NewAccountingfortheNewEconomy-TrinityUniversity.docVIP

New Accounting for the New Economy By Baruch Lev* Please do not use or reference this study without the author’s written permission. May 2000 __________________________ * Philip Brades Professor of Accounting and Finance, Stern School of Business, New York University (212-998-0028; blev@; /~blev). I am grateful for the comments and suggestions of Jim Leisenring (FASB Vice Chairman), George Massaro (Arthur Andersen) and Jim Ohlson (NYU). Responsibility for the views expressed here is mine. I. The Current State of Accounting Accountings 500 year exceptional durability is being severely tested by the New Economy, characterized by the fast pace of technological change and the consequent increased uncertainty, the substitution of intangible for tangible assets as the major drivers of value, and the blurring of the boundaries between the firm and its customers, suppliers and even competitors. The traditional accounting model, recognizing primarily tangibles as assets, dealing asymmetrically with uncertainty (recognizing expected losses but ignoring expected gains), and focusing on legally-based transactions (sales, purchases, capital expenditures) while abstracting from many value-changing events (e.g., a failure of a drug to pass clinical tests), was not designed to deal with the new economic environment, and therefore no longer serves essential managers and investors needs. Stress signs are all too visible. The average market-to-book (M/B) ratio of the SP 500 companies exceeds now 6.0, indicating that five of every six dollars of corporate market value are missing from the balance sheet. New economy M/B values are much higher -- some (Cisco, Dell) in the two and even three digit stratosphere. True, balance sheets are not intended to mimick market caps, but they should not be trivial either. Academic research corroborates the general uneasiness with the usefulness of financial information. Several large-scale empirical studies have