Do you expense research and development? Under GAAP R & D are required to be expensed. There are two reasons why accounting rules treat R & D outlays as expenses as opposed to an asset that must be amortized.
over several accounting periods.
First, it is a cruel fact of life that not all R & D outlays lead to the development of marketable products. In fact, a relatively low percentage of such outlays lead to successful products.
A second problem in treating R & D costs as assets involves deciding their useful life. Over what period of time should we spread or amortize these costs?
If the R & D costs lead to a patent we could simply use the life of a patent as our guide. But what really matters is the life cycle of a successful new product, not the period of patent enforceability.
Who knows how long a period that should be?
If accounting rules allowed the treatment of R & D costs as assets, management would be sorely tempted to record both unsuccessful and successful outlays as assets. This would lead to the overstatement of assets,
the understatement of expenses, and in turn the overstatement of income. Even if management were neutral and fair-minded it is
often impossible to predict which R & D costs will lead to successful products and which will not.
Rather than deal with estimates of dubious value accountants have chosen the very conservative path of just expensing all R & D costs as incurred.
This conservative approach to expensing R & D costs may have unintended consequences. In fact not treating R & D costs as amortizable assets probably has undesirable consequences for firms and society as a whole.
Currently, there is great pressure on managers to ensure that stock prices are maintained. CEOs of large corporations are partially compensated and evaluated based on their firm’s stock price.
In turn, stock prices are greatly affected by the current and near-term reported earnings of the company as opposed to long-term profitability. Under current accounting rules, a CEO interested in short-term earnings will avoid
long-term R & D commitments because they will depress current earnings and hence the stock price.
However, the long-term prospects of a business may be enhanced significantly by increased expenditures on R & D. So the accounting treatment of R & D probably serves as a disincentive to make such outlays.
Society is probably also better off if companies increase their R & D outlays. So the current R & D rules may be bad for businesses and bad for society as a whole.
The rules may prevent individual firms from overstating income and assets in the short run, but reduce the income of the firms and the well-being of society in the long run.
