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Arthur Andersen consultants Richard Boulton, Barry Libert, and Steve Samek compared market value with book value for 3,500 U.S. companies over a period of two decades. At the beginning, in 1978, the two were pretty well matched: Book value was 95% of market value. Twenty years later, book value was just 28% of market value. According to Baruch Lev, since 1980, the average ratio of market capitalization to book value has gone up by a multiple slightly over one to a multiple higher than five. Why? In 1970, intangible assets represented less than 20% of the market capitalization. In 2000, intangible assets represent over 85% of the market capitalization (Decoding Intangibles, CFO Magazine, April 1, 2001). The key is the increased investments in research and development, as well as technology. According to The Federal Reserve Bank of Pennsylvania, R&D adjusted profits have been 13% higher than economic profits, and nearly 37% higher than book profits during the 1990’s. The combined ROI on R&D is 30-60% higher than the ROI on ordinary capital, e.g. machinery (Baily and Chakrabarti). No wonder that since 1953 R&D expenditures have more than doubled. It is in the computer and software industry that the biggest growth in investment in research and development has occurred. Between 1995 and 1998, R&D spending by the computer software industry increased by 67% to $14.3 billion, or one-third of all R&D spending by non-manufacturing firms. Between 1995 and 1998, R&D spending in the financial services industry more than doubled to $1.6 billion. Meanwhile, tangible investment in plant and equipment was no higher in the 1990’s than it was in the 1950’s. Notwithstanding, it still costs a pharmaceutical company close to $802 million to develop a new drug over 14 years. It should also be noted that on average, only one in twenty R&D projects yields a financial return (Mansfield). Further, these figures fail to take into account all of the resources and time required to create an asset, prior to its subsequent incorporation into a product or service. There is no clear correlation being made between the investment and costs incurred to create the asset, in particular with regard to the specific value and benefits to the product or service arising from the prior resource contributions. Such investments in advertising, marketing, executive time, and business processes in support of a product or service, and its respective ROI are not fully recognized. At the heart of the problem is the role of the balance sheet. The balance sheet looks backward, records historical costs and expenses R&D, whereas intangible assets look forward and record value. Finally, until now there was neither the need nor a way to recognize intangible assets.

"There [are]...no standards in the valuation community to provide any consistency or reliability around the valuation of these intangibles." Unfortunately, the only consistency is that the numbers are high, and all too often, to quote an industry analyst, "the auditors checked nothing." Dennis Powell, Vice President and Corporate Controller of Cisco Systems, testified at a Senate Banking Committee hearing on “Accounting for Goodwill,” June 14, 2000. In July 2001, the FASB stepped in to impose full accounting and reporting of intangible assets and goodwill arising out of a business combination. Consequently, Ernst & Young stated on July 23, 2001: “These statements are among the most significant pronouncements issued by the FASB in many years and will have a profound effect on any company that engages in business combinations.” So what is the bottom line? First, the accounting standards eliminated the use of pooling-of-interest in M&As in favor of the purchase method. Second, goodwill is no longer to be amortized, but tested at least annually for impairment. Third, intangible assets, i.e. those based on a contract or legal right or separable from goodwill are to be reported separately from goodwill. Fourth, intangible assets with a definite useful life acquired in a business combination are to be amortized over their useful life. Fifth, intangible assets with an indefinite useful life are to be tested at least annually for impairment. Sixth, intangible assets and impairment losses are to be publicly disclosed in the financial statements. The impact of these new standards (SFAS 141 and 142) has been profound. In the first quarter of 2002, 59 publicly quoted companies wrote down over $210 billion of goodwill, including AOL Time Warner $54 billion, Qwest $20 billion, Vivendi $15 billion, Verisign $13.5 billion, Nortel $12.3 billion, Gemstar $5 billion, Aetna $2.97 billion, Boeing $1.9 billion, GE $1 billion, and Coca-Cola $1 billion in compliance with SFAS 141 and 142. Clearly, as Churchill once said: "this is not the beginning of the end, not even the end of the beginning," as companies come to terms with needing to comply with these new standards, but it is an opportunity to truly come to terms with what intangible assets a company has and translate them into shareholder value.