Capitalizing Research & Development: Signaling or Earnings Management?

Abstract

This paper analyzes the capitalization of Research & Development (R&D) expenditures underInternational Financial Reporting Standards (IFRS). Discretionary R&D capitalization can be exercised by managers to signal private information on future economic benefits to the market. It can, however, also serve as opportunistic earnings management. We analyze a unique, hand-collected sample of highly R&D intensive German IFRS firms during 1998-2012. We find that market values are not associated with capitalized R&D for the overall sample, indicating that earnings management may be a concern. We identify firm-years for which R&D capitalization is possibly used for pushing their earnings above a specific threshold (e.g. analysts' forecasted earnings, prior year's earnings). Our results show that both the decision to capitalize and how much to capitalize are strongly associated with benchmark beating. Consistently, we find that market values are negatively associated with capitalized R&D for firms who are likely to use capitalization for benchmark beating (about one third of the overall sample). On the other hand, the market values R&D capitalization positively for well-performing firms, for which capitalizing does not matter to beat an earnings benchmark (about half of the overall sample). This finding is robust to controls for endogeneity, various deflators, and different measures for earnings management.

Evolution of intangible asset accounting: Evidence from Australia

“…This is consistent with prior work in this area (e.g., Barth & Clinch, 1998, 2009Power et al, 2017;Shrivastava, 2014). When using lagged total assets as deflator (e.g., Dinh et al, 2016), the results for Proposition 1 show that while signs are as expected, the interaction is no longer significant. However, the results of Proposition 2 on the substitution effect of lower goodwill expenses in the presence of higher IIA expenses remain unchanged.…”

“…Firms may choose accounting policies for intangibles to signal their superior future earning power (Dinh, Kang, & Schultze, 2016;Kanagaretnam, Lobo, & Yang, 2004;Morris, 1987). Ritter and Wells (2006) show that in the AGAAP years, reported earnings of large Australian companies up to 3 years ahead are associated with current period's IIA disclosures.…”

R&D Accounting Treatment, R&D State and Tax Avoidance: With a Focus on Biotech Firms

“…However, as R&D investment causes cash outflows, it is aimed at long-term value enhancement and sustainability, not for short-term profit. However, for the firms with low performance, discretionary R&D capitalization can be used for opportunistic earnings management [2][3][4]20,21]. A high level of R&D expenditure in a firm is positively associated with R&D capitalization as consistently proved in previous studies [5,20,[22][23][24][25].…”

Accounting for Intangibles: Can Capitalization of R&D Improve Investment Efficiency?

“…We acknowledge also a possibility that the proportion capitalized may be influenced by incentives to manage earnings (Markarian et al ., ; Cazavan‐Jeny et al ., ; Dinh et al ., ).…”

“…Understanding how different accounting rules impact on investment decisions is therefore important to both users of financial information and standard setters. Second, prior literature specific to accounting for the costs of self‐generated intangibles has primarily focused on the information effects pursuant to their capitalization, for example, on the value relevance of capitalized amounts, earnings quality, and forecast accuracy (e.g., Lev and Sougiannis, ; Aboody and Lev, ; Abrahams and Sidhu, ; Ahmed and Falk, ; Matolcsy and Wyatt, ; Oswald, ; Ciftci, ; Dinh et al, ; Chen et al ., ; Russell, ) or the effect on information asymmetry (Mohd, ), rather than on the question of investment efficiency. This study complements prior research by showing the impact of such an accounting rule for self‐generated intangible assets on real investment decisions.…”