Capitalization vs Expensing and the Behavior of R&D Expenditures

59 Pages Posted: 19 Feb 2016 Last revised: 17 Feb 2019

See all articles by Dennis R. Oswald

Dennis R. Oswald

University of Michigan - Ross School of Business

Ana Vidolovska Simpson

London School of Economics & Political Science - Department of Accounting

Paul Zarowin

New York University (NYU) - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: January 2019

Abstract

We examine the effect of capitalization vs expensing on UK firms’ R&D expenditures. Our investigation is motivated by the UK’s mandatory switch from UK GAAP to IFRS in 2005. Under UK GAAP, firms could elect to expense or capitalize development expenditures, but IFRS mandates capitalization. Thus, “capitalizers” maintained their accounting method, while “switchers” were required to change from expensing to capitalization. Using a difference-in-difference design, we examine the effect of the rule change on the amount of the two groups’ R&D expenditures. Consistent with arguments that expensing’s deleterious effect on income causes firms to reduce their R&D outlays, we find that switching firms increased their R&D expenditures more than firms that continued to capitalize. We subject our results to numerous robustness tests: using entropy balanced samples, including firms that continue to expense their R&D under IFRS, comparing early vs late switchers, switchers with high vs low R&D expenditure growth, examining R&D behavior in the last year before IFRS adoption, examining SG&A expenditures, a placebo test in which we alter the switch date, excluding the financial crisis period, including a control for other IFRS changes, quantile regressions, and examining firms with high vs low R&D intensity. Across all of these tests, our results support the conclusion that the accounting method affects the amount that firms invest in R&D. Our results attest to the real effects of accounting policy on firms’ R&D investments.

Keywords: capitalization, expensing, R&D

JEL Classification: G28, G38, M41

Suggested Citation

Oswald, Dennis R. and Simpson, Ana and Zarowin, Paul, Capitalization vs Expensing and the Behavior of R&D Expenditures (January 2019). Available at SSRN: https://ssrn.com/abstract=2733838 or http://dx.doi.org/10.2139/ssrn.2733838

Dennis R. Oswald

University of Michigan - Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109-1234
United States

Ana Simpson

London School of Economics & Political Science - Department of Accounting ( email )

United Kingdom

Paul Zarowin (Contact Author)

New York University (NYU) - Department of Accounting ( email )

40 West 4th Street, Suite 400
422 Tisch Hall
New York, NY 10012-1118
United States
212-998-0015 (Phone)
212-995-4004 (Fax)

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