Problem 3 Audi, BMW and Skoda’s research and development

Car manufacturers Audi, BMW Group and Skoda Auto spend considerable amounts on research and
development and capitalize a proportion of these amounts each year. Each manufacturer
systematically amortizes development cost assets, presumably using the straight-line method,
following the start of the production of a developed car model or component. In the notes to their
financial statements, the firms report the following (average) estimated product lives:

 Audi: five to nine years;

 BMW: typically seven years,
 Skoda: two to ten years, according to the product life cycle.

In 2011 (2010), close to 99 (70) percent of Skoda’s capitalized development expenditures capitalized
concerned development costs for products under development (i.e., models or components that are
not yet in production). Audi and BMW both focus their activities on the premium sector of the
automobile market. Skoda operates primarily in the lower segments of the market. Both Audi and
Skoda are majority owned by Volkswagen Group and share car platforms and production facilities
with their major shareholder. BMW is publicly listed and independent (from other car
manufacturers). The following table displays the firms’ research and development expenditures and
the amount capitalized and amortized during the years 2004–2011.
A table presenting the manufacturers’ production volumes by car type during the period 2004–2011
is available from the book’s companion website.

1 Estimate the average economic lives of the car manufacturers’ development assets. What
assumptions make your estimates of the average economic lives consistent with those reported by
the manufacturers?

2 The percentages of R&D expenditures capitalized fluctuate over time and differ between car
manufacturers. Which factors may explain these fluctuations and differences? As an analyst, what
questions would you raise with the CFO about the levels of and fluctuations in these capitalization
percentages?

- Number of model : How many model you have right now ? and how many model that share
the same platform ?
- Class sector : Which sector that you choose ?
- Ownership / Company Structure : How the ownership can impact the RnD ?
- Competitor : How the competitor can impact the RnD ?
3 In accordance with IAS 38, the three car manufacturers do not capitalize research expenditures.
From an analyst’s perspective, which arguments would support capitalization (rather than
immediate expensing) of research expenditures?

- Income Smoothing
Asset capitalization and depreciation, compared with expensing costs when incurred,
reduces fluctuations in income over time.
- Ratio Analysis
Capitalization of expenditures will increase your company's asset balance, without changing
the company's liability balance. This will make improve many financial ratios.
- GAAP Compliance
Capitalization of expenditures often is required to be in compliance with generally accepted
accounting principles (GAAP).
- Tax Effects
Small businesses are eligible for tax benefits related to depreciation of capitalized assets.
This reduces tax expense for small business in the short run, freeing up cash for business
growth.

4 What adjustments to the car manufacturers’ 2011 financial statements are required if you decide
to capitalize (and gradually amortize) the firms’ entire R&D? Which of the three manufacturers is
most affected by these adjustments?