Research and Development (R&D)

The process of obtaining new knowledge and using it to improve existing products and introduce new ones

What is Research and Development (R&D)?

Research and Development (R&D) is a process by which a company obtains new knowledge and uses it to improve existing products and introduce new ones to its operations. R&D is a systematic investigation with the objective of introducing innovations to the company’s current product offerings. It achieves this by adding improvements to the current goods and services or introducing a new product offering.

 

Research and Development (R&D) theme

 

Research and development are applied across different industries and sectors. Generally, pharmaceuticals, software, technology, and semiconductor companies incur the highest R&D spending. Industries with companies with a large number of intangible assets generally report high spending in research and development efforts.

 

Basic vs. Applied R&D

There are two major types of research and development: Basic and Applied.

Basic research is concerned with the acquisition of new knowledge. It is a systematic study that intends to gain a deeper understanding of the fundamental elements of a concept or phenomenon. Basic research is an initial stage of the R&D process. However, it does not provide the possible applications of concepts or phenomenon in production. Also, basic research is the most time-consuming part of R&D.

On the other hand, applied research is a systematic study of application knowledge in developing products or operations. Relative to basic research, applied research is more complex in nature. Thus, it requires higher spending than basic research.

 

Accounting for R&D

The general problem with R&D accounting is that future benefits from research and development are uncertain and R&D expenditures cannot be capitalized. Accounting standards require companies to expense all research and development expenditures as incurred. 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.

 

Research and Development in Balance Sheet

 

There are also some accounting standards related to booking research and development expenditures:

  • Assets/materials: Purchased assets and materials that have alternative future use are recorded as assets. However, if assets and materials do not have an alternative future use, the costs should be expensed.
  • Computer software: If computer software is purchased for R&D purposes and it does not have any alternative future applications, the cost of purchase is immediately expensed. Nevertheless, if the computer software has an alternative future use, the cost should be capitalized.
  • Indirect costs: Overhead costs are expensed as incurred.
  • Intangible assets: If intangible assets are purchased for R&D purposes and these assets do not have an alternative future use, the costs are expensed as incurred. If the assets have some future alternative use, the costs are capitalized.
  • Software development: Software development expenditures associated with R&D are always expensed as incurred.

 

List of Research and Development Spending by Company

Below is a list and examples of prominent companies that have very large research and development budgets:

  • Amazon $22.6 billion: In 2017 Amazon spent $22.6 billion, pouring this capital into Amazon Web Services (AWS), Alexa, and new technologies.
  • Alphabet (Google) $16.6 billion: In 2017 Alphabet invested $!6.6 billion on researching new projects, businesses and technologies to drive the company forward.
  • Apple $11.6 billion: In 2017 Apple spent $11.6 billion on research and innovation in an attempt to create new cutting edge products for the business.
  • Facebook $7.8 billion: In 2017 Facebook spent approximately $7.8 billion on advancing it’s technological capabilities.
  • Pfizer $7.7 billion: In 2017 Pfizer invested $7.7 billion researching new drugs.
  • Tesla $0,8 billion: In 2017 Tesla spent approximately $0.8 billion related to designing new cars and new technologies.

Read more from Yahoo Finance about how much Amazon outpaced other tech companies in innovation spending.

 

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To help you advance your career, check out the additional resources below:

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