Questions about the Chart Why did market values diverge from book values?
Questions about the Chart Why did market values diverge from book values?Is it because some information is not included in the financial statements?
Interpretation This means that traditional accounting measures of book value of net assets represent about 1/3 of the value of the net assets. Many intangible assets (excess earnings power) are missing from financial statements Do all intangible assets qualify as assets to be recognized in financial statements?
What Are Assets?
Assets (FASB Concepts 6) Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Criteria to be considered an asset: Defined and distinct Effective control Possible to predict future economic benefits Possible to determine impairment Asset examples: Property, plant, equipment Financial assets Purchased identifiable intangibles such as patents, trademarks, and mailing lists What Are Assets?
A non-monetary asset without physical substance Examples of possible intangible assets include: Computer software Patents Copyrights Motion picture films Customer lists Mortgage servicing rights Licenses Import quotas Franchises Customer and supplier relationships Marketing rights What Are Intangible Assets?
Investment in Tangibles vs. Intangibles
Lack of physical substance Long-lived Scalability Increasing returns to scale Non-rivalry and partial excludability Use by one user does not preclude the use by another user Network effects Metcalf’s law – the value of the network increases geometrically with each new user Software Intangible Assets Characteristics (I)
High degree of uncertainty about future benefits to be derived 10% of patents account for 81-93% of total patent value Most new products fail Earnings volatility (risk) is three times greater for R&D than physical investments Non-tradability No organized and competitive markets Measurement and valuation difficult without market prices None or little value if projects abandoned Companies cannot use all of their innovations and there is no market for selling them (except patent licensing and royalties These two characteristics have significant implications for accounting of intangible Intangible Assets Characteristics (II)
Examples of Identifiable Intangible Assets Research and Development R&D is innovation - all businesses large and small engage in R&D, except in large companies it’s more formal Patents Copyrights Organizational capital Unique business process – trade secrets Supplier and customer relationships Customer lists Trademarks and brand names
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