Ask VeraSage: Accounting for Intellectual Capital?

I’ve been having a dialogue with a consultant for the last two years, and we recently had a very interesting discussion on intellectual capital (IC).

I thought you might find it of interest, since IC is what the professional knowledge firm is all about.

Our exchange focused on whether or not it is possible—or even desirable—to attempt to value IC, and perhaps placing that value on the financial statements, or a set of parallel statements.

Doug was not advocating this approach, just questioning the validity of doing it, and what the impact would be. I’ve had many other discussions with consultants and CPAs about, for instance, placing the value of a company’s brand on its balance sheet.

Should we account for IC, like GAAP accounts for transactions? Should IC be on the financial statements?

We both conclude no. Here’s why.

Hi Doug,

We do use IC as an integral part of a professional firm’s business model, which is why we refer to them as Professional Knowledge, not Service, Firms. PKFs sell IC, not time.

As for measuring IC, I find the work of others in that area interesting, and have met my share of firms that offer formulas and frameworks to value IC. All fascinating, but I’m still trying to answer, “What’s the point?”

Some insist they want IC to be put on the firm’s financial statements, which will and can never happen, since accounting is designed to capture value after a transaction, not value it before hand.

You certainly could devise parallel financials for IC, but again, what’s the point? The argument is to force managers to think about it, value it, etc.

But it seems to me that this is the “What you can measure you can manage mentality,” and with IC, effectiveness is always and everywhere more important than efficiency (the latter of which is always a measurement, where the former is always a judgment).

Since value is subjective, any formula or model for IC will be flawed from the get go. Not that it’s not a worthwhile exercise, such as how Interbrand values the world’s leading brands, but it’s the illusion of accuracy and precision. I’ve seen companies pay well over IC value calculations because value is subjective.

So, I come back to what’s the point of this? What’s the service being offering by valuing IC? What’s the value of doing so? I don’t think it’s as obvious as IC folks make it out to be. As you know, I wrote an entire book, Mind Over Matter, on this topic, but didn’t try to value IC—it can’t be done with any reliability.

Thanks Doug, look forward to your thoughts.

Thanks very much, Ron.

This is exactly the kind of response I was hoping for—informed and critical. I’m slowly committing Mind Over Matter to memory, so I have deep respect for your opinions.

I have a lot of skepticism myself. I take your point about accounting being the trail of the past. I have heard the argument that by putting NPVs on assets, is bringing the future into the present, and isn’t it true that IC is exactly about the future, and that is why [we need] a breakthrough in accounting? It is supported by IASB standards on intangible assets and impairment, which also track with FASB standards 38 & 38.

But the IC side intrigues me, because so many people believe there is such a need to recognize (and quantify and monetize) your subtitle (intellectual capital is the chief source of wealth). I think this belief is even more strongly held in the wake of the debacle over people pumping up risky underpinnings (lousy mortgages, among others) into highly leveraged clouds of crap. A wealth creation engine based on human knowledge, experience, relationships, performance, and results seems like a more positive economic foundation. But how to capture, how to harness?

Thanks again for your quick and thoughtful response. One of these days I’ll buy you a beer, or a glass of your favorite wine

Cheers, and great thanks,


Hi Doug,
I understand the argument, my problem is knowledge is also a social construct—it simply cannot be quantified, tracked, and put into a formula.

There is certainly value in valuing IC for a business sale, and indeed that is what happens. This is why accountants call the sales price over the book value “goodwill”—just a word that describes their ignorance, i.e., their inability to value an enterprise, only capture it after a transaction takes place.

But even formulas for IC won’t capture the subjective value of an enterprise. How many times have you seen a company pay way above a company’s value, as assessed and computed by business valuators? It happens a lot, and that’s because value is subjective.

And no, I do not think putting NPVs on assets is bringing the future into the present. Accounting can’t do that, and even if there existed formulas, they would be full of errors and inaccuracies.

Here’s another reason: knowledge is actually about the past, whereas entrepreneurism is about the future, and you can’t capture the Black Swans of entrepreneurialism by formulas. No amount of sophisticated IC formula could have predicted, captured, or harnessed eBay or Google. It takes the
risk-taking of entrepreneurs to create new wealth. Anything we can capture, measure and harness is almost by definition about the past that is already dying.

I’ve come to the conclusion that we’ll never be able to measure IC. So what?

We know it’s there—like dark matter in the universe—but there are too many variables. It’s spiritual, not material—meaning you can’t measure it.

To believe otherwise is the materialist fallacy—that everything needs to be measured to be understood. It doesn’t work—see the USSR, Cuba, North Korea and any other communist country.

This doesn’t mean we should ignore IC, only that trying to measure and value it is futile—like plunging a ruler into an oven to determine its temperature. It’s the wrong device.

There’s lots more to say on this topic, but it does make my brain hurt.

Doug made the final salient point about IC, what Joseph Schumpeter called the Creative Destruction of capitalism:

The key point is that the value does not arise from the accounting of it, however elaborate the accounting scheme might be, but rather in the context of a marketplace that is focused on performance and results, enhanced by a skunkworks generator, etc.

Would love to hear your opinions on this topic.


  1. Eric Fetterolf says:

    Ah – Ed’s old “So what and Who cares”. Classic.

    The concept does intrigue me. I am not one to say “I haven’t been able to figure it out so it’s really impossible or worthless”. I’m surprised that you would take such a stance, given your correct observations that Accounting needs to take a gigantic leap forward.

    Asset Depreciation appears on the income statement. Is it real? Is it accurate? Are the formulas correct and precise in all circumstances?

    Does it even help manage the business?

    No, we need numbers, metrics, KPI’s that look forward, that predict, that encourage risk and help guide resource allocation (time, money, people) toward profitable endeavours. IC valuation is one such number. If only we could grasp it….

  2. Hi Eric,

    Well, actually “So What?” is borrowed from Milton Friedman, no slouch when it came to measuring things.

    I’m not saying it’s worthless, I’m arguing that IC is spiritual, and cannot be measured, any more than value can be.

    Asset depreciation is not real, it’s merely assigning historical cost over a period of years. It has absolutely nothing to do with value. And, no, it does not help manage any business one scintilla.

    We’ll never get fully predictive KPIs. Who’d want them? (Who cares?). Would we really want to live in a world where everything was predictable? No Black Swans?

    No thanks. I cherish uncertainty as much as creative destruction. The future belongs to the dreamers, entrepreneurs, and poets, not the rationalists and MBAs with their materialist fallacies.

  3. I’m out of the closet as the “Doug the Consultant” in the discussion.

    The key issue for me might be stated as “the valuing” vs. “the accounting for”. The valuing concern springs from the intuition that the real source of wealth is human knowledge, experience, and relationships, as confirmed by the subtitle of Mind Over Matter, as I mentioned. I have worked on a couple of start-up ventures, based on the idea that the value occurs in performance in problem-solving domains, but is mostly ephemeral in a world where value is usually attached to commodities and products, and more recently puffed up derivative instruments that have physical things as the basis for leverage (housing mortgages, e.g.)

    The key thing is to somehow recognize the knowledge, experience and relationships as some form of property. Hernando De Soto’s key insight is that societies that have strong institutions that recognize property do better than those that don’t. So how to create market institutions is the key to unlocking a vast pool of largely unrecognized wealth (similar to how eBay created a market for the under-recognized “treasures” in people’s attics and basements. eBay accounts for transactions, but it is the transactions themselves that unlock the value.

    As a consultant I take a personal stake in the outcome of this discussion. I have worked in large institutional settings where my contribution has been valued according to the billable hour, not the knowledge, experience and relationships that I bring to the performance of problem-solving activities. VeraSage has advice to share in this regard. It seems there’s a role for “the accounting” of this, but possibly not directly in “the vauing”.

  4. Businesses make investments in assets in order to make a return. IC is no exception. The IC of American corporations has been built through direct investment as surely as the factories of the past were built through consistent and considered investment.

    At least part of the investment in IC is monetary and is already passing through the income statement. It is this investment that has built the knowledge era and the enormous IC capacity of American corporations.

    But we continue to ignore this capacity and will continue to do so as long as we fail to create management reports that keep track of the investments in training, process, data, software, IP, brands, networks, relationships–that is, investments in IC capacity (by the way, this approach is described in Ch 7 of Intangible Capital).

    Every board and every investor should know what a company is investing in to fuel future earnings. Ignoring the need for this information will continue to keep IC as the realm of dreamers. You may be happy with that, but I’m not.

  5. Hi Mary,

    Thank you so much for your comments, they are incredibly thought-provoking.

    I understand what you are saying, but I’m saying this: you are asking GAAP to do something that it is not capable of doing: measuring future value.

    GAAP is not a theory; it is only an identity equation that is true by definition. Hence, IC can’t be run through traditional financial statements. GAAP can only record value after a transaction has taken place.

    I’m all for users of financial statements receiving IC information, hence my support for the Enhanced Business Reporting Model. But, for instance, placing the value of a corporation’s brand on the balance sheet is, again, asking GAAP to do something that it is not capable of.

    Mark-to-market accounting is a disaster, as proven by the recent financial crisis. We have to be realistic about what accounting can and cannot do.

    The problem with most IC reporting is that it is historical, not predictive. You can count investments in education, but what I want to know is what you learned. Good luck coming up with a metric for that.

    Leading indicators would attempt to track outputs, not inputs. Hence leading indicators require a theory, and again, GAAP is not a theory.

    Maybe I should have said entrepreneurs are the dreamers, and it is they who create new IC, and hence shape our future. Knowledge is by definition about the past, which is dying everyday.

    In any event, loved your comments and I hope you continue the dialogue on this fascinating topic.

  6. Ron- I was careful to not talk about GAAP. I should have made it clear that I am talking about management accounting, not statutory accounting which will be the last to change.

    You are right about mark to market and other attempts to “value” assets for the balance sheet. IC practitioners are right to steer clear of this.

    But I think that, in all the conversations about value, we have forgotten the boring old concept of recording costs and investments. Tracking (in management accounting only) investments in IC is a simple but powerful way of getting IC onto management, board and investor agendas.

    I know that cost does not equal value (even more so with knowledge assets than tangibles). But businesses are still in the business of building production capacity and producing value for their customers.

    Why just try to look at future value? Why not also look at the cost to build the capacity? I believe that it will give us some strong clues about how to create that future value in the most effective way possible…and bring IC thinking into mainstream business.

  7. Hi Mary,

    Fair enough, and I agree with you.

    It’s not that I’m against recording costs and investments of IC, I just remain unconvinced that doing so changes anything.

    We don’t change our weight by weighing ourselves more frequently.

    Your point about it getting on the agendas of investors, boards, etc., is well-taken, and one I’m quite sympathetic with.

    But in my experience, this isn’t enough. It’s been done, and yet people still revert to the physical and materialist fallacies of “only by measuring it can we manage it.”

    This is nonsense on stilts, and I wrote an entire book attempting to prove it. Plus, measuring things contains enormous moral hazards, and maybe I need to write more on this here.

    The cost of building IC capacity can, and is, being recorded internally by sophisticated companies. I believe most pharmaceuticals and companies like Google and Apple do this.

    I’m not arguing against this.

    I just remain unconvinced that measuring, tracking, and accounting for IC is enough to change anything. It just smacks of the Materialist Fallacy to me, and measuring for the sake of measuring.

    We can count the bottles, but it’s much harder to describe the wine. And that’s where this entire IC concept runs into the wall with traditional Industrial Era metrics–so many of them track inputs and efficiencies (like the old USSR), rather than outputs and effectiveness.

    Still, love your comments, you making me think hard. And as we say, if we lose an argument we learn something.

  8. I love the wine analogy.

    The way we address the dilemmas of measurement is through the concept of triangulation–measuring intangibles using three different perspectives: investment, assessment and indicators.

    Triangulation says count what you can with numbers and dollars but still leave room for analyzing the unmeasurable through assessment. After all, even wines are assessed through rating systems…

  9. I like the triangulation, it’s very similar to my distinction between a measurement and judgment.

    In IC, a judgment is always and everywhere superior to a measurement.

    Wines may be assessed with a number, but it still is a judgment that determines the number.

    Again, this is the Moral Hazards of Measurement discussion, and I will post on this soon so you can see the full context of why I’m so skeptical of measuring for the sake of measuring.

    Just one quick example: When a family has a baby, their per capita income decreases by one-third, yet they are usually blissfully happy. A measure that non-sensical is meaningless.

    Great stuff Mary, thanks!

  10. Eric Fetterolf says:

    I think this issue might wind up floundering on the fact that any measurment, and reading, any number, any reporting, is useless for judgement unless compared to a standard. No judgement, no assessment can be made with a number by itself.
    Judgements are always a comparison. [XYZ] is ?good? is a statement that articulated that [XYZ] exceeded the minimum standard. That standard might be completely implied. Often it requires experience to even know what the standard is. For example, is a Blood Pressure of 120/80 good or bad? How about a cholesterol count of 165? Can you know based upon the number by itself? Only if you know the standard.
    There are no metrics, no measurments, no standards to compare IC data to. We could set a number, a metric, and measure to our hearts content, but could we judge that number as being “Good” or “Bad”? Of course not. This is where measurment of measuring sake falls flat on the ground.
    This discussion might be a cry in the wilderness for some way to judge, assess, interpret, those things that have great value but cannot be judged with our current tools. What standards might be created to assist the new business leaders to assess, to judge, what they have now and where can they go?

  11. Eric,

    I like this, and I think you are on the right track. I struggle with this “standard” as well.

    Here’s an example: You need heart surgery. You research two doctors that come highly recommended by people you trust, and you come across their mortality rates (the risk of dying from surgery):

    Doctor A: 65%

    Doctor B: 25%

    We know the standard of 0% would be unrealistic. But what is an acceptable standard here?

    Which doctor would you select? Would you want to know anything else?

    Of course you would. You would want to “JUDGE” the types of patients each doctor takes. Doctor A may take the most difficult, least hopeful and healthy patients, so more of them die, whereas Doctor B may screen and only take patients that are easier and healthier.

    Doctor A may be the better surgeon in this example, but the numbers, in and of themselves, don’t reflect it. You need the judgment. A standard might help (though I can’t think of a standard “patient”), but the judgment is everything.

    This is one of the moral hazards of measurement: the more we measure, the less we can compare.

    What say you?

  12. Let me first say “Hi Mary! Great to see you over here!” It seems like this discussion has turned into a great continuation of the thread I was pursuing on your ICKC site via a set of blog postings: This was riffing off your idea about knowledge factories, and what does this really mean for knowledge professionals.

    I have been meaning to post the next in that series where I intend to address a key issue of moral hazard. Since Ron raises that phrase here, let me take this opportunity to summarize. This discussion of accounting, by those of you who are more steeped in accounting than I am, may render this moot, but here goes with the short version.

    This whole discussion, for me, started because I was testing some ideas on Ron, about accounting for IC. Part of that set of ideas includes the idea of asset vs. liability, where the knowledge in the minds of employees might be considered a liability, since it is not really owned by the firm, and walks out of the office every day, someday never to return. The knowledge management techniques that make the tacit explicit, and the intangible tangible declare, within this formulation, that this KM process transforms liabilities into assets, from the point of view of the firm.

    But, what is the motivation of the employee to participate in this transformation? Why should they go out of their way to make it so that the firm owns what they know, so that when they DO walk out the door, the firm is indifferent to their leaving? (All of this is subject, of course, to the caveat that this transformation from tacit to explicit by KM is necessarily far from complete or perfect).

    This moral hazard issue was raised by colleague Trevor Hilder of Web of Wealth, who pointed out that people have a motivation to juke the system by holding back their most valuable knowledge, and/or reporting excessive value of what they do allow to be captured.

    The answer to this moral hazard, in my mind, is ownership. To the extent that employees participate in the ownership of the assets of the firm, including their contributions, to game the system is to game themselves, as well as their individual colleagues. From this point I intend(ed) to explore some ownership schemes that would attempt to line up individual and collective motivations properly, as well as address the general problem of providing “title” to IC in the sense of title to property as explored by Hernando do Soto in his The Mystery of Capital.

    So, that’s the short version. Hopefully I’ll get back to ICKC soon, and blog a more complete set of thoughts.

  13. Hi Eric,

    I’ve had these discussions with actuaries, the ultimate quantifiers, and they are quite candid about how measures can be manipulated to whatever they need to show. They still require judgment, so I agree with your second paragraph!

    You discuss standards, and that’s very interesting. Here’s one, and you can fault this for not being business related, but I still think it’s valid: What’s the “standard” for the USA? Look at the Declaration of Independence: Life, Liberty and the Pursuit of Happiness.

    All not measurable, but require judgment. Based on how many people want to live here, I’d say the vote is in.

    If the new standards you refer to are aspirational like this, I’d be thrilled. And yes, if we want to change anything, we have to work on the linguistics, and the theories.

    Great comment Eric, incredibly thought-provoking. Keep thinking!

  14. A couple follow-on points:

    To Doug – You are right that the knowledge economy ultimately will change everything. Companies do not own their human capital. To the extent that their employee knowledge, experience, etc. are important, then the company has to work to keep the employee engaged. This shifts the power dynamic irrevocably. You might want to check out where Dan Robles explores a number of ideas about knowledge and ownership.

    In this scheme, I would say that employee knowledge is definitely not a liability–rather, a contingent asset that is tied to reputation. A company has to earn the right to continued access to the employee’s contributions. These concepts of the power of the bottom up are threaded throughout Intangible Capital.

    To Eric and Ron about measurement and standards. It’s too early for standards. But it is already past time to begin collecting better data on intangibles. This data needs to be used for learning and managing.

    Everyone assumes that the answer has to come from standards organizations. But they are not going to create standards out of the ether. Standards will come out of emerging practices. So let’s get practicing.

    (By the way, there are lots of benefits to businesspeople that develop and communicate intangibles information–research shows that it can improve valuation, performance, innovation and reputation)

  15. Thanks, Mary, that’s a valuable pointer. I apologize for misusing the accounting terms. I was just repeating what I had been told about something that you have access to, but don’t own as being technically a “liability”, but I definitely defer to the experts.

    I’m actually working on a slightly different problem than strictly accounting. I’m “Doug The Consultant”, for sure, but the kind of consulting I do is business architecture. So the main topic for me is, what is the proper architecture of a business that really monetizes IC. I keep coming back to some kind of internal marketplace, with some form of alternative currency or value-marker. The issue is ownership, and not just ownership of a piece of the company, though stock options can be pretty motivating. But an actual ownership stake directly into the results of their knowledge-based and knowledge-creating performance.

    I was on that topic for awhile, took a bit of a detour through accounting, and now returning more to the original business design I was working on when I left IBM. Now it has morphed a bit, and frankly one of the morphing factors is I’m taken with the idea of a knowledge factory, and how that actually can be instantiated inside various kinds of businesses, what it looks like from the point of professional knowledge workers (PKF), and how it behaves.

    All of that not discounting the possibility that I’m just barking up some silly tree or other 😉

  16. Hi all,

    First, great conversation.

    Second, two quick thoughts:

    1) Doug, I have thought about this idea for compensation and have reached the following: –> I am not saying this is conclusive, just my latest thinking. Here is the thing, any previous model lasted no more than six months atop my list. This one has been around over 2.5 years will little change in thinking.

    2) Eric, the new language is called systems thinking. I touch on it a my Consulting Academies, but more and more is has become something I think is important. You might want to read Peter Senge, The Fifth Discipline and/or better yet the Fifth Discipline Field Guide.

  17. Hi Ed —

    I like your four elements, and I think a scheme along the lines you propose is a vast improvement over others I’ve experienced over the years.

    The difference, though, is that you are talking about pay, and I’m talking about ownership. I think this is a big difference in the motivating force.

    Oh, by the way, thanks so much for mentioning the language of systems and systems thinking. I agree 100%, and even though this is not the latest shiny metal object (I belong to the International Society for the Systems Sciences (ISSS) which celebrated its 50th anniversary a few years ago) it provides the language par excellence for understanding complex social systems.

  18. Doug, my experience with ownership systems is that a minority stake professional firm is more a liability than an asset and is essentially worthless to the holder. In the end, profit sharing is a better solution.

    I think we all agree that knowledge workers are de facto owners of the means of production (the mind), but creating financial ownership (unless it is divvied among many people with no one majority holder) does not reflect that reality where as a profit sharing scheme gets you closer, however, it is not perfect either.

  19. The next economic paradigm will likely be characterized by the reorganization of people outside the construct of the prevailing corporate structures. Try that idea on.

    IC (allow me to aggregate social capital, creative capital, and human capital in the definition used in this forum) is readily calculated and it happens every day.

    for example; BP failed to invest 1M dollars in a fail-safe system and it cost them 100B for a factor of 1:100,000 – or, 5 orders of magnitude fail. The battle fields of business are strewn with the corpses of organizations and people who failed to accurately assess their indiscretions in terms of IC.

    I believe, on average, IC is undervalued by a factor of 1:1000 against the dollar. That means that a federal reserve dollar worth of production IC is really worth 1000 dollars in a yet unspecified social currency. Social media demonstrates that IC leverage can be intense. Expect that to increase substantially as tools integrate and the dollar loses it’s ability to store and exchange value.

  20. Dan, great contribution!

    As a side note, wouldn’t it be cool to trade in some kind of IC currency! My bet is Ayn Rand would be all in favor in lieu of the death of the gold standard.

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