The capitalisation debate : R&D expenditure, disclosure content and quantity, and stakeholder views

Abstract

There are concerns that financial statements no longer reflect the underpinning drivers of value in modern business (Bernanke 2011; Haskel and Westlake 2017; Lev and Gu 2016). Such concerns are particularly relevant to accounting for intangibles, including research and development costs (hereafter R&D). Under IAS 38 Intangible Assets, while research costs are expensed, development costs should be capitalised, if they meet the six conditions specified in the standard. Thus, at least technically, the capitalisation of development costs is not considered a managerial choice. Nevertheless, from the financial statements’ preparers’ point of view, significant managerial judgement and detailed evaluations are required so as to conclude whether the six conditions have been met or not. Similarly, auditors need to exercise judgement with associated detailed evaluations to enable them to conclude that they are satisfied with the adopted accounting treatment of their clients. Interestingly, mandatory disclosure requirements in IAS 38 are only that the relevant amounts involved (ie capitalised and/or expensed and if these are material) be disclosed separately. Executive summary 6 Thus, financial statement users, when using an annual report, primarily rely on firms’ voluntary/narrative R&D disclosure decisions for understanding the value and future benefits arising from such capitalised expenditure. In practice, given the requirements in IAS 1 Presentation of Financial Statements, one would also expect companies to disclose information on significant risk factors and managerial judgement relative to material levels of capitalisation. While there is literature relevant to R&D in non-IFRS (International Financial Reporting Standards) reporting regimes, to the best of the authors’ knowledge, research on the characteristics of firms that capitalise and/or expense R&D expenditure specifically under IFRS is minimal. Similarly, research that captures the quantity of companies’ disclosures in relation to R&D under an IFRS reporting regime is also minimal. Finally, users’ and/ or preparers’ views on the matter are largely absent from extant literature following the adoption of IFRS. The overall objective of this research is to shed light on these three areas.