R&D Accounting and the Tradeoff between Relevance and Objectivity

Abstract

This paper develops a simulation model for a pharmaceutical firm to provide evidence on the tradeoff between objectivity and relevance for several methods of reporting R&D outlays. The findings indicate that a simple capitalization rule, analogous to the successful efforts method of capitalizing oil and gas exploration costs, provides a significantly higher relation between accounting information and economic values than immediate expensing of R&D outlays or capitalizing the full cost of outlays. More importantly, our findings show that the relevance of successful efforts data persists even when there is widespread earnings management.

JEL Classification: M41, M44