The movement to account for intangibles took on fad status during the technology bubble years of the late 1990s, and has lost some momentum as attention has turned to dealing with accounting abuses. Nonetheless, Professor Lev’s basic argument has never lost its relevance, or importance. His ideas for new accounting methods and the revision of longtime standards are likely to receive renewed attention as senior executives are compelled to develop knowledge assets, outsource more, and pursue other imperatives of global competition that require them to identify all the potential sources of value in their firms, and then make those sources tangible.
“Baruch Lev’s pioneering work on intangibles has been a wake-up call for the entire profession,” says Berkeley Economics Professor Hal R. Varian, coauthor, with Carl Shapiro, of Information Rules: A Strategic Guide to the Network Economy (Harvard Business School Press, 1998). In the accounting world, “he has been pushing longer and harder than most on this particular issue.”
In particular, the NYU professor has become a kind of Cassandra figure to the prevailing regulators of corporate activity: the FASB and the SEC. He contends that the legal structure of accounting rules, as enshrined in Generally Accepted Accounting Principles (GAAP) and SEC regulations, is fundamentally flawed. “The rules haven’t been changed much since the invention of accounting 500 years ago,” says Professor Lev. And they’re far from perfect. Every company, he argues, should have to disclose, in fine-grained detail, its assessments of future risks, its expenses in human development, its research costs, and other information about its investments in intangibles. Until then, investors will reward the wrong managers, and the economy will continue to spin off course.
In person, Baruch Lev is a trim, bespectacled man in his 60s who has the qualities you might expect in a maverick accounting professor: an informal style of dress and speech, overlaid by a cerebral and severe mien, with flashes of sardonic humor. He has laid out his position in a variety of books and articles. Several articles are collected in a recent anthology, Intangible Assets: Values, Measures, and Risks, coedited with University of North Carolina Professor John Hand (Oxford University Press, 2003). Others canbe found on his Web site: http://pages.stern.nyu.edu/~blev/. But his clearest, most articulate statement appears in a letter he wrote to the Senate Commerce Committee in March 2002 as a follow-up to testimony he gave on the collapse of Enron. In that letter, he named four basic elements that are missing or understated in most estimates of corporate worth:
• Intangibles. The value of research and development, patents, trademarks, brands, supply chains, secret formulas, training and development, and many other nonphysical assets that show up only as expenses on the balance sheet;
• Extended Enterprise. The alliances, joint ventures, and partnerships that foster innovation in many companies;
• Future Commitments. The unexecuted obligations and promises that each organization must redeem in the future (for instance, Enron’s financial reports didn’t acknowledge its future obligation to make good on the losses sustained by its offshore partnerships);
• Financial Risks and Prospects. The value or liability inherent in financial risks that the company has embraced — for example, through the use of derivatives, hedge funds, and stock options — and in their vulnerability to changes in interest or foreign exchange rates.
Circle of Harm
Much of the time, managers and accountants aren’t even aware of the financial impact of the four elements, because their accounting systems don’t track them. Even when the numbers are available to managers, they are generally fiercely guarded from outside eyes, for fear of lost competitive advantage. The result, according to Professor Lev, is a “vicious circle of harm,” starting with poor-quality reporting of most of the unique capabilities and “leverageable” resources of the company.