Capitalization of R&D Costs and Implications for Earnings Management

Abstract

This paper provides insights into the incentives behind the capitalization of R&D costs. In particular, this paper examines whether earnings management incentives play a role in capitali-zation of R&D costs, focusing on two earnings management activities: avoidance of losses and earnings decreases. The sample is based on German firms which are listed on DAX30, MDAX, SDAX, and TecDAX from 2006 to 2010. The evidence supports that both earnings management incentives determine the capitalization of R&D costs. An additional analysis sheds light on whether the detected earnings management incentives are driven by the inten-tion to provide information about the success of current R&D projects, searching for a positive association between current capitalized R&D costs and future profits. The findings implicate that capitalized R&D costs represent future economic benefits.

Keywords: R&D, earnings management, loss avoidance, avoidance of earnings decreases, future economic benefit

JEL Classification: M40, M41, M49