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Accounting for R&D on the Income Statement? Evidence on Non-Discretionary vs. Discretionary R&D Capitalization Under IFRS in Germany

This paper compares the informativeness of discretionary research and development (R&D) capitalization under IAS 38 with non-discretionary “as-if” R&D capitalization. While prior research has consistently demonstrated capital market benefits of “as-if” capitalization, prior evidence for reported R&D capitalization has been less favorable due to earnings management concerns. Since “as-if” studies are based on adjusted data assuming R&D capitalization, the resulting numbers are free from such concerns and may hence be more informative. We find that reported capitalized R&D is not associated with lower information asymmetry but positively associated with forecast errors. Consistently, while market values are not associated with reported capitalized R&D, they are strongly associated with “as-if” capitalized R&D. Also, actual capitalization of development expenditures under IAS 38 is only as value relevant as expensing all R&D. Our results are consistent with the notion that market participants undo actual capitalization and use the information on expensed R&D to develop their own estimates of R&D value. Our findings lend support to the proposition by Barker and Penman (2020) that deficiencies of the balance sheet that result from the uncertainty inherent in expenditures such as R&D, should be supplemented by more detailed information on the nature of the related expenses in the income statement.