Accounting for R&D expenditure: To capitalize or not to capitalize?

This study investigates the effect of R&D capitalization on earnings variability. Investment in R&D plays a significant role in the world of business by leading to innovation, development, and the growth of business enterprises. However, the current accounting standards require corporations to expense the R&D costs as incurred. Accordingly, there has been a debate over the accounting treatment for such investment for decades. We calculate earnings (adjusted for R&D capitalization), as if the company's R&D expenditures were capitalized during the period and compare it with reported earnings in financial statements. We find that earnings reported in the financial statements are more variable when R&D spending changes significantly. It implies that financial reporting under R&D capitalization provides more reliable information. The findings of this study supports the argument that we should make changes from the current accounting treatment of R&D expensing to R&D capitalization, which may provide more value-relevant and reliable information on earnings.