The End of Accounting and the Beginning of Intangibles Accounting

I’ve been discussing The End of Accounting with a lot of people but hadn’t gotten around to reviewing it here. I definitely recommend it as a fresh take on the intangibles problem and a sobering view of the challenges facing accountants today.

Baruch Lev has been talking about intangibles about as long as anyone. I often quote this quick video that we recorded of Dr. Lev at an intangibles conference we organized in DC in 2011 where he say that intangibles are “the only assets that create value.” His logic is that tangible assets are commodities available to everyone. The only alternative is the development of intangible assets.

His latest book takes a step back and looks at intangibles in the context of accounting, Spoiler Alert: he and his co-author Feng Gu construct a very careful argument that accounting has lost most of its relevancy.

They start off comparing the financial statements of U.S. Steel from 100 years ago (deep in the industrial era), with their statements today (in our post-industrial economy). The basic format is almost identical. They make that case that this is not necessarily a good thing, comparing the publication of different kinds of financial data to stock price. Their statistical analysis is very detailed and interesting. The conclusion is that financial data is not that relevant.

The three major factors that they find that are limiting the usefulness of accounting include:

  • Growth of investments in intangible assets which now far exceeds investments in tangibles
  • Proliferation of management estimates in financial statements which weakens reliability
  • Value changing events that don’t hit the financials like changes in the competitive environment or a lawsuit.

Some of this is a question of timing. You can make the case that these factors may eventually hit the financials, but it is often long after the value of a company has already been adjusted by the marketplace.

The authors offer solutions to these dilemmas. I want to focus on the intangibles piece. Their solution here is a Strategic Resources and Consequences Report, a step toward intangibles accounting, with the following columns:

  • Developing Resources
  • Strategic Resources
  • Resource Preservation
  • Resource Deployment
  • Value Created

In each, they suggest entering quantitative information in a box and qualitative information in a circle (see examples here). The stated goal is to focus on causal indicators rather than symptoms. I particularly liked their definition of strategic assets as: rare and difficult-to-imitate resources that generate benefits.

For me, just looking at unique assets is missing much of the potential and importance of intangibles. In fact, the authors do NOT refer to the integrated model which is unfortunate. After many years of using a multi-capital model to identify the full range of tangible and intangible resources of a company, I’ve come to appreciate that it’s important to take a systemic view. Unique resources confer competitive advantage but the unique resources need to be surrounded by the right value creation ecosystem.

Nevertheless, I strongly recommend this book to those who work with accounting or are affected by it. It uses clear data to make a powerful case. And it adds to our thinking about next steps to improve things from here on.

Want to learn more? Read about how ten U.S.-based companies have used integrated reporting to tell a richer story that combines financials, intangibles and sustainability in a single report.