Value of Internally Generated Intangible Capital

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2022
Authors
Iqbal, Aneel
Rajgopal, Shivaram
Srivastava, Anup
Zhao, Rong
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Internally developed intangibles are not included in reported assets under U.S. Generally Accepted Accounting Principles. Omission of this increasingly important class of assets reduces the usefulness and relevance of financial statement analysis, conducted with book value of equity and assets. Recent studies attempt to overcome this deficiency by capitalizing selling, general, and administrative (SG&A) expenses, based on a one-size-fits-all mechanical rule of thumb that (i) treats a uniform 30% of SG&A as investments; and (ii) assumes the same life of SG&A investments across all industries. We propose a new method to calculate the value of internally generated intangibles. We estimate investment and maintenance portions of research and development (R&D) and MainSG&A (SG&A minus R&D), and their amortization rates, on an industry-year–specific basis. Our modified book value, inclusive of capitalized intangibles, exhibits greater association with future returns, investments, and bankruptcies, relative to as-reported book value and the book value estimated with mechanical capitalization. We provide a better estimate of book values of assets and equity for consumers of financial statements.
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Intangibles, Book Value, Financial Statement Analysis, Valuation
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