Introduction
The measurement of intangibles is nothing new. Humans have
been measuring intangibles for a long time. Whenever a teacher assigns a grade,
they are measuring an intangible (the student’s knowledge). Whenever a boss
gives or does not give an employee a raise or a bonus, they are implicitly
measuring the employee’s skill level and value added to the company. Whenever a
customer chooses one color, make, and model of a car over another, they are
measuring a number of intangibles. Whenever an investor buys a company’s stock
based on an expectation of future gain, they are investing in intangibles.
Until recently, however, macroeconomics treated intangibles
as residuals. The most famous examples are Solow’s residual[1] and
Tobin’s Q.[2] With the
rise of endogenous growth theory and the recognition of the importance of
intangibles as drivers of economic value, more attempts have been made to
specifically measure the value of intangibles. As part of this effort,
intangibles have come to be seen as assets (stocks) as well as expenditures
(flows). These efforts have advanced progress to quantify intangibles. However,
as this summary paper will show, a number of important issues remain
unresolved.
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What are intangibles?
The first step in measuring intangibles is to define them.
There are numerous frameworks with variations upon variations. The Value
Measurement & Reporting Collaborative found more than 80 approaches or
frameworks of value and performance measures.[3]
We must first distinguish between descriptors and measures
of intangibles, and descriptors and measures of value drivers and performance
measures (financial and non-financial).
Performance measures are outcomes. They can be final
outcomes, such as customer satisfaction or profit per employee. They can be
intermediate outcomes, such as the number of turns per table at a restaurant.
In some cases, they are actually inputs used as (mostly imperfect) surrogates
for outcome, e.g., research and development (R&D) spending as a measure of
knowledge creation. On a macro level, economic indicators, such as gross
domestic product (GDP), unemployment, and inflation, and social indictors, such
as education level and life expectancy, are all performance measures.
There are numerous performance measures that touch on
intangibles at the international, national, state, and local levels. Some
common examples are the number of patents, the percent of the workforce with
higher degrees in science, technology, engineering, and mathematics (STEM), the
level of entrepreneurial activity, and the level and availability of venture
capital. (Because the broader “Innovation Vital Signs” project focuses on these
measures, they will not be discussed in this report.)
Value drivers are factors that cause an increase in
important performance measures. Some argue that intangibles are the same as
value drivers. For example, Cummins, as notes:
Intangible capital is not a
distinct factor of production as is physical capital or labor. Rather, it is
the “glue” that creates value from other factor inputs.[4]
In some cases, value drivers are simply measured directly as
inputs. Many have been selected based more on a black-box approach rather than
on a rigorous model. For example, R&D spending has long been accepted as a
value driver in most economies and industries, and numerous studies show the
return on R&D spending.[5] However,
there are also reports that raise questions about the relationship between
simply spending money on R&D and achieving desired performance outcomes.[6]
There are a number of frameworks that connect external
factors and internal inputs with intermediate variables and performance
measures and then with ultimate financial outcomes. These models allow managers
to understand the key value drivers of their specific industry and how those
value drivers can be enhanced. Such models include The Balanced Scorecard,[7] the Danish
Intellectual Capital Statement,[8] the
Skandia Intellectual Capital Navigator,[9]
Intellectual Assets Monitor,[10] the
PriceWaterhouseCoopers (PwC) ValueReporting,[11] the KPMG
Value Explorer,[12]
and, from the now defunct accounting firm of Arthur Andersen, Value Dynamics.[13]
A more direct model that links intangibles to company
performance is Jonathan Low’s and Pam Cohen Kalafut’s Value Creation Index.[14] Their
model is based on the following intangibles: [15]
•
Management/Leadership
•
Strategy Execution
•
Communication
•
Transparency.
•
Organization
•
Technology and Processes
•
Human Capital
•
Workplace Organization and Culture
•
Innovation
•
Intellectual Capital
•
Adaptability.
•
Relationships
•
Brand Equity
•
Reputation
•
Alliances and Networks.
The model links
specific value drivers to intangible assets and then to company financial
performance.
While the Low and Kalafut model provides a framework for
categorizing intangibles, there is one more aspect to consider: how to
differentiate between assets and capabilities. The European Union (EU)-funded
PRISM project has developed a framework for this differentiation. The framework
is a spectrum that runs from tangible goods to intangible goods to intangible
capabilities to latent capabilities. Tangible assets are both physical assets,
such as plants, equipment, and inventory, and financial assets, such as cash,
securities, and investments. Intangible goods include contracts, licenses,
copyrights, patents, trademarks, and brands. Intangible competencies are the
non-price factors of competitive advantages, often referred to as “distinctive”
or “core” competencies. Latent capabilities include leadership, workforce
skills, organization, and innovation capabilities.[16]
Not all intangible assets have
the same characteristics. A Brookings Institution study on intangibles assets
divided them into these three levels:
Level 1—assets that
can be owned and sold
Level 2—assets
that can be controlled but not separated out and sold
Level
3—intangibles that may not be wholly controlled by the firm.[17]
Level 1 includes not only intellectual property (IP) but
also items such as contracts and business agreements, licenses and franchise
rights, quotas and resource allocations (e.g., airport landing rights and water
rights), and employment contracts. Level 2 describes those areas proprietary to
a specific firm, but that are difficult to separate from the ongoing operation,
such as business secrets, in-process R&D, and business processes. Level 3
includes items often referred to as human capital, such as core competencies,
organizational capital, and relationship capital.
A slightly different version of this comes from Zambon, et
al.[18] Like the
other studies, this framework defines intangible assets as “non-physical
sources of expected benefits.” There are three subcategories—
Intellectual Property—Intangible
assets with legal or contractual rights, including patents, trademarks,
designs, licenses, copyrights, film rights, and mastheads.
Separately Identifiable Intangible
Assets—Information systems, networks, administrative structures and processes,
market and technical knowledge, human capital (if embodied in a codified form),
brands, intangibles embodied in capital equipment, trade secrets, internally
generated software, and drawings.
Goodwill (Non-separable Intangible
Assets)—Prior intangible investments embodied in organizations, management expertise,
geographical position, or monopoly market niche.
One of the most common frameworks for intangibles comes from
the EU’s MERITUM (Measuring Intangibles to Understand and Improve Innovation
Management) project, commonly known as the three C’s:
Human capital is defined as the knowledge that employees take with
them when they leave the firm. It includes the knowledge, skills, experiences
and abilities of people. Some of this knowledge is unique to the individual,
some may be generic. Examples are innovation capacity, creativity, know-how and
previous experience, teamwork capacity, employee flexibility, tolerance for
ambiguity, motivation, satisfaction, learning capacity, loyalty, formal
training and education.
Structural capital is defined as the knowledge that stays within
the firm at the end of the working day. It comprises the organizational
routines, procedures, systems, cultures, databases, etc. Examples are
organizational flexibility, a documentation service, the existence of a
knowledge centre, the general use of Information Technologies, organizational
learning capacity, etc. Some of them may be legally protected and become
Intellectual Property Rights, legally owned by the firm under separate title.
Relational capital is defined as all resources linked to the
external relationships of the firm, with customers, suppliers or R&D
partners. It comprises that part of Human and Structural Capital involved with
the company’s relations with stakeholders (investors, creditors, customers,
suppliers, etc.), plus the perceptions that they hold about the company.
Examples of this category are image, customers loyalty, customer satisfaction,
links with suppliers, commercial power, negotiating capacity with financial
entities, environmental activities, etc.[19]
These frameworks highlight another issue in
measurement: What is an asset? Accounting rules define an asset as something
having a probable long-term economic benefit.
An asset has three essential characteristics: (a)
it embodies a probable future benefit that involves a capacity, singly or in
combination with other assets, to contribute directly or indirectly to future
net cash inflows, (b) a particular entity can obtain the benefit and control
others' access to it, and (c) the transaction or other event giving rise to the
entity's right to or control of the benefit has already occurred.[20]
In the case of intangibles, this definition leads to some
ambiguity as to what is an asset and what is an expense. As this report will
touch on, different intangibles are treated differently depending on the
circumstances. The core issue is how the expenditure on an asset is treated: as
an immediate expense; as an asset with a short life (that depreciates quickly);
or as asset that is long-lived (that depreciates over a period of time).
There is also the unit-of-analysis issue. Intangibles can be
measured on two levels: macro- and microeconomic. Macroeconomic measures look
at the treatment of intangibles in the System of National Accounts.
Microeconomy revolves around company-level accounting and financial reporting
procedures. The remainder of this report will summarize ways to measure
intangibles at both levels.
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Macroeconomic-level intangibles
An important earlier look at a macroeconomic measurement of
intangibles was a 1987 internal Organisation for Economic Co-operation and
Development (OECD) memo that outlined the four areas of intangible investments:
R&D, software, training, and marketing.[21] That
study reportedly showed that intangible investments had grown more rapidly than
Gross Fixed Capital Formation between 1974 and 1984.[22]
A
version of this formulation is still used to publish the “Investment in
Knowledge” section of the OECD Factbook.[23] The data
is a summation of expenditures on R&D, higher education, and software (Figure
1). The United States Government uses a similar approach to report on the
federal budget.[24]
That report includes physical capital investments, federally funded research
and development, and federally funding education and training (Appendix A).
Figure 1. Investment in Knowledge in
OECD Countries
(As a percentage of
GDP, 2002 or latest available year)

Source:
OECD Factbook 2006—Economic,
Environmental and Social Statistics Statlink. http://dx.doi.org/10.1787/213340280004.
In
1992 and again in 1999, OECD held a roundtable on the subject. The 1999 Amsterdam
conference[25]
produced a number of papers that included a theoretical outline by Young[26] and a
discussion of data collection by Vosselman.[27] Another
important contribution was a compilation by OECD of various national studies
estimating intangible investments—both as part of the 1992 workshop and as part
of subsequent studies.[28]
For the most part, the national studies used the four
categories of R&D, software, education, and training, with some variations
and minor expansions. For example, France,
the United Kingdom,
and the Netherlands
included purchase of foreign licenses. Some portion of the value of
intellectual property was included by Finland
and the Netherlands.
Finland, the Netherlands,
and Norway also
included organizational development, the services of management consultants,
and worker preventative health measures, respectively.
The Young paper outlined a more comprehensive
framework based on those national studies (see Appendix B for the entire
list). However, in the end, six core areas emerged from the review. The first
was software, including large databases. Then next was R&D, including
technology purchased from abroad (licenses). In addition, there was some
discussion of whether patents should be included as part of R&D or under
another category. Industrial design and artistic design were also discussed,
but not seen as core components. Formal training was seen as core, but informal
training, along with preventative health benefits, were viewed as hard to
measure. Organization of the firm was seen as core, but there was no clear
method of measurement. Marketing, mineral exploration rights, and the
production of entertainment, literary, and artistic originals were also seen as
core. However, it was suggested that non-producing rights, such as milk quotas,
be excluded.
The Vosselman paper took the Young review and put it into a
slightly different systematic framework for data collection (Appendix C).
Core elements of this formulation are R&D; education and training;
software; marketing; rights, including licenses, brands, copyrights, and
patents; and mineral exploration. He also incorporated a set of supplementary
categories of intangible investments, which included the development of the
organization; engineering and design; construction and use of databases;
remuneration for innovative ideas; and other human resource development,
excluding training.
Vosselman noted that many of these areas are already subject
to OECD data-collection guidelines. These include the Frascati Manual for science and technology statistics, the Oslo Manual for
innovation statistics, the Technology Balance of Payments manual, and the Manual
for Better Training Statistics.[29]
Some are also already included in the international
guideline for collecting National Accounts data.[30] However,
the National Accounts treat all of these as expenditures rather than
investments. There is some ongoing work to include these as investments in the
so-called satellite accounts, which look at specific areas of economic
activity. For example, the Bureau of Economic Analysis issued a preliminary
Research and Development Satellite Account late last year showing that—
If R&D were included in the GDP
as investment instead of as an expense, business investment would be 11
percent, or $178 billion, higher; and the 2002 national savings rate would be
16 percent instead of 14 percent.[31]
Obviously, incorporation of other intangibles into the
National Accounts as investments rather than expenses would have similar
implications.
To measure intangible investments in the United
States, Nakamura used a broader definition
of knowledge investments, which included R&D, advertising and marketing,
software, financial activities, and the creative activities of writers,
artists, and entertainers.[32] He estimated the value of U.S.
gross investments in intangibles to be at least $1 trillion annually.
Nakamura used three separate methods for calculating intangibles. The
first was direct expenditures of private R&D, software expenditures, and
advertising/media costs. This came to $597 billion or 6 percent of U.S. GDP in
2000. He then added $50 billion for financial corporations and $50 billion for
publishing, motion pictures, and sound recording. He viewed the subsequent
total of nearly $700 billion as conservative because it did not include R&D
by individuals and unincorporated businesses or the administrative and direct
training costs of adopting new software. The figure also did not account for investments
in productivity-enhancing changes in business processes, education, or employee
training.
The second estimate used data on the size and median pay of workers in
creative occupations—specifically engineers, scientists, writers, and artists.
These workers earned almost 10 percent of all wages and salaries. Again, this
figure was viewed as conservative because it did not account for managerial and
other inputs or include the creative work of other professions, such as doctors
and teachers.
The third estimate used the cost of goods sold. If companies have been
increasing intangible expenditures in areas such as R&D and marketing,
there should be a decline in the percentage of total expenditures on direct
production cost (as measured by cost of goods sold). Nakamura estimated that
since 1980, the proportion of total revenues made up of the cost of goods sold
fell by 10 percentage points. That is in line with other estimates pegging the
size of direct expenditures on intangibles and the size of payroll on
intangibles at 6 percent to 10 percent.
Nakamura also used an indirect method to measure investment in
intangibles. He argued that economic theory and evidence shows that the ratio
of consumption to gross domestic product should be relatively stable—if all
investment (tangible and intangible) is properly counted. But if intangible
investments are not counted in GDP, then any rise in the consumption ratio will
indicate the size of the unmeasured investments. He estimated the size of the
unmeasured intangible investment to be “$910 billion in 2000, with a 5 percent
confidence interval of plus or minus $200 billion. Adding in the $230 billion
in software investment that was measured in that year, we arrive at a lower
bound estimate of U.S. gross investment in
intangibles of $1.1 trillion.”[33]
Webster undertook a calculation for the Australian economy
using one different and one similar method. The first (and different) method
used stock market data to derive the level of intangible assets. The second
method, similar to Nakamura’s, estimated the investment in intangibles based on
the employment of those in occupations that produce intangibles. Webster’s
goal, however, was to calculate the rate of growth of intangible investments,
not the absolute size of those investments. Her conclusion was that the ratio
of intangible capital to overall capital in Australia
grew at an average annual rate of 1.3 percent between 1948 and 1998.[34]
Another calculation of intangibles, using international
accounting rules and valuation procedures (discussed later), was conducted by
Brand Finance, which estimated the total value of more than 5,000 publicly
quoted companies in 25 countries.[35] For 2005,
the companies’ total enterprise value was $36.2 trillion—$14 trillion in
tangible net assets; $4.3 trillion in disclosed intangible assets; and $17.9
trillion in “undisclosed value.” For the U.S.,
intangible assets were estimated at $9.2 trillion.[36]
A slightly different approached was employed by John
Howkins, who estimated that the market size of the core industries in the U.S.’s
creative economy was $960 billion.[37] These
industries included R&D, publishing, software, TV and radio, design, music,
film, toys and games, advertising, architecture, performing arts, crafts, video
games, fashion, and art. There are also numerous variations on this formula
used to determine the size of these activities (generally in terms of
employment) in state and local economies.[38]
Various other intangible components have also been
estimated. For example, Siwek estimated that copyright industries contributed
$626.6 billion to U.S. GDP in 2002.[39] Shapiro
and Hassett estimated the value of U.S.
intellectual capital at more than $5 trillion, based on an imputation from
current stock market values.[40] This
derivative estimate seems excessively high, judging by the more extensive
economic analyses discussed below. But, in sheer dollar value, it does
demonstrate the importance of intangibles to the U.S.
economy.
Much more rigorous work has been done on the value of brands
and reputation, much of it at the company, rather than at the macroeconomic,
level. As we will touch on in more detail later, valuation techniques for
company brands have become relatively robust. For example, Interbrand and Business
Week publish an annual ranking and valuation of major brands based on
revenue streams.[41]
Coca-Cola tops the list with an
estimated brand value of $67 billion.[42]
The total brand valuation of the 52 U.S. companies listed in the top 100 came to
nearly $722 billion.
Using a version of the company-level methodology, Anholt
estimated the brand value of the U.S.
is roughly $18 trillion. This is not the sum of the economic value of all
private brands, but the appeal of the nation’s brand image.[43]
The most comprehensive recent analyses are two papers by
Corrado, Hulten, and Sichel.[44] This work
actually measured intangibles based on a broader framework, going beyond the
four areas outlined almost 20 years ago. Corrado, et al. estimated that as much
as $800 billion in annual investments is still excluded. As a result, the size
of U.S.
business capital stock is off by $3 trillion of intangibles.
Their framework has these three major areas (see Appendix D for the entire framework):
- Computerized
information
- Scientific
and creative property
- Economic
competencies.
Computerized information includes both software and
databases. Scientific and creative property covers not only the standard
measures of R&D but also costs related to mineral exploration, copyright
and license costs, and other product development, design, and research expenses
(not necessarily leading to a patent or a copyright), such as new architectural
and engineering designs and R&D in social sciences and humanities. Economic
competencies include brand equity, firm-specific human capital (training
costs), and organizational structure costs.
Some of the data for these areas comes from official
government sources, such as the Bureau of Economic Analysis (BEA), the Bureau of Labor Statistics (BLS),
the National Science Foundation (NSF), and the Census Bureau’s Services
Annual Survey (SAS). But,
as the authors pointed out, some investments in intangibles are not adequately
captured in the National Income and Product Accounts (NIPA). For example, the
value of brand equity is not included in their stock of assets, although the
cost of advertising to maintain brand equity is included in the NIPA as a
business expense. Likewise, what the authors call “business investments in
firm-specific human and structural resources through strategic planning,
adaptation, reorganization, and employee-skill building” are only imperfectly
captured. Employee time and additional outside costs for training would be
included as a business-consumption expenditure, but the added stock of value of
those trained workers would not be captured.
Given these limitations, the authors used a mixture of
public data, private data, and derivative measures to estimate each of the
areas. For example, development costs in the motion picture industry were
estimated using data from the Motion Picture Association of America (MPAA). In
turn, that data was used to estimate development costs in the radio and
television, sound recording, and book publishing industries by doubling the new
product development costs for motion pictures. As the authors admitted, this
last example is an especially “crude” way of estimating, which highlights the
data problem.
Other estimates include the following components:
Other product development, design, and research
expenses (not necessarily leading to a patent or copyright):
•
New product development costs in the financial
services industries, crudely estimated as 20 percent of intermediate purchases.
•
New architectural and engineering designs,
estimated as half of industry purchased services (revenues of the industry as
reported in SAS).
•
R&D in social sciences and humanities,
estimated as twice industry purchased services (revenues as reported in SAS).
Brand equity (advertising
expenditures and market research for the development of brands and trademarks):
•
Purchases of advertising services; advertising
expenditures, grand total by type of advertiser as reported by Universal-McCann
(data begin in 1935) [a private data source].
•
Outlays on market research, estimated as twice
industry purchased services (revenues of the market and consumer research
industry as reported in SAS).
Organizational structure (costs of
organizational change and development; company formation expenses):
•
No broad statistical information and no clear
consensus on scope.
•
Purchased “organizational” or “structural”
capital, estimated using SAS data on the revenues of the management consulting
industry.
•
Own-account component, estimated as value of
executive time using BLS data on employment and wages in executive occupations.[45]
The papers are a major step forward in dealing with the many
technical problems associated with classifying intangible expenditures as
investments, including how to break out the investment expenditures from the
consumption expenditures, and how to estimate the missing investments. These
innovative methods of data analysis and collection are the foundation for
future work.
The papers also attack the issue of how to price and deflate
those intangible investments.
The purpose of depreciation is to account for an asset as it
is used up. Even for tangible assets, there is controversy and disagreement
over the appropriate rates (such as how many years to depreciate a machine
tool). The question becomes much more difficult for intangible assets. As
endogenous growth theory tells us, the expansion of knowledge is
self-perpetuating with increasing, rather than diminishing, returns. Yet we
know that the specific use of that knowledge for economic advantage—for
example, in a patent—can diminish over time. But how rapidly does the patent
diminish?
Corrado, Hulten, and Sichel analyzed this issue and had this to say:
Relatively little is known about depreciation rates for intangibles.
Based on the limited information available, we made the following assumptions
about depreciation rates: [46]
Category Depreciation Rate
Computerized information (other than software): 33%
R&D, scientific: 20%
R&D, nonscientific: 20%
Brand equity: 60%
Firm-specific resources: 40%
But measurement was not their final goal; rather, they
sought to understand the impact of these missing investments on the overall
economic picture. Treating intangible expenditures as investments rather than
consumption has the following consequences:
Specifically, when intangibles are
treated as an intermediate input, the spending on intangibles is subtracted
from revenue as an expense, reducing measured profits. On the other hand, when
intangibles are treated as an investment, they are not subtracted from revenue
in the period of purchase, and profits are higher.[47]
Their conclusion should therefore come as no surprise: If
one corrects for the current misclassification of intangible expenditures as
consumption rather than investments, adds in those missing investments and
properly capitalizes them, then business investment is higher than normally
calculated.
The papers also tell us about the areas that contributed the
most to growth.[48]
Comparing the time period 1973–1995 with 1995–2003, overall intangible assets
grew from 9.4 percent of total national income to 13.9 percent. Not
surprisingly, computerized information went from 0.8 percent to 2.3 percent.
However, scientific R&D was almost flat, increasing its share from 2.4
percent to only 2.5 percent. Brand equity rose slightly from 1.7 percent to 2
percent. The other big gainers were nonscientific R&D, which went from 1
percent to 2.2 percent and firm-specific resources, which increased from 3.5
percent to 5 percent.
In other words, the largest increase in contribution by
intangibles to U.S.
economic well-being was not necessarily scientific R&D, but
computerization, nonscientific R&D, and company reorganization and
management/worker skills.
A slightly different view comes from looking at the annual
real capital growth rate of these intangibles between the two time periods.
Overall, the annual rate of growth of intangible capital increased slightly
from 6.2 percent in the 1973–1995 time period to 6.9 percent in the 1995–2003
time period. However, the growth rate in the intangible capital of computerized
information dipped from 16 percent to 13 percent. The scientific R&D growth
rate increased slightly from 3.6 percent 3.9 percent; nonscientific R&D
declined from 12.4 percent to 7.2 percent; brand equity increased slightly from
4.2 percent to 4.6 percent; and firm-specific resources grew from 5.3 percent
to 6.2 percent. This analysis shows that we are likely to get our biggest
increase in intangible capital in the category of firm-specific resources and
nonscientific R&D (even though growth in the latter category slowed down in
the latter time period).
Yet, as the papers pointed out, these are exactly some of
the areas where we lack adequate measures. As mentioned before, brand valuation
is much more than advertising expenditures. The value of organizational change
is much more than expenditures on consultants and, at the same time, the value
of product design is much greater than the expenses involved, even with more
refined measures of those expenses. The path-breaking work of Corrado, Hulten,
and Sichel is key to helping us understand this issue, but it also shows how
much more needs to be done.
There is one other controversial attempt at macroeconomic
measurement worth mentioning. Hausmann and Sturzenegger argued in a paper first
published in late 2005 and revised in 2006 that a large portion of our
international current account is missing,[49] a notion
that set off a flurry of comments. Made up of intangibles, this “dark matter”
actually showed that our current account is closer to balance than the official
statistics. Methodology starts with the fact that the U.S.
had a positive net income on its international financial portfolio, even though
that international position was deeply negative. The authors attributed that
positive income flow to the uncounted intangible assets and said:
We know that the U.S.
net income on its financial portfolio is $30 [billion]. This is a 5 percent
return on an asset of $600 [billion]. So the U.S.
is a $600 [billion] net creditor, not a $4,100 [billion] net debtor. Since the
assets have remained stable, then, on average, the U.S.
has not had a current account deficit at all over the past 25 years. That is
why it is still a net creditor.
We call the $4,700 [billion]
difference between our measure of U.S.
net assets and the standard numbers “dark matter” because it corresponds to
assets that generate revenue but cannot be seen. The name is taken from a term
used in physics to account for the fact that the world is more stable than you
would think if it were held together only by gravity emanating from visible
matter.[50]
As critics have pointed out, there are many reasons why the U.S.
can have net positive income on a debt, having to do with rate-of-return
differentials between our international assets and our international debt and
with the seignorage on foreign holdings of U.S.
currency.[51]
Using a similar derivative calculation based on net income from royalties,
Jarboe calculated that the value of uncaptured intangibles is closer to $640
billion to $785 billion.[52]
While the methodology used by Hausmann and Sturzenegger is
suspect, the exercise does make a useful point. It is not clear that our
macroeconomic statistics capture international flows of intangibles because
much of their value is embodied in other products and services. Breaking out
the value-added of a specific intangible (e.g., the design value of an iPod) is
difficult enough domestically. When the production process is distributed
globally, the measurement difficulties are that much greater.
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Microeconomic-level intangibles
At the microeconomic level, some of the same categories and
concepts apply. However, the firm-level situation is much more detailed than at
the national level. As Bismuth points out:
Although such classificatory
schemes have been used in developing guidelines and by researchers, they may
not be so value-relevant for investors and managers. Few analyst reports
labelled “Intangibles” or even “Relational Capital” or “Structural Capital” or
“Organisational Capital” have been released. It doesn’t mean that investors do
not take into account intellectual assets in their research and in their judgment
about investments. Rather, they consider other more summary categories of
intellectual assets such as “brand equity”, “reputation”, “management of
skills”, “franchise value” or “FDA approvals” on a company or sector basis and
according to a specific situation.[53]
Company-level measurement of intangibles is governed by
accounting rules, known in the U.S.
as Generally Accepted Accounting Principles (GAAP), which are administered by
the Financial Accounting Standards Board (FASB). Rules for intangibles that are
acquired from outside the firm (via mergers or acquisitions) are covered in
FASB’s Statements of Financial Accounting Standards (SFAS) 141 and 142.[54] In many
other countries, the governing rules are the International Accounting Standards
Board’s (IASB) International Financial Reporting Standards (IFRS) 3 and International Accounting
Standard (IAS) 38.[55]
SFAS 141 and 142 break down intangibles into the following
five main categories: marketing-related intangible assets; customer-related
intangible assets; artistic-related intangible assets; contract-based
intangible assets; and technology-based intangible assets. (See Appendix E for the entire list.) IAS 38 uses a similar categorization.
It should be noted that both SFAS 141/142 and IAS 38 only
apply to intangible assets acquired through a merger or an acquisition. The
purpose of these standards is to break out intangibles from the broader
category of “goodwill.” IASB is exploring the possibility of a new project on
intangible assets.[56] The
purpose of the project will be to develop similar rules to account for
internally generated and separately purchased intangible assets. After
commissioning a number of technical papers, the IASB will make a decision at
its December 2007 meeting. If the project advances, it is anticipated that it
will be conducted jointly with FASB and completed in September 2009.
In Australia,
Hunter, Webster, and Wyatt developed a framework specifically for reporting
intangibles, based on the OECD outline described earlier.[57] This
framework consists of these five major categories: information system
infrastructure; production and technology; human resources; organization and
administration; and procurement, distribution, and customer linkages (Appendix F). Each category has a number of expenditure items that would be
classified as investments in intangible assets, rather than as expenses.
In the U.S.,
there are a number of differences between the company accounting rules and the
national system of accounts. One very large difference is the treatment of
human capital. Various national-level measurement models attempt to take human
capital into account, specifically expenditures on education and training. SFAS
141 states, “[The] assembled workforce shall
not be recognized as an intangible asset apart from goodwill.”[58]
The following rationale was employed for this exclusion:
[T]he Board concluded that techniques to measure the
value of an assembled workforce and the related intellectual capital with
sufficient reliability are not currently available. Consequently, it decided to
make an exception to the recognition criteria and require that the fair value
of an assembled workforce acquired be included in the amount initially recorded
as goodwill, regardless of whether it meets the recognition criteria in
paragraph 39.[59]
This illustrates a larger difference between national and
company accounts. At the national level, intangible assets are measured
according to the expenditures made on those assets. The level of the capital
stock of intangibles is calculated based on those expenditures. Measuring
expenditures is relatively straightforward: cash out the door. The trick is
turning expenditures into assets via depreciation and in setting the starting
point for capital accumulation.[60]
At the firm level, valuation of intangible assets can take a
more direct—but no less complicated—route. As the Value Measurement &
Reporting Collaborative pointed out:
Accountants are perfectly capable
of measuring intangibles, just as they are capable of measuring tangibles, so
long as there is a transaction. The issue that arises with attempting to expand
recognition of intangibles in financial statements is not their intangibility,
but rather that most intangibles are internally generated, and do not therefore
arise as a result of a discrete third party transaction.[61]
There are three traditional methods for valuation of
intangible assets: the market approach, the cost approach, and the income
approach.[62]
Of these, the market approach, which looks for comparable market transactions,
is the most straightforward. However, because this method relies on robust
market transactions, it is not always the most applicable. Real estate or a
piece of equipment can be reliably valued because there are a number of
comparable transactions upon which to determine a price. In many cases, there
are only thin markets for some intangibles (such as patents). In other cases,
it is very difficult to separate out the specific asset and assign it a value
distinct from all of the other assets that might be involved in a market
transaction.
At the firm level, the cost approach can operate somewhat
differently from the tracking of expenditures used at the national level. One
way is to track past expenditures and apply an appropriate depreciation rate. However,
another version of the cost approach calculates what would have to be expended
to either reproduce (exactly duplicate) or to replace (create a functional
equivalent of) the asset. Thus, rather than look at past expenditures, this
method looks at current costs.[63]
The income approach looks at what income would be gained
from having the assets. Specifically geared toward traditional intellectual
property (IP), such as patents, trademarks, brands, and copyright, this could
be either one of two methods. The first is the relief from royalty methods,
which looks at how much a company would have to pay in royalty and licensing
fees to use the IP. The second is a “Multi Period Excess Earnings Method,”
which attempts to separate out the cash flows due to the intangible assets from
overall cash flows.
All of these methods have their own limitations. As
mentioned above, the market approach can break down if there are thin markets.
The cost approach must figure in depreciation/obsolescence and does not always
count all intangible inputs, such as managerial efforts and workers’ skills.
The income method faces imprecise assumptions about royalty rates and rates of
return to various assets. Other variations and refinements of these approaches
also exist.
These traditional valuation models are bottom up. They seek
an overall value of the enterprise by aggregating all the separate assets:
physical, financial, and intangible. Lev has developed an expanded valuation
model that backs out the value of the unreported intangible assets from the
whole.[64] This is
done in part by estimating the contribution of intangible capital to normalized
earnings; specifically by estimating a certain rate of return on physical and
financial capital. In this manner, the implied value of intangibles as a whole
can be measured, rather than having to identify, separate out, and value
specific intangibles.
However, this approach raises concerns about the assumptions
needed for the calculation, as Zambon, et al. noted in their research:
Lev’s basic assumption is that
earnings can be broken down into two distinct components, one portion
attributable to tangible and long-term financial assets on the one hand, and a
portion to intangible assets on the other. But this assumption, for example, is
not part of the Italian business accounting tradition according to which
earnings are an aggregate, one and indivisible, in that they express the
interaction of all the company’s resources considered as a unit.
A second criticism of Lev’s
proposed method is directed at the calculation method for the portion of
earnings attributable to tangible and long-term financial assets and, as a
consequence, for the portion attributable to intangible assets. In fact, there
is no unanimous agreement on this calculation method since determining average
earnings from tangible and long-term financial assets is highly subjective and
so it is difficult to define technically.
Finally, determining the discount
rate to be applied to kno