Financial Accounting: In an Economic Context

RESEARCH AND DEVELOPMENT COSTS

Research and development (R&D) costs are incurred to generate revenue in future periods through the creation of new products or processes. Such costs are significant for many major U.S. manufacturers. In 2008, for example, Eli Lilly and Company invested $3.8 billion in research and development, which amounted to about 19 percent of sales.

The matching principle suggests that R&D costs should be capitalized and amortized over future periods. However, it is difficult to match specific research and development expenditures with the creation of specific products or processes. Some R&D expenditures are for basic research, others lead to failures, and still others provide only indirect benefits or benefits that could not have been foreseen when the expenditure was incurred.

Concerned with the wide variety of practices used by companies to capitalize and amortize R&D expenditures, the FASB published SFAS No. 2 in 1974. This pronouncement required that expenditures for most types of R&D costs be expensed in the year incurred, rather than capitalized and amortized as intangible assets. While this pronouncement promoted uniformity of accounting practices in the area of R&D, relieved pressures on auditors and managers to subjectively determine which R&D costs should be capitalized, and reduced some of management's ability to manipulate the financial statements, it is definitely inconsistent with the matching principle. In line with this standard, many R&D costs ...