Academic journal article Journal of Business and Behavior Sciences

The Uncertainty of Future Earnings Caused by R&d and Capital Expenditures: A Further Investigation

Academic journal article Journal of Business and Behavior Sciences

The Uncertainty of Future Earnings Caused by R&d and Capital Expenditures: A Further Investigation

Article excerpt

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INTRODUCTION

The US GAAP requires that all R&D costs are expensed when they are incurred, while capital expenditures are capitalized and depreciated over their useful economic life. The uncertainty about future economic benefits of R&D projects as well as the difficulty of matching costs and future revenues associated with these projects prompted the FASB to issue SFAS No. 2, requiring the immediate expensing of R&D outlays (FASB 1974). The central objectives of SFAS No. 2 are to increase uniformity in the reporting of R&D expenditures by removing managerial discretion over accounting choices and to achieve comparability across firms.

However, there have been calls from accounting practitioners and researchers for further research on the accounting treatment on R&D investments due to various reasons. First of all, the United States and many other countries have recently experienced an unprecedented and dramatic boom in R&D investments and the emergence of new, science-based industries, including computer, pharmaceutical and electronics, etc. (Lev, Sougiannis, 1996; Chan, Lakonishok, Sougiannis, 2001). For instance, Chan, et al. (2001) reported that technology-based and the pharmaceuticals industries together comprised approximately 40% of the value of the S&P 500 index as of the end of year 1999. Moreover, R&D expenditures of some major technology industries have exceeded their earnings. In a report issued by the National Science Board, R&D expenditures by the U.S. business sector were estimated to have reached $282 billion in 2009 which accounted for 71% R&D performed in the United States (National Science Board, 2012). Therefore, in response to the dramatic surge in R&D expenditures and the emergence of a number of high-tech industries in the United States, the allowance of R&D capitalization would help the company recognize the value of the assets created by research and secure the investor capital needed for the company to grow. Nevertheless, according to Lev and Sougiannis (1996), despite this trend, R&D capitalization is not permitted under the US GAAP as the standard setters do not concede a direct link between R&D costs and their future benefits which is not the case for capital expenditures. Therefore, more studies should be conducted to look into this issue. Secondly, there is an on-going debate among academics, practitioners, and regulators on capitalization versus expensing of R&D expenditures. In contrast to the results of some previous studies that are in favor of the current standard of expensing R&D investments, recently a number of studies argue that capitalizing R&D costs would improve financial reporting. This accounting standard change would make general financial accounting measures such as earnings and assets more comparable across R&D-intensive and capital intensive firms, and therefore make the financial reporting more useful to investors, creditors and other external users (Chambers, et al., 2003). To find a solution to the on-going debate, more confirming evidence is needed to contribute to the debate. Thirdly, accounting treatment of research and development (R&D) activities is one of the areas of divergence between U.S. Generally Accepted Accounting Standards (U.S. GAAP) and International Financial Reporting Standards (IFRS). Under GAAP, R&D costs are charged to expenses and reported on the income statement as a deduction towards net income. However, under IFRS, these costs can be capitalized and amortized as intangible assets if specific criteria are met, thus resulting in higher income (Gomik-Tomaszewski and Millan, 2005). The United States has been working toward convergence of U.S. GAAP and IFRS for several years, but the convergence project on this issue is still in a very preliminary stage. Therefore, it is necessary that more studies should be conducted to provide evidence in support of FASB's decision on the treatment of R&D costs during the process of convergence with IFRS. …

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