Signaling the Uncertainty of Future Economic Benefits: Accounting for R&D in Australia

Abstract

This paper contributes empirical evidence to the international accounting debate over whether capitalisation of research and development (R&D) expenditure should be permitted. It exploits more flexible accounting rules in Australia prior to 2005 which allowed expensing or capitalisation of R&D at management discretion. Following Kothari, Laguerre and Leone (2002), association with the uncertainty of future economic benefits is used to evaluate the capitalising versus expensing decision. This paper examines the associations of total R&D expenditures and separate capitalised and expensed R&D expenditures, as well as PPE expenditures, with future earnings variability. The results, which are robust to alternative measures of key variables, show that the expensed R&D is associated with higher earnings variability. We interpret this as indicating that management uses its accounting choice to signal the uncertainty of future economic benefits from R&D expenditures to investors, rather than using it to manage earnings.

Keywords: research and development, accounting discretion, information

JEL Classification: M41, M48