Tuesday, June 03, 2003

There was an interesting set of articles in yesterday's Wall Street Journal about the relevance of accounting as currently practiced (articles not online, at least not for free). Investors focus on EPS, yet earnings under GAAP do not count the cost of capital. Investors have a choice of companies to buy stock in, and expect a return of, say, 10%. Interest on loans is deducted as an expense, but the implied interest rate on equity is ignored. So a company can issue $1 million worth of stock, on which investors expect to make $100K per year, and then actually earn $50K a year, and it will show up under GAAP as a profitable company.

On the balance sheet, intangible assets are ignored, even though they form an estimated 80% of the assets of US corporations! Intangible assets are things like trademarks, computer software, etc. They are usually created by employees and their salaries are expensed. No assets appear on the books. Intangible assets should be capitalized and then depreciated over a period of years.

It makes you think and wonder when and where a clearer set of books will be found.