Question

Following are the 2016 income statements for Apple Inc. and Microsoft Corporation, competitors in the computer industry. Use these financial statements to answer the required.

APPLE INC. Income Statements
(in millions)	Sep. 24, 2016	Sep. 26, 2015	Sep. 27, 2014
Net sales	$ 215,639	$ 233,715	$ 182,795
Cost of sales	131,376	140,089	112,258
Gross margin	84,263	93,626	70,537
Operating expenses:
Research and development	10,045	8,067	6,041
Selling, general and administrative	14,194	14,329	11,993
Total operating expenses	24,239	22,396	18,034
Operating income	60,024	71,230	52,503
Other income/(expense), net	1,348	1,285	980
Income before provision for income taxes	61,372	72,515	53,483
Provision for income taxes	15,685	19,121	13,973
Net income	$ 45,687	$ 53,394	$ 39,510

MICROSOFT CORPORATION Income Statements
(in millions)	Jun. 30, 2016		Jun. 30, 2015		Jun. 30, 2014
Revenue
Product	$61,502		$75,956		$72,948
Service and other	23,818		17,624		13,885
Total revenue	85,320		93,580		86,833
Cost of revenue
Product	17,880		21,410		16,681
Service and other	14,900		11,628		10,397
Total cost of revenue	32,780		33,038		27,078
Gross margin	52,540		60,542		59,755
Research and development	11,988		12,046		11,381
Sales and marketing	14,697		15,713		15,811
General and administrative	4,563		4,611		4,677
Impairment, integration and restructuring	1,110		10,011		127
Operating income	20,182		18,161		27,759
Other income (expense), net	(431)		346		61
Income before income taxes	19,751		18,507		27,820
Provision for income taxes	2,953		6,314		5,746
Net income	$16,798		$12,193		$22,074

Required:

a) How do Apple Inc. and Microsoft Corporation account for R&D expenditures?

b) Apple Inc.’s and Microsoft Corporation’s R&D expense includes many different types of costs. List three specific costs that could be included in R&D expense on the income statement.

c) What trend do you notice in the R&D expenses of each company over time?

Answer 1

a) Accounting treatment for R&D expenditures
Accounting standards require companies to expense all research and development expenditures as incurred since the future benefits from research and development are uncertain and R&D expenditures cannot be capitalized. However, in case of an M&A transaction, the R&D expenses of the target company may be capitalized because the acquirer can recognize the fair value of the R&D assets. The R&D costs are included in the company’s operating expenses and are usually reflected in its income statement.

There is an option to defer the R&D expenditure and carry it forward as an intangible asset if the following criteria are met:

•   There is a clearly defined project
•   Expenditure is separately identifiable
•   The project is commercially viable
•   The project is technically feasible
•   Project income is expected to outweigh cost
•   Resources are available to complete the project.

If these criteria are met, the entity may choose to either capitalize the costs, bringing them ‘on balance sheet’, or maintain the policy to write the costs off to the profit and loss account. Note that if an accounting policy of capitalization is adopted it should be applied consistently to all R&D projects that meet that criteria.

The capitalized R&D costs should be amortized over the periods expected to benefit from them. Amortization should begin only once commercial production has started or when the developed product or service comes into use.

Considering the above accounting standard it is very clear that Apple Inc. and Microsoft Corporation both the Companies are accounting for R&D expenditures as operating expenses as incurred.

b) List of three specific costs that could be included in R&D expense on the income statement.
Research and development (R&D) expenses are associated directly with the research and development of a company's goods or services and any intellectual property generated in the process. A company generally incurs R&D expenses in the process of finding and creating new products or services.
I.   R&D expense related to develop the processor inside its own product instead of buying off from another company.
II.   R&D expense on upcoming products that might take years to hit the market.
III.   R&D expense on self-driving car technologies
IV.   Third-party development and programming costs, localization costs incurred to translate software for international markets.

c)  Trend in the R&D expenses of each company over time

	APPLE INC.		MICROSOFT CORPORATION
Year	2016	2015	2014		2016	2015	2014
Net sales	$215,639	$233,715	$182,795		$ 85,320	$ 93,580	$ 86,833
R&D expenditure	$ 10,045	$     8,067	$     6,041		$ 11,988	$ 12,046	$ 11,381
% of Sales	5%	3%	3%		14%	13%	13%

   

From the above table and graph it is very clear that the % of R&D expenditure on net sales for both the companies remained same for the year 2014 and 2015 but there is an increase for the year 2016.