Accounting for R&D: Evidence and Implications

Abstract

Accounting rules require that certain R&D expenditures be capitalized, but academic research often states that all R&D expenditures must be immediately expensed. An accurate understanding of actual R&D accounting practices is critical because that understanding influences research questions and design choices. To examine the competing R&D accounting perspectives, we survey 184 experienced financial officers. Our survey reveals that R&D capitalization is common and extensive in practice. Over 90% of respondents indicate that their firm capitalizes at least some R&D expenditures, and our evidence shows that about 22% of annual R&D expenditures are capitalized. When facing an earnings shortfall, respondents indicate that firms are often willing to cut R&D expense. However, respondents also indicate an unwillingness to cut types of R&D expenses that cause long-term harm—for example, laying off scientists or delaying the execution of trials—and they often redirect the freed-up R&D resources to R&D expenditures that are capitalized. Using archival data, we also corroborate our survey finding about the pervasiveness of capitalized R&D, and we demonstrate its empirical implications. Our study helps to align the characterization of R&D accounting rules in the academic literature with the authoritative professional literature and provides a more nuanced understanding of firms’ R&D response to an earnings shortfall.

Keywords: research and development, R&D capitalization, R&D expense, earnings management, real earnings management, earnings shortfall

JEL Classification: G32