36 Pages Posted: 17 May 2010
Date Written: September 23, 2009
As we move from manufacturing to service based economies, an increasing large proportion of the firms that we value derive their value from intangible assets ranging from technological patents to human capital. In this paper, we focus on a few variables that make valuing these service companies different from conventional manufacturing firms. The first is that accountants routinely miscategorize operating and capital expenses, when firms invest in intangible assets. Thus, R&D expenses, which are really capital expenses, are treated as operating expenses, thus skewing both reported profit and capital values. The second is that firms with intangible assets are more likely to use options and restricted stock to compensate employees and the accounting treatment of this compensation can also affect earnings and cash flows. In this paper, we look at how best to correct for the accounting errors and the consequences for valuation.
Keywords: Intangible Assets, Valuation
JEL Classification: G12, G31
Suggested Citation: Suggested Citation