Accounting Treatment of Research and Development Expenditure: A Critical Literature Review

Abstract

Intangible investments have been found to contribute largely to value enhancement in firms and economies that spend colossus resources on them. Despite being an important component of valuation, such investments are largely ignored or given subjective treatment by the existing accounting standards and consequently, not included on firm valuation. The American standard (FASB-S2) establishes standards of financial accounting and reporting for research and development (R&D) costs. This Statement requires that R&D costs be charged to expense when incurred. It also requires a company to disclose in its financial statements the amount of R&D that it charges to expense. On the other hand, the accounting for R&D under IFRS standards requires judgment of the expectation of future economic benefit that will flow to the entity due to R&D. If it can be "ascertained", then these costs should be treated as an asset rather than an expense since they meet the definition of an asset as prescribed by the IASB Framework for the Preparation and Presentation of Financial Statements. This paper, therefore, seeks to critically analyze the literary works of various researchers on the treatment and hence the impact of accounting for research and development expenditure on: firstly, the value relevance of financial information to investors; secondly, allocation of equity and debt resources to the firm; thirdly, growth of intangible assets; and lastly, firm value in capital markets. Previously studies conducted under here have cut across the accounting treatment of R&D expenditure, and generally, internally generated intangibles using the International Financial Reporting Standards (IFRSs) and the U.S.' Generally Accepted Accounting Principles (GAAPs). Majority of the studies analyzed agree that sufficient disclosure of R&D investment as well as other internally generated intangibles can supplement and improve the financial information provided by the firm. This in turn will improve the outlook of the financial statements which can improve their use and reliability to investors as well as give reliable inputs to financial analysts, thus improving the applied valuation models in computing dependable valuation figures for the firm. This, by and large, should avoid the negative consequences that may result from inadequate accounting treatment of R&D expenditures.