessment of the magnitudes of economic assets and liabilities that currently are omitted from the balance sheet. Turning to the issue of the likely impact of expanded application of fair values, the paper asks how large are the actual and potential differences between fair values and book values of various assets and liabilities and how credit, interest rate and prepayment risks are likely to determine those differences. It considers the availability of market-based information for measuring fair value and evaluates the correlations between fair values of economic assets and liabilities due to natural hedges, asset-liability management, and changes in asset values affecting the risk and value of liabilities. It also addresses the issue of how a switch to fair value accounting would mitigate or, alternatively, facilitate earnings management activities. The primary conclusion of the analysis is that expanding fair value accounting is not likely to significantly improve the information in bank financial statements and, in some cases, may introduce distortions that reduce accounting quality. The analysis is pertinent to bank analysts and investors for it not only documents the impact of fair value accounting on banks but also informs about the drivers of value and risk on which accounting should report

Debt vs. Equity: Accounting for Claims Contingent on Firms' Common Stock Performance with Particular Attention to Employee Compensation Options

This paper lays out a comprehensive solution to the problem of accounting for claims based the performance of a firm's stock price. The accounting covers employee stock options, stock appreciation rights, put and call options, convertible debt and preferred stock, warrants, and other hybrid securities. This issue has vexed the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) who have approached the problem on a piecemeal basis, leading to inconsistent treatments of claims that in substance are very similar

On the Balance Sheet-Based Model of Financial Reporting

The FASB adopted a balance sheet-based model of financial reporting about 30 years ago, and this model has been gradually expanded and solidified to become the required norm around the world today. Currently, the FASB and the IASB are re-considering their Conceptual Framework, and this is the right time to have a much-needed debate about the proper conceptual foundations of accounting. This paper argues that the balance sheet orientation of accounting standard-setting is flawed, for the following reasons: 1. Accounting is supposed to reflect business reality, and thus the essential features of the financial reporting model need to reflect the essential features of the underlying business model. However, the balance sheet orientation of financial reporting is at odds with the economic process of advancing expenses to earn revenues, which governs how most businesses create value, and which represents how managers and investors view most firms. 2. The adoption of the balance sheet approach was driven by conceptual considerations; standard setters argued that the concept of assets is more fundamental and logically prior to the concept of income. However, this paper argues that the concept of income is clearer and practically more useful than the concept of assets, especially with the recent proliferation of intangible assets. 3. Earnings is the single most important output of the accounting system. Thus, intuitively, improved financial reporting should lead to improved usefulness of earnings. However, the continual expansion of the balance sheet approach is gradually destroying the forward-looking usefulness of earnings, mainly through the effect of various asset re-valuations, which manifest as noise in the process of generating normal operating earnings. During the last 40 years, the volatility of reported earnings has doubled and the persistence of earnings has gone down by about a third, while there is little change in the properties of the underlying business fundamentals. 4. The balance sheet approach has pushed accounting into incorporating more and more valuation estimates into financial reports, creating tautological and dangerous feedback loops between financial markets and the real economy. The paper concludes with two suggestions about a "good" model of financial reporting. The first suggestion is that accounting needs to make a sharp theoretical and practical distinction between operating and financing-type activities and assets, and this distinction needs to be reflected in all financial statements. The second suggestion is that for most firms the accounting for operating activities needs a renewed emphasis on the principle of matching of expenses to revenues

The Design of Financial Statements

This paper proposes a redesign of financial statements. It is written in response to proposals by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to revise the presentation of financial statements. The paper is not an evaluation of the Boards’ proposals, but rather a stand-alone design developed from first principles to contrast with those proposals. After a hiatus, the IASB and FASB recently returned to the issue, so this document is offered as a contribution to that effort. The aim of the design is to reformulate financial statements in a way that reflects the operations of the business. Accordingly, the design readies the financial statements for an analysis of the performance of a business, the valuation of the business, and an evaluation of the stewardship of management. In practical terms, financial statements can then be loaded into an analysis spreadsheet without the cumbersome adjustments that often have to be made with the current financial statements. The paper largely endorses the approach proposed by the Boards while varying significantly in the implementation. Like the Boards’ proposals, it is built around three key ideas: (1) the cohesion between financial statements is an important aspect of accounting that conveys information that needs to be brought to the fore, (2) activities to do with a firm’s business operations should be clearly distinguished from activities that involve the financing of the business, and (3) disaggregation in the financial statements should be made with the objective of enhancing information about future cash flows. The architecture in the paper in built in three steps. First, the bottom-line numbers in each financial statement―the totals to which all other line items aggregate―are specified under the principle that the financial reports are to report faithfully to shareholders. Second, subtotals that sum to those bottom-line numbers are identified under the principle of distinguishing operating activities from financing activities. Third, further disaggregation is carried out under the principle of providing further information about the future cash flows. With this breakout of financial statement information, the paper shows how the component parts of financial statements connect to each other to provide information that adds to that in each financial statement—thus bringing the cohesion principle into life. A key feature of the design is the recognition that the accounting system is organized by a set of accounting relations—an accounting structure—that can be exploited to convey information. That is, financial statements convey information, not only through the accounting for individual line items, but also in the way those line items are organized in the financial statements and aggregated into totals according to this structure. Employing the structure to organize financial statements in a form that aligns with the way firms operate significantly enhances their information content

Moving the Conceptual Framework Forward: Accounting for Uncertainty

To meet the objectives of financial reporting in the IASB's Conceptual Framework, the 'balance-sheet approach' embraced by the Framework is necessary but not sufficient. Critical, but largely overlooked, is the role of uncertainty, which we argue defines the role of accrual accounting as a distinctive source of information for investors when investment outcomes are uncertain. This role is in some sense paradoxical: on the one hand, uncertainty undermines both the balance sheet (because uncertain assets are unrecognized) and the income statement (because mismatching is unavoidable). However, these inevitable accounting effects can be exploited to provide information about uncertainty, though not by a balance-sheet approach alone. Rather, criteria for balance sheet recognition and measurement, and for income statement presentation, are established by consideration of the impact of uncertainty on matching and mismatching in the income statement. This combination of balance-sheet and income-statement approaches enhances the communication of information to investors under conditions of uncertainty, thereby giving greater clarity and purpose in satisfying the objective of the Framework to provide information about "the amount, timing, and uncertainty of future cash flows"

PET Imaging a MPTP-Induced Mouse Model of Parkinson’s Disease Using the Fluoropropyl-Dihydrotetrabenazine Analog [18F]-DTBZ (AV-133)

Parkinson’s disease (PD) is characterized by the loss of dopamine-producing neurons in the nigrostriatal system. Numerous researchers in the past have attempted to track the progression of dopaminergic depletion in PD. We applied a quantitative non-invasive PET imaging technique to follow this degeneration process in an MPTP-induced mouse model of PD. The VMAT2 ligand 18F-DTBZ (AV-133) was used as a radioactive tracer in our imaging experiments to monitor the changes of the dopaminergic system. Intraperitoneal administrations of MPTP (a neurotoxin) were delivered to mice at regular intervals to induce lesions consistent with PD. Our results indicate a significant decline in the levels of striatal dopamine and its metabolites (DOPAC and HVA) following MPTP treatment as determined by HPLC method. Images obtained by positron emission tomography revealed uptake of 18F-DTBZ analog in the mouse striatum. However, reduction in radioligand binding was evident in the striatum of MPTP lesioned animals as compared with the control group. Immunohistochemical analysis further confirmed PET imaging results and indicated the progressive loss of dopaminergic neurons in treated animals compared with the control counterparts. In conclusion, our findings suggest that MPTP induced PD in mouse model is appropriate to follow the degeneration of dopaminergic system and that 18F-DTBZ analog is a potentially sensitive radiotracer that can used to diagnose changes associated with PD by PET imaging modality