Australian Lefty on Politics, Governance, Science and Info Management

Accounting standards can improve knowledge economy

Posted by Dave Bath on 2007-11-16

Hot on the heels of my various posts on knowledge economy issues comes a pertinent article at the always-stimulating VoxEU that discusses weaknesses of the way R&D is taken into account when assessing the market value of companies, along with recommendations for changes to accounting practices to fix the situation.

I’d argue that the same changes to accounting can be applied to reporting of government assets and liabilities to stimulate productive growth that can improve our current account and trade balances, as well as improve standards of living, and by improving R&D investment by Australian companies without an extra dollar of government spending.

"The value of R&D and patents in European firms" (2007-11-16) by Hall, Thoma and Torrisi includes the following observations, which I’ll discuss further down.

  • When you subtract the tangible assets of a company from its market capitalization, intagibles (goodwill, intellectual property, yadayadayada) are signficant.  Intangible assets account for one third to half the market value of US corporate securities.  (I’ll note The Economist reported that worldwide for publically listed companies, tangibles accounted for only 25% of market cap, suggesting intangibles are even more important!)
  • Accounting standards committees (Financial Accounting Standard Board in the US and the International Accountaing Standard Committee) downvalue the contribution of R&D by either
    • Treating R&D as an expense rather than investment
    • Preventing it from being capitalized, except sometimes when there is a merger or acquisiting happening.

The authors argue that resource allocation (via market pricing) would be more efficient if…

  • Accounting standards were changed to allow R&D capitalization.
  • R&D reporting was mandatory for publically listed companies.

While our representatives at the IASB can push for such changes to accounting standards, there is nothing stopping such calculations to be used within Australia, by both governments and corporations, as supplementary documents, or when explaining policy to stakeholders.

When R&D is looked upon as an investment, stakeholders will more readily accept such spending, and, whether or not the figures form part of a statutory reporting, they will be used by the market to increase the market capitalization of the companies that do more R&D and use it more effectively.

Such as simple change, the way we add up numbers, and yet it could lead to such an improvement of our knowledge economy, and then our economic outloook.

Here is the concluding paragraph from the paper:

The revision of international accounting standards recently started is a rational choice because R&D capitalisation increases the efficiency of market prices and resource allocation (it helps filling the gap between the book value of assets and the stock value).  However, a first and perhaps more important step towards a greater market transparency and a better evaluation of intangible assets would be requiring European publicly-listed firms to disclose their R&D expenses.

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