Accounting for Intangibles: Does
Method of Accounting Matter?
V. Brooks Poole
J. Shaw
University of Mississippi
February 9, 2008
Motivation
• To contribute to the conflicting literature on
the understanding of the market’s reaction
to differences in reporting intangiblerelated transactions
• Companies are investing heavily in
intangible assets; the ratio of tangible to
intangible assets has changed from 30:70
to 63:37 from 1929 to 1990 (Canibano, et.
al., 2000)
Motivation
• IASB hopes to create a framework that will
establish international agreement on how
to account for intangibles.
• In the US, internally generated intangibles
are expensed while those acquire
externally are capitalized because
internally generated intangibles are difficult
to value (Radebaugh, et. al., 2006)
Motivation
• To determine whether international
consensus on how to account for
intangible-related transactions is
necessary
• To determine if mandatory disclosure of
accounting treatment is more appropriate
than specific accounting rules
Prior Research
• Disclosed intangibles, while consistently
undervalued relative to tangible assets, are
valued positively (Choi et. al., 2000)
• The market values R&D, goodwill, and brands
regardless whether they are treated as assets or
expenses (Lev, 1999)
• Australian and UK F/S are more informative
about intangibles than US F/S (Goodwin, 2003;
Abrahams and Sidhu, 1998; Alford, et al., 1993)
Prior Research
• British companies that disclose internally
generated brand names by capitalizing
them reap positive benefits (Mather and
Peasnell, 1991)
• Even though internally-generated
intangibles are difficult to value, they are
valuable and should be disclosed in F/S
(Amir and Lev, 1996)
Prior Research
• US F/S have substantially less value than
they could because internally generated
intangibles go unreported (Wyatt, 2005)
• Limiting managements’ choices to record
intangibles as assets tends to reduce the
quality of the B/S. Accounting method of
intangible-related transactions does affect
users of F/S (Luft and Shields, 2001)
Research Questions
• Is the market efficient in understanding
that two transactions are identical in
nature even though they are accounted for
differently to adhere to particular reporting
requirements?
• Does size of an intangible-related
transaction affect investors’ perceptions of
its benefit on future earnings?
Research Questions
• Is a large or small intangible-related
expenditure perceived more favorably by
investors when it is accounted for in a
particular manner—capitalized or
expensed?
Underlying Theory
• Efficient Market Hypothesis
– All publicly available information is quickly
incorporated into stock share prices.
– The prices of traded assets reflect all known
information about the company and what
investors project for the company’s future
(Fama, 1970 & 1991; Lev, 1999).
– If true, method of accounting for intangibles is
irrelevant as long as full disclosure of
accounting treatment is disclosed.
Hypothesis 1
Ceteris paribus, the market’s reaction to
two identical intangible-related
transactions will differ as accounting
treatment of such transaction differs, given
the accounting treatment of such
transaction is fully disclosed
Underlying Theory
• Size
– Small expenditures will be perceived by
investors in the same manner as no
expenditure would be perceived.
– A reasonable investor will not be influenced in
investment decisions by a fluctuation in net
income less than or equal to 5% (Vorhies,
2005).
Underlying Theory
• Size
– Jordan and Clark (2004) find that when
defining materiality for capitalizing interest, 4
to 5 percent or less of operating income is
considered immaterial and does not affect
stakeholders’ analyses of financial statements
Hypothesis 2
Ceteris paribus, the market’s reaction to
two identical intangible-related
transactions will differ as size of the
expenditure differs, given the amount of
such transaction is fully disclosed.
Hypothesis 3
Ceteris paribus, the market’s reaction to
two identical intangible-related
transactions accounted for differently will
differ as size of the expenditure differs,
given the accounting treatment and size of
such transaction is fully disclosed.
Research Design
• 2X2 Behavioral Experiment
• Subjects
– 104 upper-level and masters-level business
students
– Students who have completed financial
accounting courses are able to acquire and
use financial information in a similar manner
to nonprofessional investors (Elliot et. al.,
2007)
Research Design
• Instrument
– 4 versions
– Narrative describing the intangible-related
activities of an automobile company
– Financial statements
– 2 questions asking subjects to determine the
benefit of the intangible expenditures
– 2 demographic questions
Research Design
• Development costs is the intangible
manipulated since convergence of US
GAAP and IFRS remains unresolved
• Manipulation
– US company expenses development costs
– UK company capitalizes development costs
– Within each company the amount of the
expenditure is varied from an small to large
amount
Data Analysis
• Pilot test
• Factorial ANOVA
– Purpose: to determine if a relationship
between independent variable(s) and
dependent variable exists
– Are accounting treatment, size, and/or the
interaction of accounting treatment and size
significant indicators of subjects’ responses
Data Analysis
• Independent variables
– Accounting Treatment
• Coded 1 for IFRS treatment (capitalize)
• Coded 2 for GAAP treatment (expense)
– Size
• Coded 1 for a material expenditure
• Coded 2 for an immaterial expenditure
• Dependent Variable
– Investor’s Perceived Benefit of an Intangible
Expenditure (Q1 and Q2 of the instrument)
Results
• Demographics: Neither gender nor level
of education of subjects is significantly
related to the DV when entered into the
ANOVA model alone or in conjunction with
the IVs; therefore they are excluded from
the ANOVA models.
Mean Scores for the DVs
Manipulation
Q1
Q2
Capitalize/
Material n=28
Capitalize/
Immaterial n=24
Expense/
Material n=24
Expense/
Immaterial n=28
7.714
7.000
6.166
5.000
7.333
6.167
7.535
6.465
ANOVA Results
DV:Q1;Adj R2=0.13 DV:Q2;Adj R2=0.13
SS
F-stat
SS
F-stat
Model
36.568
6.177***
54.462
7.618***
Method
6.309
3.197*
2.572
1.079
Size
11.693
5.925**
18.726
7.858***
Interact.
19.788
10.03***
34.111
14.31***
***p-value<0.01;**p-value<0.05;*p-value<0.10
ANOVA
• Accounting Treatment is statistically significant
at the p<0.10 level when Q1 is treated as the DV
• Size is statistically significant at the p<0.05 level
when Q1 is treated as the DV and at the p<0.01
level when Q2 is treated as the DV
• The interaction of accounting treatment and size
is statistically significant at the p<0.01 level
when Q1 or Q2 is treated as the DV
Interpretation of ANOVA Results
• Method of Accounting is statistically
significant when Q1 is the DV.
• Investors will not perceive the benefit of 2
identical intangible-related expenditures
the same if they are accounted for
differently.
• Thus, H1 is not rejected.
Interpretation of ANOVA Results
• Size is statistically significant in each
ANOVA model.
• As size of intangible-related expenditures
varies, investors’ expected benefit from
the expenditure varies.
• Thus, H2 is not rejected.
Interpretation of ANOVA Results
• The interaction of method and size is
statistically significant in each ANOVA
model.
• Neither method of accounting nor size
alone reveals how investors perceive an
intangible-related expenditure.
• It is the interaction term that is most
meaningful.
Interpretation of Method*Size
• Perceived benefit depends on the
combination of accounting method and
size of the expenditure.
• H3 is not rejected.
• Pairwise comparisons reveal where
differences among groups exist.
Pairwise Comparisons
• Simple t-tests reveal differences in these
four groups:
– IFRS treatment of a large expenditure
– IFRS treatment of a small expenditure
– GAAP treatment of a large expenditure
– GAAP treatment of a small expenditure
Pairwise Comparisons
Group Difference;Q1=DV
Difference;Q2=DV
1 vs. 4
0.1786
0.5357
1 vs. 3
0.3810
0.8333
1 vs. 2
1.5476*
2.0000*
4 vs. 3
0.2024
0.2976
4 vs. 2
1.3690*
1.4643
3 vs. 2
1.1667*
1.1667*
*p-value<0.05
Pairwise Comparisons
• A large expenditure accounted for as an
asset is perceived more beneficial than a
small expenditure accounted for as an
asset.
• An expenditure accounted for as an
expense is not perceived differently based
on size; the perceived benefit of a large
vs. small expense does not differ.
Interpretation
• A large expense is perceived no more
beneficial than a small expense.
• Had the expenditure been capitalized, the
large expenditure would have been
perceived more beneficial than the small
expenditure.
Interpretation
• No difference is perception is found between a
large expense vs. a large asset
• Small expenses are perceived more beneficial
relative to small assets. (Investors perceive a
small asset as insignificant relative to other
assets or total assets of a company perhaps.)
• While expenditures are identical in nature, their
perceived benefits differ as size and accounting
treatment differs.
Relevance of Findings
• IASB and FASB should resume convergence
efforts
• International investors are valuing identical
transactions differently
• Investors do not perceive the future benefits of
identical (large or small) expenditures that are
accounted for differently in the same manner
• To make international companies’ F/S
comparable, consensus is needed
Limitations
• Different markets have different levels of
efficiency. IASB must consider this when
developing international consensus of
standards
• Subjects
– All US citizens and part of the US market
– Upper-level undergraduate and masters-level
students; not investors
Future Research Ideas
• Use subjects from different markets
• Determine empirically through an archival study
if expenditures related to development costs do
have potential future value and should therefore
be capitalized or if their benefits are exhausted
upon incurrence and should therefore be
expensed
• Test whether the deductibility for tax purposes of
expensed intangibles influences how companies
account for intangibles.
Questions/Comments