The importance of intangibles in the modern economy: accounting, strategic relevance, valuation

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EXECUTIVE SUMMARY 
In the last decades the concept of intangibles has received increasing considerations from 
different fields of economics. In general, what has been observed is that intangibles are more 
and more important in today’s knowledge-intensive, information-based economy. Some 
macroeconomic researches have visualized the shift of developed economies from tangible 
to intangible investments (such as Lev, 2018), providing empirical evidence of the event: in 
2016 the tangible investments in the US private sector have amounted $1.49 trillion, while 
intangible investments have reached $2.16 trillion.  
The interesting fact is that, moving from macroeconomic data, the understanding of 
intangibles is still generating debates and conflicting theories. The elusive, polyhedral nature 
of intangibles, in fact, causes problems in giving a clear and distinctive definition, which, in 
turn, has consequences on other important aspects such as intangibles accounting, 
management and valuation. In particular, these problems reflect on the understanding of a 
specific category – internally generated intangibles – which, conversely, is considered by a 
growing body of academics and managers the most valuable and important for firms.   
The aim of this master thesis is to investigate the gap between the empirically-verified 
importance of intangibles in the modern economy and the limited understanding of their 
main aspects, starting from their definition, to their management and valuation, focusing on 
internally-generated intangibles.  
The analysis conducted in the thesis covers three main topics: accounting treatment, strategic 
management theories and firm-valuation implications.  
Starting from a review of the existing definitions and taxonomies of intangibles, the thesis 
moves to the most pragmatic approach: the accounting treatment of intangibles. It discusses 
the accounting standards on intangibles provided by the IASB (International Accounting
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Standards Board) and their limitations and consequences, analyzing if and to what extent 
intangibles are affecting financial statements’ informativeness and value relevance. 
It subsequently expands the concept of internally generated intangibles, first from the 
contribution of the resource-based view, and therefore through the research on intellectual 
capital and its tripartite categorization in human, organizational and relational capital, 
moving from a static to a dynamic and integrated vision.  
Finally, it covers the role of internally-generated intangibles in firm valuation, analyzing to 
what extent intellectual capital is affecting abnormal earnings, or, in other words, the market-
to-book ratio.  
The findings of this research are multiple: 
• Internally generated intangibles and accounting have few points in common. While 
some exchanges to accounting standards could allow a wider capitalization of 
intangibles, the core of the problem is that the foundations of accounting and the 
nature of internally generated intangibles are antithetical. Therefore, the solution of 
a better understanding of internally generated intangibles must be searched outside 
of financial statements. 
• The strategic-management focus on firm-specific drivers to explain competitive 
advantage, embraced by the resource-based view, offers interesting insights on a 
better understanding of (internally generated) intangibles. It is possible to observe 
that the literature on intellectual capital builds on the theoretical assumptions of the 
resource-based view to expand on the dynamics of intellectual capital, moving from 
a static to a dynamic, interrelated view of intangibles. Human, organizational and 
relational capital dynamics are better understood under this perspective.
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• Internally-generated intangibles contribute to firms’ abnormal earnings and have 
explanatory power on the market-to-book divergence. However, the existing 
researches’ methods focus on a cost-based valuation of intangibles, which is a limited 
proxy and doesn’t fully measure the value-relevance of intangibles. To better assess 
the value of intangibles, quantitative data should be backed by precise, value-relevant 
qualitative information. At the moment, the understanding of intangibles is not yet 
as complete as to offer specific criteria for their assessment, at least on a general, 
comparable level.
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1. DEFINITIONS AND TAXONOMY 
1.1 GENERAL DEFINITIONS AND VIEWS ON INTANGIBLES: WHAT’S 
MEANT BY INTANGIBLES? 
The idea that firms are made by tangible and intangible assets is not new: in the ‘80s 
Hiroyuki Itami published a book called “Mobilizing invisible assets” (1987), arguing that in 
the list of corporate resources information play a determinant role, with all its components 
(consumer trust, brand image, control of distribution, corporate culture, management skills). 
His attempt to define what he called “invisible assets” has been one of the first recognized 
by the literature. 
However, after decades of research, the definition of intangibles still causes debates between 
the academics as the concept has been shaped through different point of views, generating a 
considerable amount of definitions without a consensus on which best describe the term, as 
noted by Kristandl and Bontis (2007). This is testified by the fact that there are different 
terms other than intangible used to label the same concept, such as intellectual capital, 
knowledge capital, intellectual property and sometimes even goodwill. 
In some cases, the different terminology comes from different fields of research: the term 
intangible is related with accounting, intellectual capital is used in the economic-strategic 
field and intellectual property is related to the legal literature.  
Among the most cited definitions there is the one of Blair and Wallman (2001), who describe 
intangibles as “Non-physical factors that contribute to or are used in producing goods or 
providing services, or that are expected to generate future productive benefits for the 
individuals or firms that control the use of those factors”. Lev (2001) define them as “A 
claim to future benefits that does not have a physical or financial (a stock or a bond) 
embodiment”. Comparing these two accredited definitions there are some recurrent
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elements, such as the non-materiality and the probability of future economic benefits, which 
are also mentioned in the accounting notation: the International Accounting Standards Board 
(IASB) defines intangible assets in the IAS (International Accounting Standard) 38 as “an 
identifiable non-monetary asset without physical substance”. According to the revised 
Conceptual Framework for Financial Reporting issued by the IASB on 29 March 2018, an 
asset is “A present economic resource controlled by the entity as a result of past events. An 
economic resource is a right that has the potential to produce economic benefits”. The 
definition has changed from the 2010’s one (where an asset was defined as “a resource 
controlled by the entity […]”) to highlight the fact that the physicality is not a distinctive 
characteristic of an asset.  
These definitions, in their generality, share some common points and seem to build on the 
same concept of intangibles. However, having a deeper look, the differences become 
evident. The accounting view on intangible is limited by its scope, embodied by the 
principles of relevance and reliability, and it requires specific criteria of identification and 
measurement that will be discussed later. This is due, indeed, to the fact that financial 
statements must be comparable between firms and cannot allow for subjective judgements.  
On the other side, other areas of study that deal with intangibles, such as strategic 
management and firm valuation, have a different focus that allows for a broader 
consideration of the category of intangibles: the goal of strategic management is to define 
how firms achieve and sustain competitive advantage, and, as highlighted by Kristandl and 
Bontis (2007), firm-specific (or, in accounting terms, internally generated) intangibles have 
an important role in the discussion. Firm valuation deals with the understanding of a firm’s 
value based on its future profitability, leaving space for considerations on the profitability 
of intangible investments and, more generally, on how intangibles affect the valuation of a 
firm.
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2.THE ACCOUNTING TREATMENT OF INTANGIBLES 
2.1 ACCOUNTING DEFINITION 
The accounting definition of intangible assets is disciplined by the IAS 38 and by the IFRS 
(International Financial Reporting Standards) 3 for what concerns the goodwill. 
 IAS 38 establish three main attributes for assets to meet the definition of intangibles:  
identifiability, control and probability of future economic benefits.  
• Identifiability: to be identifiable an asset must be separable, i.e. “capable of being 
separated and sold, transferred, licensed, rented, or exchanged, either individually or 
together with a related contract” (IAS 38.12) or it must arise from contractual or other 
legal rights, “regardless of whether those rights are transferable or separable from the 
entity or from other rights and obligations” (IAS 38.12).  
• Control: to control an intangible asset means to have the power of obtaining the 
economic benefits (such as revenues or reduced future costs) flowing from it in an 
exclusive way, which also means being able to restrict the access to the intangible 
asset. 
• Probability of future economic benefits: it refers to the potential that future cash 
flows will incur thanks to a specific asset. It must be “based on reasonable and 
supportable assumptions about conditions that will exist over the life of the asset” 
(IAS 38.22). 
According to these requirements, the most common typologies of intangible assets to be 
capitalized in the balance sheet are patents, licenses, trademarks, copyrights, computer 
software and development costs.   
A study of the consulting company KPMG (2009) has categorized the intangibles 
recognized by the IAS 38 in the following list:
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• Technology related: Patented technologies, computer software, databases, trade 
secrets such as secret formulas or algorithms. 
• Contract related: Licenses, royalties, construction management, service, delivery and 
supply contracts, lease agreements, construction permits, franchise agreements, 
operating and broadcasting rights, use rights (such as drilling, water, air, timber 
cutting and route authorizations) 
•  Customer related: Customer lists, customer contracts and related customer 
relationships, non-contractual customer relationships 
•  Marketing related: Trademarks, trade names, newspaper mastheads, Internet domain 
names, non-competition agreements 
• Art related: Plays, operas and ballets, books, magazines, newspapers and other 
literary works, musical works such as compositions, song lyrics and advertising 
jingles, pictures and photographs, video and audiovisual material, music videos and 
television programs.  
Most of the intangible assets recognized by the accounting standards are arising from 
contractual or legal rights, as the criteria are more easily met if the asset is disciplined by the 
framework of the law. Intellectual property rights exist to recognize and legitimize the rents 
deriving from the development of an idea to its owner, from the technologic innovation to 
the artistic content. 
There are some identifiable intangibles for which IAS 38 explicitly deny the recognition: 
these are “internally generated brands, mastheads, publishing titles, customer lists and items 
similar in substance” (IAS 38. 63). According to the view of the IASB, expenditures on these 
assets cannot be distinguished from the cost of developing the business as a whole and 
therefore they cannot be capitalized.