Accounting's Recognition of Intangibles: Response to Penman/CEASA - Why Marking Equity to Market Makes Sense - 'Divining Rods Unnecessary'

Abstract

Columbia University’s Center for Excellence in Accounting and Security Analysis (CEASA) recently distributed Stephen Penman’s June 2009 paper, “Accounting for Intangible Assets: There is Also an Income Statement”. Penman acclaims accounting’s “brilliance” and provides a reasoned argument as to why intangible assets should remain largely excluded from the balance sheet: Intangible assets are speculative. This essay summarizes Penman’s logic and offers a rebuttal. Grant that Penman is correct, that most intangibles are speculative, that speculative intangibles merit exclusion from the balance sheet, and that exclusion facilitates efforts of securities analysts to gauge a corporation’s fair value. Still, Penman’s basic premise merits closer scrutiny: What if an asset, while intangible, nonetheless has readily measurable value against which contracts are struck? What if its value can be monetized at will? How should such a “tangible intangible” be treated when the speculative element is, for all intents and purposes, entirely absent? From a strictly utilitarian standpoint, would recognition of “tangible intangibles” improve financial statements?“Equity market value added” or “GAAP’s gap”, the spread between a firm’s GAAP book value and its public equity market value, is a “tangible intangible” that Penman gives short shrift. The gap is a hallmark of “modern” accounting, and, for the typical public company, is quantifiable, substantial, and readily monetized. Penman’s opposition notwithstanding, marking equity to market would eliminate the gap and increase the utility of financial statements to their key constituency, corporate shareholders, as illustrated through the parable of Apex Securities and example adjusted financial statements.