For the Investor:
By Gary Buesser, FASB Member

Internally Generated Intangible Assets

An intangible asset is an asset that is not physical. Examples of intangible assets include a company’s customer lists, brand name, data, or workforce.
Intangible assets have become an increasingly larger component of the valuation for all companies, from newer social media companies to even the most established and iconic manufacturers.  One area where intangible assets are recognized on the balance sheet is in a business combination. In this instance, the acquirer is required to assign a fair value to the acquired company’s assets on its balance sheet, including intangible assets.

Under U.S. GAAP, however, most internally generated intangible assets are not recorded on the balance sheet.  Some proponents of recognizing internally generated intangible assets on the balance sheet point to the fact that some information-based intangible asset companies trade at stock price-to-book value multiples of 5x–10x.  Therefore, they believe the balance sheets of these companies do not reflect the value of their intangible assets.

When deciding whether companies should recognize and measure intangible assets on the balance sheet, accounting standard setters would have to answer the following questions:
  • Does an intangible asset meet the U.S. GAAP definition of an asset?
  • How should an intangible asset be measured?
  • Would intangible assets on the balance sheet be comparable across companies, and therefore, more useful information for investors?
I believe the primary reason accounting standard setters have not required internally generated intangible assets on the balance sheet is that the information would probably not be useful for investors and would be very costly for companies to prepare.  If social media companies were required to recognize data or workforce as an intangible asset on the balance sheet, would investors find that information useful in valuing a company?  In my opinion, that’s doubtful, because the information would be highly subjective, require forward looking estimates, and would probably not be comparable across companies.

How do Investors Analyze Internally Generated Intangible Assets?

Investors are laser-beam focused on a company’s sustainable long-term revenue growth rate, margins, and cash flow.

Growth companies that trade at high valuations generally have above-average revenue growth expectations and/or margin structures.  Investors are laser-beam focused on a company’s sustainable long-term revenue growth rate, margins, and cash flow.  Most of their analysis is directed towards the income and cash flow statements rather than the balance sheet.  The success (or failure) of a company’s internally generated intangible asset investments is ultimately reflected in higher (or lower) future revenue growth rates and margins.

In more established industries, such as the auto industry, the analysis of internally generated intangible assets is also important.  Some forecasters believe innovation in the autonomous vehicle and electric vehicle areas will drive future success and value creation in this industry.

My View on Possible Improvements to Internally Generated Intangible Assets

Accounting standard setters could conduct outreach with investors to determine their views on the one area of U.S. GAAP that requires the recognition of intangible assets on the balance sheet: the fair value of an acquired company’s intangible assets following an acquisition. This would help determine whether investors find this information useful.  In my experience prior to joining the Board, investors did not consider the post-acquisition footnote disclosures on intangible assets relevant to their analysis and valuation of a company.  Companies net out the intangible asset amortization number in their non-GAAP numbers and few (if any) analysts include this information in their company financial models.

One potential area for improvement could focus on finding what internally generated intangible asset disclosures companies might provide that investors would find useful. One caveat: over my investment career, companies typically did a good job of disclosing information on their competitive advantages related to internally generated intangible assets outside of their SEC-required annual and quarterly filings.  I believe a review of the information already provided by companies through these other means of communication would be a good starting point for the FASB.

The views expressed in this column do not necessarily reflect the views of the FASB. Official positions of the FASB are arrived at only after extensive due process and deliberation.