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"What is your organization's most important asset? CEOs often respond that the organization's people are its greatest asset. But if this is true, where are people accounted for in the financial statements? Today, people are generally classified as expenses on the income statement and liabilities on the balance sheet -- not as an investable asset. Thus, when CEOs seek to increase profit, they cut costs -- like people -- rather than investing in assets -- like people -- that can appreciate. "
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In fact, investment advisory firm Ocean Tomo estimates that in 1975 more than 80% of the value in the S&P 500 firms consisted of tangible assets -- like land, plant and equipment. In 2010, approximately 80% of the S&P500 market value is attributed to intangible assets. But, today's accounting systems and financial reporting are still using 20th century definitions, creating a "gap in GAAP" (the Generally Accepted Accounting Principles) on how value is created in the 21st century.
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- historical cost,
- replacement cost, and
- opportunity cost.
In January 1967, the Harvard Business Review published, "Put People on Your Balance Sheet," which discussed various methodologies for classifying human resources as assets, including:
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"What if the origin of political division in this country could be traced to a simple glitch of the generally accepted accounting practices?
In other words, charging money for baggage essentially transfers this service from the liability column to the asset column of the accounting statement. As a liability, it can only atrophy under the weight of austerity measures."
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By charging fees, once neglected baggage service departments have become star revenue performers for airlines. Department managers can now justify new technology and equipment. Where before, baggage service only represented a cost, it now provides millions in revenu
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The basic problem is that regulators have been working for the last two years to define the difference between hedging and gambling, and can’t.
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"I guess it’s time to talk about Accounting for Intangible Assets: There is Also an Income Statement by Stephen Penman. When this new paper first came out from the Center for Excellence in Accounting & Security Analysis at Columbia University, I decided to ignore it as an apology for current accounting standards–which are completely inadequate for the knowledge era.
But now the paper is getting more attention so I feel the need to answer it."
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- Intangible asset is a “speculative notion” – This is a common problem for accountants. They cannot see an intangible so how can it be real?
- “Intangible assets involve using assets jointly” – This is a related problem. The utility of intangibles is related to their use in a system. (This is why we help companies model their IC as a system)
- The cost of intangibles “would be hard to identify” – This I don’t buy. Every day, accountants make a distinction between money spent on current operations (an expense) versus money spent on building future capacity (an investment).
- “Establishing an amortization schedule would typically be quite speculative” – He’s right. It would be. It’s one of the key reasons why we cannot create new accounting standards…yet.
Penman’s argument explains all the reasons that intangibles cannot and should not be booked to a balance sheet today. These include:
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But if I were an investor or an analyst, I would still ask the question: How are you spending your money on future capacity? How does your annual intangible capital expenditure break down?
"I have been really heartened to see more attention to the way that the intangible information gap skews investors’ understanding of what’s really going on in today’s knowledge-driven companies. This latest article comes on the heels of a Reuters piece last month calling for getting intangibles on the balance sheet."
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He responded by stating that our current accounting system doesn’t value “intangible capital accumulation” appropriately
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Most certainly, intangible capital accumulations are “expensed,” not capitalized. Such accumulations increase productivity, foster more efficiency, and drive better financial money flows than are currently measured
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"I continue to be amazed that clients try to create a business case for a major, multi-million dollar project request at the eleventh hour. How can business and IT managers be so naïve? They know a business case is required."
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Getting access to these business metrics requires engaging business people and typically their finance staff, too. Harder to do, but it’s time well spent. Consider conducting an interview where a business person highlights their key requirements, which are dutifully documented. They rant about a particular process or system that is broken, and now is the time (during the first weeks of the project) to ask how much it is costing them and to ask them for supporting data. Inform them right away that your ability to help them automate is dependent upon the financial data they provide.
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Even though every business and its auditors has adopted Generally Accepted Accounting Procedures (GAAP) for revenue reporting and tax purposes, internal cost accounting is completely different, and no standards exist.
"The rise of the knowledge economy has broken this model. The balance sheet does not include intangibles. Investments in intangibles instead are mixed in with current year operating expenses. And no one knows how much is spent on building intangibles within an organization."
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A company can only put assets for which it has a clear ownership right on its balance sheet. Most intangibles don’t meet that test.
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Second, the value of intangibles is closely linked with related assets. You may have heard this one too. It is hard to separate the human from the relationship from the structural capital.
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"The tools, technologies, and methods we deploy in business are used as they cause the business (the asset) to perform better: bottom line down or top line up, simple stuff. This seems to have been forgotten. Some of the newer tools – such as social business design – can add value in this content, but they are only tools. If they make sense and add value, then they will be adopted. If not, then they will wither and die. For many companies, it looks like they will only provide marginal utility."
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many marketing machines and practitioners have forgotten that for these tools to be adopted they need to add value, and that it’s hard for them to add value in the command-and-control structures that exist in most companies.
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They’re focused on managing that central asset and there is currently no proof that these new techniques can do that any better than existing practices. As Dennis pointed out, the kinds of management structures to use these new tool in this context don’t currently exist.
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We have also seen social media form communities that increase productivity in manufacturing processes, software development, and project management. We have seen people self manage in social media to segregate and elevate good information away from bad information. We have seen communities act with logic, tact, and precision previously thought to be the province of top management guidance.
In short, we have seen social media replace or duplicate almost every structural element of the traditional corporation outside of the construct of corporations. Can social media provide a corporate structure in and among itself?
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Increasingly, access to the community knowledge inventory is becoming a means be which people can convert productivity to money.
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The next paradigm of economic development will reside almost entirely on a statistical game of managing risk and return, matching surplus to deficit, and increasing human productivity in the operating system of Social Media.
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Because traditional financial accounting measures like ROI give misleading signals about continuous improvement and innovation, more integrated approaches to performance measurement are needed. An obvious candidate here is Kaplan & Norton's Balanced Scorecard (BSC), which assess performance from the perspectives of (i) staff development/learning (ii) internal processes (iii) customer service and satisfaction and (iv) financial effectiveness, efficiency and cash flow.
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