The rise of intangibles and the demise of accounting

> Now take company N which is a “New Economy company”. It invests $10M in R&D to create software. This software will continue to be useful in the future, but per GAAP accounting, it will expense all of the $10M this year. So in year 1, the impact on earnings of this investment is a $10M expense, and the balance sheet reflects nothing.

This is wrong. R&D gets capitalized to the extent it has future benefits.

> " In addition, let’s say they spend $10M to acquire recurring revenue customers. They will earn revenue from these customers for many years in the future, but many of the costs are expensed immediately."

This is also wrong. Under revenue recognition rule (ASC 606) any costs to acquire customers are recognized on the balance sheet and not expensed immediately.

I stopped reading because it's clear the author isn't writing a factual article.

It is common for software development expenses to be capitalized and expensed over time (depreciated).

A lot of what shows up as intangibles is from M&A activity. If the acquirer paid more than book value for a company, then all of the remainder goes into intangibles (goodwill).

The write-up argues that non-physical assets (software) show up as intangables (balance sheet) then argues that they are expenses (income statement). It doesn't make sense.

I don't follow what the article is arguing, and it seems to draw big and likely incorrect conclusions from loosely related accounting terms and data points.

First, the blog post does cite "The End of Accounting" by Lev and Gu, which provides a pretty good academic dive into this topic and I'd recommend to anyone who likes this post: https://www.amazon.com/Accounting-Forward-Investors-Managers...

Second, in conversations with professional investors (firm with AUM >$1B), their analysts and portfolio managers have been making these kind of intangible asset adjustments for years, if not decades, now. That's the whole point of having professional investment analysts, especially at "value" firms; they wouldn't be able to generate alpha if they weren't trying different methods to identify opportunities. So all this "intangibles" chatter that's become popular in tech media isn't news to the investment community.

Third, the big question inspired by the book but not covered as much in this blog post is: If investors are already making valuation adjustments for intangible assets, and company's are having to estimate a lot of the accounting inputs anyway, then is it better to try and fix/update GAAP, or can we just reduce the regulatory paperwork burden for public companies and have investors demand the metrics for each company that they feel are relevant?

Fourth, this post is a good overview of the topic and something anyone in a business role at a tech company (and ideally eng/prod/design as well) should understand.

I feel like the article highlights an interesting point, but stops short of speculating what would happen if the accounting rules were updated? I know in my country, that intangibles are not expenses, but assets. Because that makes them taxable.

If anything, it is a boon for these intangible-majority companies, that R&D can be written off as expenses, because that can make for a favourable tax report.

But regardless of all that, accounting will still be necessary to account for a company's finances, so it's hardly a demise of accounting. I may have misheard, but I believe to recall, that modern companies often keep two accounting books, one for the officially required accounting, and one that - they feel - better reflects their actual financial situation.

Neat. While the intangible share increases, there will always be a baseline intangible share -- the wires of the internet, to give a coarse and simple analogy. What do you propose in improving balance sheets to keep track of abstract entities such as IP and brand? These quantities hardly seem measurable until they translate into "actual dollars" which may or may not happen.

This is becoming less of an issue practically with the transition to SaaS (both on provider and consumer end). For the rest of intangibles I don’t see how it’s any different compared to old state. Let’s keep in mind many of these things are also inflated in practice because of acquisitions.

The idea that book value is insufficient to value a company is decades old. I remember learning about it during the first few weeks of business school.

The author's statement that goodwill gets expensed immediately is incorrect, as can be verified by consulting any introductory accounting textbook. (The whole point of goodwill is to make sure that an acquisition doesn't have an immediate impact on today's reported income. So expensing goodwill immediately would defeat the purpose.)

The chart showing how enterprise value is comprised of tangible and intangible assets confused me. There's nothing that says enterprise value (market value of the company's stock, plus debt) must equal the sum of intangible+tangible assets, and it's actually pretty unlikely.

>R&D is for new economy companies what purchasing PPE is for the old ones

Struggling to follow a bit here. Am I missing a similarity that should be obvious? Or is this saying that PPE purchased for use in R&D would be expensed versus capitalized if intended for use in revenue-generating activities?

A better recent piece on the subject: https://www.morganstanley.com/im/publication/insights/articl...