The issue of booking intangible assets to the balance sheet is at the fore now, with the accounting authorities having taken it up for consideration. It is often asked: If tangible assets are booked to the balance sheet, why not intangible assets?
That sounds reasonable, but there is an important subtlety. If a firm buys inventory that it can sell tomorrow with high probability, it books it as an asset on the balance sheet, If a firm builds a plant to produce inventory that it can sell with high probability, it books the plant to the balance sheet. But if a firm invests in R&D that has produced no product of revenue as yet…and it might not be successful…should the investment be booked to the balance sheet? There is a lower probability of payoff, so should an asset be booked with the pretense that it provides collateral? We are told that 85% of R&D investment is unsuccessful.
The investor is interested in the payoff to investment, and th ecutting edge here is the probability of payoff. That is the criterion for capitalizing assets in the balance sheet under FASB and IFRS accounting standards. For the accounting for R&D under FASB Statement No. 2, the FASB requires the investment to be expensed due to the “uncertainty of future benefits.” In IAS 38, the IASB applies the criterion of “probable future economic benefits” to distinguish between “research” (which is expensed) and “development” (which is capitalized in the balance sheet and amortized). Even IAS 16 on property, plant, and equipment requires benefits to be “probable” for the asset to be booked.
Reporting R&D just says an expenditure has been made, nothing about the likely payoff. So the criterion for booking any asset to the balance sheet is the probability of future benefits. That suits the investor who is concerned about the risk to payoffs. Indeed, we will see in chapter 8 on risk to value that the expensing of intangible assets to the income statement conveys important risk information to the investor. The accounting authorities might not have the precise calibration as yet, but the investor is warned: Buying a firm with R&D with relatively low probability of payoff (an R&D startup, for example) is risky. And that applies to other intangible assets. For expenditures on advertising or brand building, it is uncertain whether the customers will be hooked. For investment in human capital, the outcome is uncertain; the employees may leave and go to a competitor. And so for investment to develop supply chains and distribution systems, customer loyalty programs, software development, merger costs, start-up and organization costs, and more.
For more on this, see
Barker, R., A. Lennard, S. Penman, and A. Teixeira. 2021.Accounting for Intangible Assets: Suggested Solutions.” Accounting and Business Research Vol. 52 No. 6, 601-630
Penman, S. 2023. Accounting for Intangible Assets: Thinking it Through. Australian Accounting Review Vol. 33 No. 1, 5-13.
Penman, S. 2024. Empirical Research on Capitalizing Intangible Assets is Logically Incoherent. At https://ssrn.com/abstract=4982366.
