Financial Education

Although cumulative R&D expenditures could give rise to a valuable intangible asset for a company, they could also end up generating no value at all. This uncertainty explains why they are expensed rather than capitalized. However, the current expense reduces current earnings. A company spending the money ineffectively would be better served by reducing the current expense, while companies that are using the money effectively may be better off taking an earnings hit today in order to generate even more earnings in the future. In such cases investors may even want to adjust the financial statements to show an asset related to the research efforts.

For Xerox, both revenues and R&D expense were lower in 2006 than in 2001. However, the relationship between research expense and future sales is weak, given that the steepest sales dropoff followed the highest R&D expenditure.

Apple, by contrast, was able to convert a much smaller research budget into significantly greater innovation. As a result, its sales nearly quadrupled between 2001 and 2006, eventually overtaking Xerox in sales while still spending less on research (although more than they had initially.)

For more information, see all articles on: Accounting, Adjusting Reported Financial Statements, Financial Statement Analysis, Fundamental Analysis

See also:

Research and Development Expense

In Process Research and Development Charge

The Analytical (Variance-Covariance) Method for Estimating Value at Risk (VaR)

Cash Flows from Investing Activities

The Defensive Interval