Question

Assuming management compensation is based on profits, how could Requirements in IAS 38/ AASB 138 influence management research and development (R&D) decisions?

I need to know a few different reasons.

I think that I have found 1 reason. The difference between having to expense research in the short term and capitalize for the long term.

just in need of a bit of guidance. cheers

Answer 1

It is important here to distinguish between Research and Development because the accounting treatment of these expenditure are different. While research expenditure alone has to be booked to profit and loss acoount, i.e. expensed out; the expenditure on development can be capitalised. Thus, while booking the research expenditure will have an impact on the management compensation (as it is based on profits), the expenditure on development will be preferred by the management as it wont impact the profits of the company. Thus, there would be an inclination in the management to book the research costs as development expenditure.

Similarly, as per IAS 38, the expenditure on R&D, when capitalised, will be treated as intangible asset. However, whether this asset will have indefinite life or finite life will also affect the management compensation. It is because, in the case of indefinite life, there will be no amortization every year. Thus, there will be no compulsory periodic reduction in the profits or the company. Thus, the management would try to treat the R&D asset as having indefinite period, so as to keep their compensation unaffected.

Moreover, there have been various studies conducted which provide the empirical evidence for the following. Firstly, R & D expenditures have no statistically significant effect on firms’ gross profit, net operating income, or net income in the short term. Secondly, R & D expenditures have a statistically significant, positive and strong effect on these profits in the long term. In other words, for firms that are listed in the BIST manufacturing sector between 1998 and 2012, continuous investment in R & D was found to have a positive impact on gross profit, net operating income and net income.(Murat, Ferdi, Duygu 2016). It implies that the management has incentive to incur expenditure on R&D.

Thus, these are various considerations which the management will consider before taking Reasearch and Development Expenditure.