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Robert McGarvey: Accountants need to start putting a value on intangible assetsIf you’re in business today, you no doubt face a conundrum: the financial statements of your company tell you that certain physical objects are the principal assets of your business but, sadly, that’s not what the market or your gut tell you.

Business increasingly relies on non-traditional sources of value.

For example, most software companies rely on semi-official communities of practice, groups of interconnected specialists who are (often voluntarily) feeding new material into the software system, continually keeping it up to date. Most of this value is in relationships that are undocumented and invisible to third parties.

However, not just new-age companies are impacted by intangibles. If you’re a manager of a more traditional business, you’ll be increasingly aware that your corporate reputation is a valuable asset and – more importantly – in today’s socially-connected world, your reputation can be slammed in a moment.

So, yes, things are changing in the world of business.

Studies conducted by the World Bank and others suggest that intangible sources of value now contribute more than 80 percent of gross domestic product (GDP) in many developed economies.

While this newer intangible economy is growing, industrial-type manufacturing is in decline. Between 1995 and 2002, developed economies in the west lost 22 million industrial jobs. In the last decade, the United States economy alone lost close to 25 percent (four million) of its domestic manufacturing jobs. Yet, despite the shrinking of their industrial workforces, the output in these countries as a measure of GDP increased by half.

And this is only the beginning. Long-standing businesses like hotels, taxis and newspapers are facing massive disruption by digital competitors like Airbnb, Uber and Troy Media Digital Solutions. Meanwhile artificial intelligence will likely replace humans in the productive process in the near future. It’s scary.

So what’s going on?

The engine of growth in modern capitalism is in rapid transition from a factory-based economy that produced tangible products to a technology-driven knowledge economy that employs intangible inputs in non-mechanical production processes. This new economy produces intangible (often digital) outputs like software, social media networks and apps, and instantly distributes them globally.

This new reality obliterates almost every conventional law of economics.

The thing that’s changed most is the kind of economic capital being employed in the productive process.

It’s commonly accepted among economists that value is created in an industrial economy through a process in which capital (predominately mechanical) is combined with labour to create something.

However, where the old industrial economy assumed that only tangible forms of capital are important, the modern intangible economy employs six capital forms. Today, for instance, innovation (in the form of intellectual capital) and knowledge (human capital and/or artificial intelligence) dominate the economic landscape.

These new sources of value are not only changing how the economy works, they’re different in kind to traditional assets. Not only are they non-physical, they generally don’t obey the law of scarcity – and that essentially overturns the laws of supply and demand.

The science of economics and our primary economic institutions are behind the curve in documenting these changes. And that means that corporations are under-reporting these new sources of value on their balance sheets. Lacking formal visibility, these assets are often poorly managed and/or wasted.

This alteration in the fabric of capitalism is putting big challenges on corporate managers. They must manage many new and unfamiliar classes of assets. And they must develop vastly different strategies to compete in an increasingly erratic commercial environment.

So what’s an intangible asset?

The accounting definition of an asset is something you own, from which you expect future economic benefits.

So it ought to be simple to identify and document these new assets. But very few of the new intangible value drivers fit into the existing accounting framework.

This is affecting national economic statistics. Not capitalizing intangibles at the firm level means a vast under-reporting of intangible investment. And that distorts GDP calculations and productivity analytics, leading to wrong-headed policy in national economies.

Distortions at this level have consequences, adversely impacting capital markets and investment decisions.

In the 1960s, Bob Dylan sang: “the times they are a-changin’.” That was never more evident than today.

Robert McGarvey is an economic historian and former managing director of Merlin Consulting, a London, U.K.-based consulting firm. Robert’s most recent book is Futuromics: A Guide to Thriving in Capitalism’s Third Wave.

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