Why Are R Expenses Not Capitalized
Capitalization EffectsWhether R costs should be capitalized or treated as expenses isn’t just a technical question about accounting procedures. It has a direct impact on the most basic calculations of a company’s value and profitability. If your business could capitalize its R then your balance sheet would show more assets, which would increase the value of the company. At the same time, because the costs wouldn’t be treated as expenses, your company’s profits, at least on paper, would be higher. For a small or start up company that has significant R costs, that could make the difference in securing the investor capital needed to grow.
Uncertain BenefitsThe main reason companies aren’t allowed to capitalize their research and development costs is that there’s no way to reliably measure the future economic benefits of those costs. R involves trial and error a lot of error. When it set the rules for R spending in the 1970s, the accounting standards board cited data showing that only 2 percent of product ideas become commercially viable,
titleist 915 d2, and only 15 percent of products that actually go into development become viable. When your company spends money on R you have no way of knowing which projects will pan out that is, produce future benefits and which won’t. Even if you could identify the projects that will work, you can’t put an objective figure on what their benefits will be. And then there’s the unresolved question of how to treat "failed" projects when later successes are built on the lessons learned from those failures.
Amortization IssuesBecause it’s so difficult to draw direct cause and effect relationships between specific amounts of R spending and future economic benefits, it would be impossible to follow one of the fundamental principles of business accounting: the "matching principle." This principle holds that whenever you report revenue,
titleist vokey sm5, you must at the same time report the expenses incurred in generating that revenue. This is why companies depreciate "hard assets" such as vehicles and equipment. If you buy a $25,000 truck that will last 10 years in other words, help you generate revenue for 10 years you first capitalize the $25,000 and then take a depreciation expense each year for the next 10 years until the truck is fully depreciated. Similarly, intangible assets which is what a hypothetical R asset would be are amortized over time to match them with the revenue they produce. If it’s not possible to directly match R expenses with revenue, then the asset can’t be amortized. For these reasons, accounting rules require that all R costs be treated as expenses when they are incurred.
"In Process" R one exception to the rule against capitalizing research and development costs. If your business buys another company, you must capitalize any "in process" R projects that come with the purchase. The rationale behind this exception is that some portion of the price you paid to acquire the company was allocated to those projects, so the projects have a definable value that you can list as an asset. Say you buy out a competitor for $250,
titleist 915 d3,000. As you combine your companies’ finances,
titleist 915 d3, you’ll allocate a portion of that $250,000 to the competitor’s R projects,
titleist 915 d2, and then report that amount as an asset. When the R project is completed, one of two things will happen. If the project doesn’t produce tangible results, you’ll report an expense for the full amount of the asset you’ll "write it off," in other words. If the project bears fruit, you’ll have to assign a "life span" to the benefits of the project and then amortize the asset over that life span.