Does the Capitalization of Development Costs Improve Analyst Forecast Accuracy? Evidence from the UK

22 Pages Posted: 21 Dec 2009

See all articles by Seraina C. Anagnostopoulou

Seraina C. Anagnostopoulou

University of Piraeus, Department of Banking and Financial Management

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Abstract

It has been documented that investments in Research and Development (R&D) are associated with increased errors and inaccuracy in earnings forecasts made by financial analysts. These deficiencies have been generally attributed to information complexity and the uncertainty of the future benefits of R&D. This paper examines whether the capitalization of development costs can reduce analyst uncertainty about the future economic outcome of R&D investments, provide outsiders with a better matching of future R&D-related revenues and costs, and therefore promote accuracy in analyst forecasts. UK data is used, because accounting rules in the United Kingdom permitted firms to conditionally capitalize development costs even before the introduction of the International Financial Reporting Standards. The choice to expense R&D rather than conditionally capitalize development costs is found to relate positively to signed analyst forecast errors. This finding is robust to controlling for the influence of other factors that may affect errors, as well as for the influence of R&D investments on forecast errors. The decision to capitalize versus expense is not observed to have a significant influence on analyst forecast revisions. The findings are interpreted as evidence that the choice to capitalize as opposed to expense may help to reduce deficiencies in analyst forecasts; hence, is informative for users of financial statements. Increased informativeness is expected to have repercussions for the effectiveness with which analysts produce earnings forecasts, and, as a result, market efficiency.

Suggested Citation

Anagnostopoulou, Seraina C., Does the Capitalization of Development Costs Improve Analyst Forecast Accuracy? Evidence from the UK. Journal of International Financial Management & Accounting, Vol. 21, Issue 1, pp. 62-83, Spring 2010. Available at SSRN: https://ssrn.com/abstract=1525977 or http://dx.doi.org/10.1111/j.1467-646X.2009.01036.x

Seraina C. Anagnostopoulou (Contact Author)

University of Piraeus, Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
Piraeus, 18534
Greece

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