Article,
R&D Reporting Biases and Their Consequences
Contemporary Accounting Research, 22 (4): 977 - 1026 (2005)
Abstract
The immediate expensing of research and development (R&D) expenditures is often justified by the conservatism principle. However, no accounting procedure consistently applied can be conservative throughout the firm's life. We therefore ask the following questions: (I) When is the expensing of R&D conservative and when is it aggressive, relative to R&D capitalization? (2) What are the capital-market implications of these reporting biases? To address these questions we construct a model of profitability biases (differences between reported profitability under R&D expensing and capitalization) and show that the key drivers of the reporting biases are the differences between R&D growth and earnings growth (momentum), and between R&D growth and return on equity (ROE). Companies with a high R&D growth rate relative to their profitability (typically early life-cycle companies) report conservatively, while firms with a low R&D growth rate (mature companies) tend to report aggressively under c
