Contemporary Accting Res - 2022 - Canace

Accounting for R&D: Evidence and Implications*
THOMAS G. CANACE, Wake Forest University
SCOTT B. JACKSON, University of South Carolina†
TAO MA, Texas Tech University
AARON ZIMBELMAN, University of South Carolina
ABSTRACT
Accounting rules require that certain R&D expenditures be capitalized, but academic research
often states that all R&D expenditures must be immediately expensed. An accurate understand-
ing of actual R&D accounting practices is critical because that understanding influences
research questions and design choices. To examine the competing R&D accounting perspec-
tives, we survey 184 experienced financial officers. Our survey reveals that R&D capitalization
is common and extensive in practice. Over 90% of respondents indicate that their firm capital-
izes at least some R&D expenditures, and our evidence shows that about 22% of annual R&D
expenditures are capitalized. When facing an earnings shortfall, respondents indicate that firms
are often willing to cut R&D expense. However, respondents also indicate an unwillingness to
cut types of R&D expenses that cause long-term harm—for example, laying off scientists or
delaying the execution of trials—and they often redirect the freed-up R&D resources to R&D
expenditures that are capitalized. Using archival data, we also corroborate our survey finding
about the pervasiveness of capitalized R&D, and we demonstrate its empirical implications.
Our study helps to align the characterization of R&D accounting rules in the academic literature
with the authoritative professional literature and provides a more nuanced understanding of
firms’ R&D response to an earnings shortfall.
Keywords: research and development, R&D capitalization, R&D expense, earnings management,
real earnings management, earnings shortfall
This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribu-
tion and reproduction in any medium, provided the original work is properly cited.
* Accepted by Kristina Rennekamp. We gratefully acknowledge helpful comments and suggestions from Kristina
Rennekamp (editor), two anonymous reviewers, Amanda Badger, Terry Baker, Paul Black, Long Chen, Kirsten
Cook, Steven Jackson, Sarah Judge, Ethan LaMothe, Robert Lipe, Leigh Salzsieder, Carlton Tartar, Nate Waddoups,
Joseph Zhang, participants at the 2018 AAA annual meeting, and workshop participants at Shanghai Science and
Technology University, Texas Tech University, University of International Business and Economics, Villanova
University, and Wake Forest University. We also thank the accounting academics and practicing professionals who
participated in our surveys/interviews.
† Corresponding author.
© 2022 The Authors. Contemporary Accounting Research published by Wiley Periodicals LLC on behalf
of the Canadian Academic Accounting Association.
Vol. 39 No. 3 (Fall 2022) pp. 2212–2233
doi:10.1111/1911-3846.12780
19113846, 2022, 3, Downloaded from https://onlinelibrary.wiley.com/doi/10.1111/1911-3846.12780 by Cochrane Peru, Wiley Online Library on [24/08/2023]. See the Terms and Conditions (https://onlinelibrary.wiley.com/terms-and-conditions) on Wiley Online Library for rules of use; OA articles are governed by the applicable Creative Commons License
Accounting for R&D 2213
Comptabilisation de la R-D : données probantes et implications

RESUM
E
Les règles comptables exigent que certaines dépenses de R-D soient capitalisées, mais la recherche
universitaire affirme souvent que toutes les dépenses de R-D doivent être immédiatement passées
en charges. Il est essentiel de bien comprendre les pratiques comptables réelles en matière de
R-D, car cette compréhension influence les questions de recherche et les choix de conception.
Afin d’examiner les perspectives comptables concurrentielles de la R-D, les auteurs ont interrogé
184 responsables financiers expérimentés. Leur étude révèle que la capitalisation de la R-D est
courante et étendue dans la pratique. Plus de 90 % des répondants mentionnent que leur
entreprise capitalise au moins une partie des dépenses de R-D, et les données de l’étude révèlent
qu’environ 22 % des dépenses annuelles de R-D sont capitalisées. Lorsqu’ils se trouvent devant
un déficit de recettes, les répondants indiquent que les entreprises sont souvent prêtes à réduire
les dépenses de R-D. Cependant, les répondants indiquent également qu’ils ne sont pas disposés
à réduire les types de dépenses de R-D qui causent des dommages à long terme — par exemple,
licencier des scientifiques ou retarder l’exécution des essais — et qu’ils redirigent souvent les
ressources dégagées par la R-D vers les dépenses de R-D capitalisées. À l’aide de données
d’archives, les auteurs corroborent également les résultats de leur étude sur l’omniprésence de la
R-D capitalisée, et démontrent ses implications empiriques. Cette étude permet d’aligner la car-
actérisation des règles de comptabilisation de la R-D dans la littérature académique avec la littér-
ature professionnelle faisant autorité et fournit une compréhension plus nuancée de la réponse
des entreprises en matière de R-D face à un déficit de recettes.
Mots-clés : recherche-développement, capitalisation de la R-D, dépenses de R-D, gestion des

résultats, gestion réelle des résultats, déficit de recettes
1. Introduction
In 1974, the FASB issued SFAS No. 2 (now ASC 730 Research and Development), which
established standards of financial accounting and reporting for R&D costs. Since then, accounting
research commonly presents the view that all R&D expenditures must be expensed immediately.
However, while ASC 730 requires that some R&D expenditures be expensed immediately, the stan-
dard also requires that R&D expenditures with alternative future uses be capitalized on the balance
sheet. These rules leave open the possibility that capitalization is common and extensive in practice.
Given this difference between the R&D accounting narrative in the academic literature and the
authoritative professional guidance, we survey financial executives to determine the pervasiveness
and magnitude of capitalized R&D in practice. Our survey findings and archival analyses explore
the empirical implications of capitalized R&D and provide insights about how managers use R&D
to manage earnings.
A review of R&D studies published in academic journals during the past half-century reveals
that papers typically focus on the expense requirement, while few mention the capitalization
requirement. Indeed, only two studies fully acknowledge that certain R&D expenditures must be
capitalized. At the same time, every article we examined makes explicit statements about the
expense requirement. Overall, the academic literature on R&D leaves an incomplete impression
about an important provision of ASC 730. In addition, the nearly exclusive focus on R&D
expense in academic research results in research designs that do not reflect the realities of firms’
actual R&D investments, which include both expensed R&D and capitalized R&D expenditures.
This may impact the inferences drawn by prior studies about cuts to R&D, especially if firms rou-
tinely capitalize significant amounts of R&D.
To explore the R&D practices of public firms, we conduct a survey of 184 public-firm
financial officers who have experience with R&D accounting. We also interview seven financial
executives, each from a different public firm, to provide further insights about the survey responses.
CAR Vol. 39 No. 3 (Fall 2022)

2214 Contemporary Accounting Research
We find that, while expensed R&D is a significant component of firms’ innovation investments,
R&D capitalization is common and extensive in practice. Over 90% of our respondents indicate
that their firm has capitalized R&D expenditures at some point in the past and about 79% of our
respondents indicate that their firm has capitalized R&D expenditures in the most recent year.
Moreover, respondents report that about 22% of R&D expenditures are capitalized in any year, and
about 20% of property, plant, and equipment (PP&E) on the balance sheet is capitalized R&D. For
our 184 survey respondents in aggregate, we find that capitalized R&D included in PP&E amounts
to about $18 billion. In addition, we find that managers do not feel that their judgments about
whether R&D investments have alternative future uses will be challenged by auditors.1 Overall,
our results appear to be the first evidence of widespread R&D capitalization in practice.
Our survey also sheds new light on prior research that documents that firms may cut R&D
expense to meet an earnings target (Baber et al. 1991; Bange and De Bondt 1998; Bushee 1998;
Canace et al. 2018; Graham et al. 2005; Gunny 2010). This research often equates R&D cuts to lay-
ing off scientists, which would myopically hinder innovation efforts (Himmelberg and Petersen 1994;
Hall 2002; Brown and Petersen 2011; Erkens 2011). However, prior research does not provide direct
evidence of the types of R&D managers actually cut. To address this omission, we ask survey
respondents what types of R&D expenses firms cut to meet an earnings target. We find that financial
officers are more likely to cut R&D expenses that can be reversed with minimal negative conse-
quences to their R&D operations. For instance, they are likely to delay new hires and to freeze
expenses such as training and travel. However, financial officers show no willingness to cut expenses
that could have a greater long-term effect on R&D operations and innovation efforts, such as laying
off scientists or delaying execution of tests and trials. To provide further insights on whether cutting
R&D entails sacrificing long-term value, we then ask officers how they would allocate the unspent
cash that would have otherwise been invested in expensed R&D. We find that financial officers
show a strong preference to redirect the freed-up R&D resources to R&D expenditures that are capi-
talized (and a lesser preference to redirect the freed-up R&D resources to non-R&D expenditures that
are capitalized). Our evidence suggests that a decrease in reported R&D expense does not always
mean that a firm has decreased total investments in R&D when capitalization is considered.
To complement our survey results, we look for evidence of capitalized R&D in the financial
statement data of a large sample of public firms. If long-lived R&D assets are a significant pro-
portion of PP&E, then depreciation of those assets should also be a significant proportion of firm-
wide depreciation. We estimate that approximately 17% of firm-wide depreciation is attributable
to long-lived R&D assets, which is similar to our survey findings. This provides further evidence
that capitalized R&D assets are a meaningful proportion of total PP&E and that firms frequently
capitalize R&D expenditures.
To explore the empirical implications of capitalized R&D further, we extend Bushee’s (1998)
finding that firms with high transient institutional ownership tend to cut R&D expense when
faced with the threat of falling short of an earnings target. These firms are of special interest
because the short-term horizon of their investors could lead managers to make myopic decisions
in response to earnings pressure. We first confirm Bushee’s (1998) results using our more recent,
expanded sample. We then extend his findings by documenting that firms with high ownership
by transient institutional investors tend to increase capitalized R&D expenditures concurrent with
earnings-motivated R&D expense cuts. When both expensed and capitalized R&D investments
are considered, we find no reduction in total R&D investments.
This study makes several contributions to the literature. First, while most academic accounting
studies explicitly or implicitly assume that all R&D expenditures are expensed, we show that many
1. One implication of this evidence is that the amount of capitalized R&D we identify could be attributable, in part, to
managers’ discretion to capitalize R&D. However, the availability and use of discretion in determining whether
R&D investments have alternative future uses is outside the scope of the current study and does not affect our
conclusions.

firms routinely capitalize material amounts of R&D expenditures. Second, we provide evidence that
failure to consider capitalized R&D has empirical implications. Although prior research concludes that
managers cut R&D investments to avoid missing an earnings target (Baber et al. 1991; Shehata 1991;
Bushee 1998; Graham et al. 2005; Gunny 2010), we show that total R&D investments may not actu-
ally decrease when capitalized R&D is considered. Third, our study provides the first evidence that
managers do not indiscriminately cut R&D expense to meet earnings targets, as has been argued by
prior literature (Himmelberg and Petersen 1994; Hall 2002; Brown and Petersen 2011; Erkens 2011).
Instead, managers appear to be judicious in cutting R&D expense in order to minimize disruption to
R&D operations. Collectively, we provide evidence that managers’ response to earnings pressure may
not be as myopic as previously believed.
Our paper is organized as follows. Section 2 discusses R&D accounting rules under
ASC 730 and then compares those rules to the way in which R&D accounting has been character-
ized in academic studies. Section 3 reports the results of a survey of experienced financial execu-
tives. Section 4 provides analyses using archival data that corroborate our survey findings and
enhance insights from an empirical R&D study. Section 5 provides some concluding comments.
2. Contrasting perspectives
R&D accounting rules
ASC 730 establishes standards of financial accounting and reporting for R&D costs for firms that
follow US GAAP. The standard specifies activities that constitute R&D, the elements of R&D
costs, and the accounting for R&D costs. Figure 1 summarizes the guidelines for classifying
R&D activities and their accounting treatment under ASC 730.
First, a manager must determine whether an activity qualifies as R&D. ASC 730 defines
“research” as investigation aimed at discovery of new knowledge for developing a new product
or process or significantly improving an existing one, and “development” as translation of such
knowledge into a design for a new product or process or the significant improvement of an exis-
ting one. Thus, R&D constitutes activities necessary to reach commercial viability of a product or
process prior to production. For activities that qualify as R&D, the type of cost determines its account-
ing treatment. ASC 730 identifies five elements of R&D costs. They are (i) materials, equipment, and
facilities, (ii) personnel, (iii) contract services, (iv) indirect costs, and (v) intangibles purchased from
others.
The standard identifies (ii) personnel, (iii) contract services, and (iv) indirect costs as R&D
costs that should be expensed immediately. In contrast, ASC 730-10-25-2a states the following
about (i) materials, equipment, and facilities:
The costs of materials (whether from the entity’s normal inventory or acquired specially for research
and development activities) and equipment or facilities that are acquired or constructed for research
and development activities and that have alternative future uses (in research and development pro-
jects or otherwise) shall be capitalized as tangible assets when acquired or constructed. The cost of
such materials consumed in research and development activities and the depreciation of such equip-
ment or facilities used in those activities are research and development costs.
Hence, the cost of materials, equipment, and facilities that have alternative future uses are not
R&D costs at the time of acquisition. Instead, those costs are defined to be tangible assets, which
are capitalized when acquired or constructed.2 These assets are subsequently included as part of
R&D expense on the income statement when consumed or used. In contrast, when these R&D
cost elements have no alternative future uses, they bypass the balance sheet and are immediately
2. There are other R&D-related costs that may be capitalized under US GAAP. For instance, ASC 985 permits the
capitalization of software development costs once the point of technological feasibility has been reached. However,
our focus is not on software development costs.

Figure 1 R&D activities and accounting treatment under ASC 730
Notes: aIn determining whether an activity meets the recognition criteria for R&D, ASC 730 provides
several guidelines for managers to consider, including whether the activity involves (i) discovery of new
knowledge and/or (ii) translation of knowledge into a design (iii) for a new or existing product or service
(iv) that is beyond routine efforts and (v) is prior to economic viability and commercial production. See
ASC 730 for examples of activities that would typically be included in or excluded from R&D. bThe
accounting treatment for intangibles purchased from others was revised in 2007 by ASC 805 Business
Combinations. When the intangibles are acquired in a business combination, they are required to be
capitalized regardless of whether they have an alternative future use.
expensed. Notice that the “alternative future uses” provision of ASC 730 requires that managers
exercise judgment about whether R&D assets have alternative future uses. Although those judg-
ments may sometimes be unambiguous, there are likely instances in which those judgments
involve ambiguity and, therefore, the potential for discretionary capitalization.
The final cost element is intangibles purchased from others—that is, acquired in-process
R&D. If these elements have alternative future uses, they are capitalized as intangible assets and
subsequently amortized as R&D expense, or expensed immediately if they have no alternative
future uses. Overall, this discussion and Figure 1 highlight how, in accordance with ASC 730,
R&D expenditures include expensed and capitalized R&D.
Consensus views on R&D accounting rules in the academic literature

We now turn our attention to how academic studies characterize R&D accounting under
ASC 730. To do this, we examine peer-reviewed articles published in six leading accounting
journals (Accounting, Organizations and Society (AOS); The Accounting Review (TAR);

TABLE 1
Search results for articles that discuss R&D accounting under ASC 730
TAR CAR RAST JAR JAE AOS Total
Total search engine hits 122 49 46 78 58 86 439

Less: False positives (no R&D-related content) 22 16 7 39 21 53 158
Less: Articles not peer reviewed (e.g., editorials) 16 0 0 0 2 12 30
Less: Articles published pre–ASC 730 41 0 0 3 0 0 44
Less: Articles that do not discuss R&D accounting 22 15 22 23 25 17 124
Equals: Total R&D-related articles examined 21 18 17 13 10 4 83
Contemporary Accounting Research (CAR); Journal of Accounting and Economics (JAE);

Journal of Accounting Research (JAR); and Review of Accounting Studies (RAST)) during the
period 1975–2019. To locate relevant articles, we search the journals for keywords related to
R&D using the EBSCO Business Source Complete database.3 As shown in Table 1, there are
439 search hits and 83 peer-reviewed journal articles that make explicit statements about R&D
accounting under ASC 730. A citation analysis indicates that these articles are influential. As of
February 2020, Google Scholar shows that these articles have been cited 25,568 times, yielding
an average of approximately 308 citations per paper.4
Of the 83 articles we examine, 69 articles do not acknowledge that certain R&D expenditures may
be capitalized. For example, some articles state that R&D expenditures/investments must be expensed.
Other articles state that R&D is immediately or fully expensed. Some articles state that R&D capitaliza-
tion is not permitted. Statements from these articles leave the impression that there is one accounting
treatment for R&D expenditures—immediate expensing. In total, we find just 12 articles that describe
ASC 730 as allowing certain R&D expenditures to be capitalized. Those articles state that firms must
expense “most” R&D or use similar language, although some appear to use the word “most” to refer to
the permissibility of capitalizing certain software development costs. We find just two articles that
acknowledge that firms may capitalize certain R&D expenditures.5
Overall, it appears that the academic literature presents an incomplete characterization of
accounting for R&D expenditures by conveying the message that the totality of firms’ R&D
expenditures is expensed.6 One reason for this characterization is that expensed R&D is publicly
disclosed while capitalized R&D is not, making awareness of capitalized R&D expenditures less
salient. Further, it seems possible that researchers make the simplifying assumption that capital-
ized R&D is minimal. For example, Chircop et al. (2020, 129) recognize that R&D expenditures
may not equal R&D expense due to the capitalization of certain R&D expenditures, but the
3. We search for articles containing any of the following keywords: “research and development,” “research &
development,” “R&D,” “SFAS 2,” “SFAS No. 2,” “FAS2,” “Statement of Financial Accounting Standards No. 2,”
“ASC 730,” and “Accounting Standards Codification 730.”
4. A PhD student who was blind to our research objectives independently applied the four criteria listed in Table 1
and resolved any disagreements with a coauthor.
5. Two PhD students who were blind to our research objectives independently evaluated the relevant R&D statements
from the 83 articles. In arriving at the tabulations reported in this paragraph, there were only a few initial disagree-
ments, which were successfully resolved among the PhD students. A comprehensive list of statements about R&D
accounting from the 83 journal articles we examine is available from the authors upon request.
6. A question that may arise is whether archival researchers generally agree with our characterization of R&D in the
academic accounting literature. To address this question, we randomly survey 300 financial archival researchers
who have published at least one article in the Financial Times accounting journals. Respondents (n = 51) largely
believe the accounting literature focuses on the expense requirement for R&D and overlooks the capitalization
requirement. In addition, respondents believe that the expense requirement is no more important than the capitaliza-
tion requirement. Detailed survey procedures and results are available from the authors upon request.

authors “maintain that the differences between R&D expenditures and R&D expense in these
instances are minimal.”
The discussion in this section highlights potential benefits of surveying financial executives
about actual R&D accounting practices. Survey evidence could illuminate whether firms capital-
ize certain R&D expenditures in practice and, more importantly, whether the capitalized amount
is significant. Significant capitalization of R&D expenditures would suggest that research focus-
ing on R&D expense alone may exclude key components of R&D investments.
3. Survey of financial officers

Recruitment procedures
We identify potential respondents by searching the Corporate Affiliations database compiled
by the LexisNexis Enterprise Management Group. For each firm, the database provides the
names of executives, their job titles, and the corporate mailing address, among other vari-
ables. We exclude individuals who are employed at firms in regulated industries (SIC codes
4000–4999) and firms in the financial services industry (SIC codes 6000–6999). Next, we
identify public-firm employees who have job titles indicating they hold positions in the
accounting or finance functions—for example, chief accounting officer, controller, chief
financial officer, director of finance, and so on. These procedures result in 5,362 unique
names from 4,095 unique firms. We do not screen firms based on the presence or magnitude
of R&D expense. A consequence of this decision is that some potential respondents come
from firms that have no R&D expenditures. In such cases, potential respondents may discard
the survey because it is inapplicable, thereby reducing the response rate.
We mailed the survey to 5,362 potential respondents.7 Of the 5,362 surveys mailed, 442 were
returned as undeliverable. Of the 4,920 surveys that presumably reached their intended recipient,
215 were returned. The response rate of approximately 4.4% is similar to the response rate of 5.4%
reported in Dichev et al. (2013). Of the 215 returned surveys, 22 were excluded because most ques-
tions were left blank, 6 were excluded because respondents had little accounting/finance experience
(one year or less), and 3 were excluded because respondents were not intended recipients of the sur-
vey (e.g., an internal auditor). Our analyses examine the responses of the remaining 184 respondents.
In addition to the survey, we interview 7 financial executives from different public firms. Of
these executives, 3 are CFOs, 3 are controllers, and 1 is a vice-president who oversees global
technical accounting.8 All of the executives are knowledgeable about R&D accounting, and the
firms make significant R&D investments. The interviews involve open-ended discussions of
R&D accounting together with questions similar to those that appear in the survey. We integrate
the interviews into our discussion of the survey results to complement our survey responses and
provide additional insights.
7. We developed an initial draft of our survey and then revised it based on comments and suggestions from colleagues
and business professionals. After each revision, we held follow-up conversations to ensure comments were properly
interpreted and fully addressed. Business professionals recommended that the survey be brief in order to maximize
the participation rate. Thus, we designed the instrument to take about 15 minutes to complete, and we limited its
length to one legal-size page, front and back. To avoid having respondents feel like they must look up information
in firm records, the instrument indicates that they can “provide rough estimates when responding to questions that
involve dollars or percentages.” We obtained Institutional Review Board approval for the survey.
8. The interviews were arranged and conducted by one of the coauthors with the understanding that the identity of the
firms and executives will not be disclosed. The interviews were conducted either in person or via telephone and
lasted approximately one hour, on average. An author took notes during the interviews, but the quotes may not be
exact and are sometimes paraphrased. The conclusions should be interpreted with some caution as the interviews,
unlike our survey, were not anonymous and the individuals may feel uncomfortable providing fully candid answers.
Although the interviews were considered exempt from Institutional Review Board review, we obtained approval to
report the content of the interviews.

TABLE 2
Survey respondent and firm demographic information (n = 184)
Panel A: Respondent demographic information
First Third
Variables Mean Median quartile quartile SD
Age (years) 52.16 53.00 47.00 58.50 8.12

Work experience (years) 28.92 30.00 25.00 35.00 7.89
Work experience in accounting or finance (years) 27.63 28.00 23.00 34.00 7.93
Self-rated knowledge of R&D accountinga 7.47 8.00 7.00 8.00 1.69
Percent male 82.02 100.00 100.00 100.00 38.50
Panel B: Firm demographic information
First Third
Annual sales ($millions) 2,327.27 250.00 20.00 1,400.00 6,645.23

Total assets ($millions) 4,515.45 267.50 31.00 2,100.00 1,6089.07
Total PP&E ($millions) 1,039.38 57.50 2.60 380.00 3,507.78
Number of employees 5,845.37 825.00 90.00 4,600.00 14,683.86
Notes: aWe ask respondents to “Rate your general knowledge of R&D accounting rules” on a scale from 1
(Very Low) to 10 (Very High).
Demographics
Table 2 reports respondent and firm demographic information. As shown in panel A, respondents aver-
age about 52 years of age and have about 29 years of total work experience. Most of their work expe-
rience is in the accounting or finance function (about 28 of 29 years). To understand respondents’
knowledge of R&D accounting rules, we ask them to rate their knowledge on a scale from 1 (Very
Low) to 10 (Very High). On average, respondents rate their knowledge as 7.47 on the 10-point scale,
which suggests we effectively recruited professionals who are knowledgeable about R&D accounting.
Eighty-two percent of our respondents are male. We also collect job title information (untabulated).
Our respondents are comprised of chief financial officers (45.65%), chief accounting officers and con-
trollers (21.20%), vice presidents (19.02%), directors (5.98%), and a few other titles (8.15%). Panel B
provides firm demographic information.9 Mean annual sales are about $2.3 billion, mean total assets
are about $4.5 billion, and mean PP&E is about $1.0 billion. The mean number of employees is 5,845.
Results for R&D expenditures

The survey begins with instructions and brief background information:
We are interested in learning about your company’s R&D expenditures and how your company
accounts for investments in facilities and equipment used in R&D activities when preparing
financial statements under U.S. GAAP (ignore income taxes).
Examples of facilities and equipment used in R&D activities include, but are not limited to,
(1) buildings, building improvements, and leasehold improvements, (2) tools and machines,
(3) testing and measurement devices, and (4) computers and peripheral devices.
9. The demographic information for our survey firms is comparable to the Compustat universe. For example, mean
sales, total assets, PP&E, and total employees are $3.4 billion, $4.8 billion, $1.1 billion, and 6,189, respectively, for
Compustat firms. Moreover, consistent with Compustat firms, the means for the variables are significantly larger
than their respective medians, which indicates that the distributions are right-skewed.

TABLE 3
Results from financial officer survey for firms’ R&D expenditures (n = 184)
First Third
R&D expenditures in most recent year ($millions) 150.47 8.00 1.00 37.00 728.44
R&D expenditures by category (%):
R&D facilities and equipment (alternative
future uses) 21.90 10.00 2.00 30.00 29.08
R&D facilities and equipment (no alternative
future uses) 10.94 1.50 0.00 10.00 21.49
Acquired in-process R&D 3.13 0.00 0.00 0.00 13.39
Other R&D expenditures (not involving above
categories) 64.03 80.00 40.00 95.00 36.35
PP&E comprised of R&D facilities and
equipment (%) 19.78 10.00 2.00 25.00 25.78
Capitalized R&D in current year (%)a 79.35 100.00 100.00 100.00 40.59
Capitalized R&D in any year (%)b 91.30 100.00 100.00 100.00 28.25
Likelihood auditor will dispute alternative future
use judgmentc 3.24*** 4.00*** 5.00 3.00 1.97
Notes: aCalculated based on the number of nonzero responses for the percentage of total R&D expenditures in
facilities and equipment that have alternative future uses. bCalculated based on the number of nonzero responses
for the percentage of PP&E comprised of R&D facilities and equipment. cRespondents answer on an 11-point
scale ranging from 5 (Very Unlikely) to +5 (Very Likely) (the midpoint of 0 is unlabeled). *** represents signif-
icance compared to the response scale’s midpoint of zero at the p < 0.01 level (two-tailed test).
In some questions below, we use the phrase “alternative future use.” When R&D facilities and
equipment have an alternative future use, they can either be used in another R&D project or a
non-R&D project. When R&D facilities and equipment have NO alternative future use, they
cannot be used in any way beyond their current specific use.
Although we mention the meaning of “alternative future use” for R&D facilities and equipment,
we do not mention the relevant accounting rules under ASC 730.
Table 3 provides descriptive information about the R&D expenditures of the firms from
which our respondents come. We primarily focus on mean values. Respondents start by answer-
ing a question about their firm’s total R&D expenditures:
Please provide a rough estimate of your company’s TOTAL annual R&D expenditures in the
most recent year (indicate whether in thousands, millions, or billions).
The mean amount of R&D expenditures is $150.47 million. Notice that this question does
not ask for R&D expense, which is not necessarily equivalent to R&D expenditures. Respondents
then answer the following question, which asks about the different types of R&D expenditures in
which firms invest:
Please indicate the percentage of your company’s TOTAL annual R&D expenditures (from
your response above) that gets invested in each of the following R&D categories. Rough esti-
mates of these percentages are fine.
There are four categories provided, which are intended to be mutually exclusive and collectively
exhaustive, and the percentages should sum to 100%. The categories are (i) R&D equipment and
facilities that have alternative future uses, (ii) R&D equipment and facilities that have no alterna-
tive future uses, (iii) acquired in-process R&D, if applicable, and (iv) other R&D expenditures

that do not involve equipment, facilities, or acquired in-process R&D.10 The mean percentages
are 21.90%, 10.94%, 3.13%, and 64.03%, respectively. This shows that expensed R&D is a large
component of firms’ innovation efforts, consistent with the focus on such investments in the aca-
demic accounting literature. However, the first category is our primary interest because expendi-
tures on R&D equipment and facilities that have alternative future uses are capitalized. The
reported percentage suggests that a substantial proportion of firms’ annual R&D resources—
approximately 22% or $19 million on average—is capitalized annually.
Next, the survey asks respondents to indicate the extent to which their firm has capitalized
equipment and facilities used in R&D activities:
On your company’s balance sheet, what percentage of net PP&E is comprised of R&D equip-
ment and facilities?
The mean response is 19.78%, which suggests that capitalization of R&D expenditures is com-
mon. This provides new information about the composition of firms’ PP&E that is not available
from public disclosures. At the same time, 79.35% of respondents indicate that their firm capital-
ized R&D expenditures in the most recent year, and 91.30% of respondents indicate that their
firm capitalized R&D expenditures at some point in the past. These findings suggest that the capi-
talization of R&D is common among our survey firms. Cumulatively, our respondents indicate
that their firms have capitalized about $17.7 billion of R&D expenditures. Thus, our evidence
about capitalized R&D expenditures contrasts with the assumption in most academic research that
R&D expenditures are only expensed.
The alternative future use provision of ASC 730 refers to facilities and equipment that may
be used “. . . in other research and development projects or otherwise.” This provision gives man-
agers some discretion in capitalizing R&D investments. As a preliminary exploration of that pos-
sibility, we ask participants about the degree to which external auditors are likely to constrain
managers in making judgments about alternative future uses:
In your experience, what is the likelihood that external auditors will DISPUTE your company’s
judgment that an investment in R&D equipment and facilities either does or does not have an
alternative future use?
Respondents answer on an 11-point scale ranging from 5 (Very Unlikely) to 5 (Very Likely) (the
midpoint of 0 is unlabeled).11 The mean response is 3.24, which is significantly below the scale’s
midpoint of zero (p-value <0.01) (we use two-tailed p-values throughout this paper). Hence, managers
are unlikely to be challenged by auditors, which implies significant discretion over R&D capitaliza-
tion. Our interviews provide insights as to why managers may not be constrained by auditors. One
executive we interviewed stated that it is often difficult for auditors to second-guess management’s
judgments about the use of an R&D asset because auditors do not have as much knowledge about
R&D operations as scientists and other firm employees. The executive also stated that firms can often
use R&D assets in multiple projects, so the alternative future use criterion is a fairly low hurdle to
overcome. Hence, when firms purchase tangible R&D assets, those expenditures are usually capital-
ized. Consistent with these views, our survey reveals that the percentage of R&D expenditures for
equipment and facilities that have no alternative future uses (10.94) is about half of the percentage for
equipment and facilities that have alternative future uses (21.90).
10. Other R&D expenditures (category iv) consists of the cost elements identified in ASC 730 for personnel wages/
labor costs, contract services, and indirect costs.
11. In this section, we test whether various responses differ from the response scale’s midpoint. We interpret a response
significantly above (below) the midpoint of the scale to be at least somewhat likely (unlikely). We interpret
responses that are indistinguishable from the midpoint of the scale as being neither likely nor unlikely.

Results for hypothetical actions involving R&D investment

In this section, we investigate the implications of our survey results for the stream of literature
that suggests that firms reduce R&D expense to avoid missing earnings targets (Baber et al. 1991;
Bange and De Bondt 1998; Bushee 1998; Graham et al. 2005; Gunny 2010). We first corroborate
the findings of the literature. We then extend this finding by examining the types of R&D
expenses that are reduced and the resource reallocation decisions firms make when reducing
R&D expense (i.e., what do firms do with the unspent R&D resources?).
R&D expense and earnings targets

We first discuss the findings on the relation between R&D expense and earnings targets. Cutting
R&D expense to meet an earnings target is often viewed as myopic and dysfunctional (Bushee
1998). In sensitive situations such as this, survey participants could provide responses that they
consider to be “correct” or socially acceptable (Fisher 1993). However, evidence suggests that indi-
rect questioning reduces social desirability bias related to variables that are subject to social influ-
ence (Fisher 1993). Therefore, to help mitigate this bias in our survey design, we use indirect
questioning whereby the scenario and questions focus on a hypothetical firm and management
team. To this end, we describe a hypothetical scenario and ask questions related to it:
Consider the following HYPOTHETICAL situation. A company’s annual earnings might fall
below an important earnings target. Management believes that missing the target will cause the
company’s stock price to fall significantly.
Our first question helps to establish a baseline with related prior research by focusing on the
willingness of managers to reduce planned R&D expense:
How likely is management to reduce planned R&D expense to help avoid missing the earnings
target?
Respondents answer on an 11-point scale ranging from 5 (Very Unlikely) to 5 (Very Likely) (the
midpoint of 0 is unlabeled). Table 4 shows that the mean response of 1.32 is above the scale’s
midpoint (p-value <0.01). Furthermore, 71% of respondents indicate that management is, at mini-
mum, somewhat likely (defined as a response of 1 or greater) to reduce planned R&D expense to
help the firm avoid missing the target (untabulated). Thus, our survey confirms a conclusion of
prior research that managers may cut R&D expense to meet an earnings target.
However, prior studies have not examined the types of R&D expenses that firms cut in
response to an earnings shortfall. Further, several studies assume that reducing R&D expense
entails laying off scientists, which disrupts firms’ R&D efforts (Himmelberg and Petersen 1994;
Hall 2002; Brown and Petersen 2011; Erkens 2011). Thus, before we explore what firms do with
the unspent R&D resources, we examine the types of R&D expenses that managers express a
willingness to cut. To do this, we lay out the following scenario:
Assume that management has decided to reduce planned R&D expense to help meet the earn-
ings target. In what specific ways do you think that management will most likely reduce
planned R&D expense?
We identify seven different ways that firms could reduce R&D expense, which include (i) reduce
planned new employee hires, (ii) reduce existing employee headcount through layoffs, (iii) reduce
contract employees and consultants, (iv) reduce employee training and travel, (v) cut back on mate-
rials and supplies, (vi) delay execution of tests and trials, and (vii) reduce facilities expenses.
Respondents can list other ways in additional space provided on the instrument. Five respondents
listed an additional way, but each was an alternatively phrased version of one of our provided
options. During the instrument development, we asked several knowledgeable professionals for
their opinions about the types of R&D reductions that would be most damaging to firms in the long

TABLE 4
Results from financial officer survey for hypothetical actions involving R&D reductions (n = 184)
Panel A: R&D expense and earnings targets
First Third
Likelihood of reducing R&D expense to

avoid missing earnings targeta 1.32*** 2.00*** 1.00 3.00 3.06
Ways R&D reduced to meet earnings targeta
(i) Reduce planned new employee hires 3.15*** 4.00*** 3.00 5.00 2.25
(ii) Reduce existing employee headcount
through layoffs 0.61*** 0.00 3.00 2.00 2.99
(iii) Reduce contract employees and/or
consultants 2.88*** 4.00*** 2.00 4.00 2.31
(iv) Reduce employee training and travel 2.35*** 3.00*** 1.00 4.00 2.60
(v) Cut back on materials and supplies 1.35*** 2.00*** 0.00 3.00 2.68
(vi) Delay execution of tests and trials 0.18 0.00 3.00 3.00 3.13
(vii) Reduce facilities expenses 0.20 0.00 2.00 2.00 2.69
Type of reductions in R&D (%)
Real operating decisions 93.05 100.00 95.00 100.00 17.18
Accounting judgments 6.95 0.00 0.00 5.00 17.18
Panel B: Reallocation of unspent R&D resources
First Third
Use of unspent R&D resourcesa

(i) Capitalized R&D items 2.32*** 3.00*** 1.00 5.00 2.92
(ii) Capitalized non-R&D items 1.80*** 3.00*** 0.00 5.00 3.14
(iii) Pay down debt 0.43* 0.00 3.00 3.00 3.30
(iv) Accumulate in cash 2.26*** 3.00*** 1.00 5.00 2.97
Ability to fund all positive NPV projects
(% responding “no”) 75.14 100.00 100.00 100.00 43.34
Notes: Respondents answer on an 11-point scale ranging from 5 (Very Unlikely) to +5 (Very Likely) (the
a
midpoint of 0 is unlabeled). *** and * represent significance compared to the response scale’s midpoint of
zero at the p < 0.01 and p < 0.10 level, respectively (two-tailed test).
term. Ways (ii) and (vi) stood out in that respect. To the extent that our respondents prioritize R&D
reductions to mitigate harm to their R&D operations and innovation efforts, we expect ways
(ii) and (vi) to be the least popular.
Respondents answer on an 11-point scale ranging from 5 (Very Unlikely) to 5 (Very Likely)
(the midpoint of 0 is unlabeled). The results are shown in panel A of Table 4. We find that
respondents are willing to reduce planned new employee hires (mean = 3.15, p-value <0.01),
reduce contract employees and/or consultants (mean = 2.88, p-value <0.01), reduce employee
training and travel (mean = 2.35, p-value <0.01), and cut back on materials and supplies
(mean = 1.35, p-value <0.01). These ways of reducing R&D expense to meet an earnings target
are among the ways that cause the least long-term harm to firms.
On the other hand, managers are least likely to reduce existing employee headcount through lay-
offs (mean = 0.61, p-value <0.01), and they show no proclivity to delay execution of tests and trials
(mean = 0.18, p-value = 0.44) or reduce facilities expenses (mean = 0.20, p-value = 0.33). As
expected, the most damaging ways to reduce R&D expense, ways (ii) and (vi) (see discussion above),

are avoided by respondents. Thus, it appears that while managers are willing to cut R&D expense
using real operating decisions, they also seek to mitigate the harm caused by such actions.
This conclusion is also supported by our interviews. All of the executives we interviewed
were emphatic that they would not lay off scientists to increase short-term earnings. Instead, they
would temporarily freeze hiring. One executive stated the following:
Laying off current scientists would set us back and pose competitive risks. Instead, we tell our
scientists to do more with existing resources. They take on the responsibilities of the planned
new headcount, at least temporarily.
Another executive explained that cuts to training and travel for R&D employees are very likely
because when there is earnings pressure, the firm generally freezes these expenses for all departments.
A third executive framed the notion of R&D expense reductions in a different way by explaining the
types of R&D activities of scientists (i.e., “research” versus “development”) as follows:
Basic research is the first to go since there is no direct link to a product. Then, applied research
since we can see potential realization. The last item is development because this could have com-
mercial impacts and delay time to market if we slow momentum toward product realization.
These comments seem to support the unwillingness of survey respondents to delay execution of
tests and trials and reduce facilities expenses.
Although managers express some willingness to use real operating decisions to reduce R&D
expense, we also want to determine the proportion of reductions in R&D expense that are
achieved through real operating decisions versus accounting judgments. We ask the following
survey question to assess the relative use of both approaches:
The previous question identifies ways in which management might reduce R&D expense to
meet an earnings target through real operating decisions. Management could also alter various
R&D-related accounting judgments to meet an earnings target. For example, management could
(1) extend the depreciable lives of certain R&D facilities and equipment and/or (2) classify
more R&D facilities and equipment acquired in the current period in a way that results in the
costs being capitalized. Based on your experience, what fraction of the total reduction in R&D
expense would most likely come from each type of action?
Respondents assign a percentage to “Reduction in R&D expense from real operating decisions”
and a percentage to “Reduction in R&D expense from accounting judgments.” As reported in
panel A of Table 4, about 93% of earnings-motivated reductions in R&D expense come from real
operating decisions, while only about 7% come from reporting decisions. This suggests that man-
agers are much more likely to use real operating decisions as opposed to reporting decisions when
reducing R&D expense to meet an earnings target. However, our evidence should be interpreted
with caution as managers may be unwilling to self-report the use of accounting judgment for
earnings-motivated reductions in R&D expense.
Reallocation of unspent R&D resources

Although prior research suggests that managers reduce R&D expense to meet earnings targets, it
remains unclear how firms invest the unspent cash that would have otherwise been invested in
expensed R&D. For instance, it is possible that managers invest the saved resources in capitalized
R&D so that firms’ total R&D investment remains unchanged. In this section, we examine
whether total R&D investment is actually cut after considering capitalized R&D. The following
question addresses this issue:
Assume that management has decided to reduce planned R&D expense to help meet the earn-
ings target. There are now unspent R&D resources. How will management most likely use
these unspent R&D resources (assume that the uses listed below have positive returns)?

We provide respondents with four different uses of the unspent R&D resources, which are
(i) invest the unspent R&D resources in R&D items that are capitalized rather than expensed,
(ii) invest the unspent R&D resources in non-R&D items that are capitalized, (iii) use the unspent
R&D resources to pay down debt or other financial obligations, and (iv) allow the unspent R&D
resources to accumulate in cash until the next year. Respondents may list other uses in space pro-
vided on the instrument. Four respondents list one other use, but each of those other uses was an
alternatively phrased version of one of our listed uses.
Respondents answer on the same 11-point scale discussed above. Panel B of Table 4 shows
that respondents would invest the unspent R&D resources in (i) R&D items that are capitalized
rather than expensed (mean = 2.32, p-value <0.01) and (ii) non-R&D items that are capitalized
(mean = 1.80, p-value <0.01). However, we also find that managers are more likely to invest
the unspent resources in capitalized R&D items than capitalized non-R&D items (mean differ-
ence = 0.52, p-value <0.01).12 Therefore, although firms may reduce R&D expense to meet an
earnings target, those firms may productively invest the unspent resources in long-lived R&D assets.
This has not been documented in prior literature. In addition, respondents are willing to allow the
unspent R&D resources to accumulate in cash until the following year (mean = 2.26, p-value
<0.01) so that the resources are available in the R&D function for future investment. They are
somewhat likely to use unspent R&D resources to pay down debt (mean = 0.43, p-value = 0.08).
Interview results also provide evidence as to why managers are likely to invest the unspent
R&D expense in capitalized R&D expenditures. One executive stated that the R&D organization
thinks about its resources in terms of projects, holistically considering both the expense and capi-
tal components. The executive elaborated as follows:
When we are worried about earnings, we trade out expense for capital within and between
research projects to keep things moving. It is often much quicker, easier, and more effective to
switch out funds within the R&D business.
Another executive provided a specific example of how reallocating expense dollars to capital can
be justified in the R&D business:
We look to automate not only production but also research, which drives capital investment.
This is especially helpful when there is scrutiny on adding headcount because it pushes lab per-
sonnel to move their labs toward robotics.
The executive mentioned that this provides a benefit where scientists can run labs continuously.
Finally, a third executive pointed out that when expenses are being cut, scientists do not want
their projects to come to a standstill, so they spend capital dollars, which are more versatile. The
executive elaborated as follows:
A scientist might buy equipment that will help move along several projects. This allows them
to keep many projects active even though only some are funded and shows that progress is
being made on various projects. Ultimately, this gives them more shots on goal given that any
one project might fail.
An important observation from these discussions is that findings from both the survey and inter-
views provide direct evidence that, in contrast to the conclusions of prior studies, firms’ total
investments in R&D (both capitalized R&D and expensed R&D) may remain unchanged when
firms cut expensed R&D to meet an earnings target. Thus, we provide a more nuanced perspec-
tive on the consequences of reducing R&D expense in response to the threat of missing an
12. Canace et al. (2018) provide archival evidence that capital expenditures increase when firms have earnings-
motivated cuts in R&D expense. Our survey evidence supports their findings, while also documenting new evidence
on the types of R&D expenses that are cut and how firms invest the unspent R&D resources when reallocating
resources.

earnings target and highlight the importance of estimating and incorporating capitalized R&D in
research designs.
Note that the previous question had respondents “assume that the uses listed below have pos-
itive returns.” If firms generally fund all positive net present value (NPV) projects, there would
be no opportunity to invest unspent R&D resources productively. With this in mind, our final
question focuses on the sufficiency of firms’ resources to fund investment opportunities:
For investment opportunities related to both R&D and non-R&D projects that are expected to
generate your company’s desired level of return, does your company always have sufficient
financial resources to fund every one of them?
Respondents may answer “Yes, all projects expected to generate the desired level of return get funded”
or “No, some projects expected to generate the desired level of return get delayed or declined.” As
shown in Table 4, about 75% of respondents say “no,” which suggests that the reallocation decisions
are not value destroying, as the majority of firms can productively invest unspent R&D resources.
4. Archival evidence
Archival evidence that R&D is capitalized
In this section, we examine financial statement data for a broad sample of public firms that have
R&D expenditures. This analysis helps validate our survey finding that firms routinely capitalize
material amounts of R&D expenditures, as it is possible that such investment for our survey firms
differs from that of the broader universe of firms. For instance, survey firms may use more tech-
nology in their R&D operations, which can make them more likely than other firms to capitalize
significant amounts of R&D.
Depreciation associated with long-lived R&D assets is part of R&D expense. Thus, if capital-
ized R&D assets are a significant proportion of total PP&E, then depreciation of capitalized R&D
should be a significant proportion of firm-wide depreciation.13 GAAP does not require firms to
partition PP&E or depreciation expense into R&D related and non-R&D related. However, we
can use regression to estimate firm-wide depreciation included in R&D expense. Prior research
provides a comprehensive set of determinants of R&D expense (Switzer 1984; Baber et al. 1991;
Shehata 1991; Bushee 1998; Darrough and Rangan 2005; Biddle et al. 2009; Canace et al. 2018).
We estimate the following model using ordinary least squares:
R&Dit ¼ β0 þ β1 DEPit þ β2 CAPX it þ β3 R&Dit1 þ β4 MBit þ β5 LEV it þ β6 CASH it1 þ β7 SIZE it

þ β8 SG&Ait þ β9 FINCF it þ β10 CFOBRDit þ β11 ΔSALESit þ β12 DIV it þ β13 TSTK it
þ β14 AQC it þ εit : ð1Þ
Variables are defined in the Appendix. We include industry and year fixed effects (industry is
defined at the 2-digit SIC code level). Standard errors are clustered by firm. We expect the coeffi-
cient on DEPit to be positive. If firms have significant amounts of R&D assets in PP&E, then we
should observe a significant positive association between R&D expense and firm-wide deprecia-
tion expense after controlling for economic determinants of R&D expense. Our survey reveals
that R&D facilities and equipment comprise about 20% of total PP&E (see Table 3), so we expect
that the coefficient on DEP will be of similar magnitude.
We use firms from the annual Compustat database during the period 1988–2016. We begin
with 1988 because that is the first year that operating cash flows are available from the statement
of cash flows. We exclude regulated industries (SIC codes 4000–4999) and financial institutions
(SIC codes 6000–6999). We delete observations with missing data. We also delete observations
13. Firm-wide depreciation expense reported in Compustat captures depreciation included in (i) R&D expense,
(ii) SG&A expense, and (iii) cost of goods sold.

TABLE 5
Regression of R&D expense on depreciation and economic determinants (n = 50,682)
Variables Coefficient t-statistic p-value
Test variable
DEPit 0.167 12.57 <0.01
Economic determinants
Intercept 0.012 3.07 <0.01
CAPXit 0.021 2.92 <0.01
R&Dit1 0.783 93.40 <0.01
MBit 0.001 3.95 <0.01
LEVit 0.003 1.38 0.17
CASHit1 0.032 15.09 <0.01
SIZEit 0.002 12.80 <0.01
SG&Ait 0.022 8.54 <0.01
FINCFit 0.007 2.09 0.04
CFOBRDit 0.013 4.79 <0.01
ΔSALESit 0.012 8.49 <0.01
DIVit 0.061 5.12 <0.01
TSTKit 0.003 1.48 0.14
AQCit 0.000 0.40 0.69
Industry fixed effects Yes
Year fixed effects Yes
Adjusted R2 (%) 78.45
Notes: Variables are defined in the Appendix. Industry fixed effects are defined at the 2-digit SIC code level.
Standard errors are clustered by firm.
where lagged R&D is zero. This results in 50,682 firm-year observations and 7,629 different
firms. To reduce the effect of outliers, we winsorize continuous variables at the 1st and 99th
percentiles.
Table 5 reports the regression results for equation (1). Consistent with prior literature, most
of the economic determinants are significant and the model’s explanatory power is substantial
(approximately 78%). The test variable is DEP, and its coefficient is 0.167 (t-statistic = 12.57,
p-value <0.01). The magnitude of the coefficient on DEP suggests that, on average, about 17% of
annual depreciation is associated with long-lived depreciable assets used in R&D activities. This
finding is consistent with our survey evidence showing that about 20% of PP&E is comprised of
R&D facilities and equipment (see Table 3). This corroborates our survey findings that capitaliza-
tion of R&D expenditures is both common and extensive in practice.
Empirical implications of capitalized R&D

Our survey suggests that earnings-motivated cuts to R&D expense may cause managers to increase
their investments in capitalized R&D expenditures. We explore how inferences from a published
study could be affected if both capitalized and expensed R&D expenditures are considered simulta-
neously. Bushee (1998) examines the impact of transient institutional investors on managers’ incen-
tives to cut R&D in order to meet an earnings target. Bushee (1998) argues that transient investors
impose pressure on managers to focus excessively on short-term performance as those investors
actively trade the shares for short-term gains. Consistent with this, Bushee (1998) finds that firms
with high levels of transient institutional ownership are more likely to cut R&D expense to avoid
missing an earnings target. Bushee (1998, 307) concludes that cutting R&D is “myopic investment
behavior by corporate managers. . .” as cutting R&D hurts long-run value. Given our survey find-
ings, we examine whether managers maintain overall R&D investment when they cut R&D expense.

We first replicate Bushee’s (1998) main finding that firms cut R&D expense to meet an earn-
ings target when transient institutional ownership is high. We then extend the analysis by examining
whether such firms are also more likely to increase capitalized R&D simultaneously. Moreover, we
examine whether those same firms maintain their total R&D investment (R&D expense plus capital-
ized R&D) when they cut R&D expense to avoid missing an earnings target. Our analyses comple-
ment prior research by illuminating a broader array of real responses to concerns about missing a
short-term earnings target.
Although we cannot directly observe capitalized R&D using archival data, we can infer capi-
talized R&D expenditures from capital expenditures. Capital expenditures reflect capitalized
R&D expenditures, non-R&D capital expenditures, or some combination of both. To minimize
measurement error associated with using capital expenditures to infer capitalized R&D, we elect
to constrain our sample to firms from high-tech manufacturing industries where capitalized R&D
is more likely to comprise a significant proportion of firms’ capital expenditures.14
Drawing upon prior research on R&D expense and capital expenditures (Switzer 1984; Baber
et al. 1991; Shehata 1991; Bange and De Bondt 1998; Bushee 1998; Darrough and Rangan 2005;
Richardson 2006; Biddle et al. 2009; Canace et al. 2018), we estimate two logistic regressions.
These regressions are specified as follows:
Prob ðCUTR&Dit ¼ 1Þ ¼ α0 þ α1 TARGET it þ α2 TDit þ α3 DDit þ α4 QDit þ α5 PIH it

þ α6 ðTARGET it TDit Þ þ α7 ðTARGET it DDit Þ
þ α8 ðTARGET it QDit Þ þ α9 ðTARGET it PIH it Þ þ α10 ΔCAPX it
þ α11 ΔR&Dit1 þ α12 MBit þ α13 LEV it þ α14 CASH it1 þ α15 ΔSALESit
þ α16 SIZE it þ α17 CFOBRDit þ α18 FINCF it þ α19 SG&Ait þ α20 DIV it
þ α21 TSTK it þ α22 AQC it , ð2Þ
Prob ðINCCAPX it ¼ 1Þ ¼ π 0 þ π 1 TARGET it þ π 2 TDit þ π 3 DDit þ π 4 QDit þ π 5 PIH it
þ π 6 ðTARGET it TDit Þ þ π 7 ðTARGET it DDit Þ
þ π 8 ðTARGET it QDit Þ þ π 9 ðTARGET it PIH it Þ þ π 10 ΔR&Dit
þ π 11 ΔCAPX it1 þ π 12 MBit1 þ π 13 LEV it1 þ π 14 CASH it1
þ π 15 ΔCASH it1 þ π 16 AGE it1 þ π 17 SIZE it1 þ π 18 RET it1
þ π 19 CFOit þ π 20 ΔSALESit þ π 21 DIV it þ π 22 TSTK it þ π 23 AQC it : ð3Þ
Variables are defined in the Appendix. The first variable of interest is TARGETit, which is an
indicator variable for whether earnings just meet or slightly exceed an important earnings target.
This variable is defined in a manner consistent with prior research (Burgstahler and Dichev 1997;
Graham et al. 2005; Gunny 2010). The second variable of interest is TDit, which is an indicator
variable for high transient institutional ownership from Bushee (1998). We include industry and
year fixed effects (industry is defined at the 2-digit SIC code level). Standard errors are clustered
by firm. Our sample consists of 26,558 firm-year observations and 2,968 different firms.15
Equation (2) examines whether having high transient institutional ownership (TDit) increases
the probability of cutting R&D expense (CUTR&Dit) when facing the threat of missing an
14. We include the following industries (2-digit SIC code): 28 (Chemicals and allied products), 35 (Industrial and com-
mercial machinery and computer equipment), 36 (Electronic and other electrical equipment, 37 (Transportation
equipment), and 38 (Measuring, analyzing, and controlling instruments). These industries are known for their heavy
investment in R&D activities (Amir et al. 1999; Barron et al. 2002; Canace et al. 2018), which suggests they would
have more R&D assets to support those activities.
15. We begin with our sample from the previous subsection. We then merge data on institutional investor holdings into
our data set and delete observations with missing data. Finally, we constrain our sample to firms from high-tech
manufacturing industries resulting in the final sample for analysis. We thank Brian Bushee for making the institu-
tional investor holdings data available on his university website.

important earnings target. Consistent with our survey findings and prior research, we expect the
coefficient on TARGETit to be positive, indicating that managers are willing to reduce R&D
expense to meet an earnings target. The interaction, TARGETitTDit, establishes a common base-
line with Bushee (1998). We expect that the coefficient on the interaction will be positive because
firms having high transient institutional ownership have been found to be more likely to cut R&D
expense to avoid missing a short-term earnings target.
In equation (3), we look beyond cuts to expensed R&D and consider whether firms also
increase capital expenditures (INCCAPXit). We expect the coefficient on TARGETit to be posi-
tive, consistent with our survey findings that managers are likely to increase capitalized R&D
when they cut R&D expense to meet an earnings target. We are interested in the interaction,
TARGETitTDit, which represents our extension of Bushee (1998) and indicates whether there
is a co-occurring response to cutting R&D expense. A positive coefficient would indicate that
firms having high transient institutional ownership are incrementally more likely to increase
their capital expenditures when facing the threat of missing an important earnings target.
Panels A and B of Table 6 provide the abbreviated regression results for equations (2) and
(3), respectively. For brevity, we only tabulate results for the earnings target variable (TARGETit),
the institutional ownership variables (TDit, DDit, QDit, PIHit), and the relevant interactions among
these variables. TDit is the focal institutional ownership variable in Bushee (1998), and it is the
focal institutional ownership variable here. In panel A, the coefficient on TARGETit is positive
and significant (z-statistic = 2.69, p-value <0.01), which indicates that firms facing an earnings
shortfall are significantly more likely to cut R&D expense. The coefficient on the test variable,
TARGETitTDit, is also positive and significant (z-statistic = 6.47, p-value <0.01), which indi-
cates that firms with high transient institutional ownership are incrementally likely to cut R&D
expense to meet an earnings target. These findings are consistent with the results reported in
Bushee (1998).
Our extension of Bushee (1998) is shown in panel B. The coefficient on TARGETit is posi-
tive and significant (z-statistic = 2.40, p-value = 0.02), indicating that firms facing an earnings
shortfall are significantly more likely to increase their capital expenditures in the same periods
in which R&D expense has been cut. Furthermore, we find that the coefficient on the test vari-
able, TARGETitTDit, is positive and significant (z-statistic = 3.26, p-value <0.01), which
indicates that firms with high transient institutional ownership are incrementally more likely to
increase capital expenditures in the same periods they cut R&D expense to meet an earnings
target.16 This is consistent with our survey results, which indicate that cutting R&D expense
does not occur in isolation of other actions, such as investing freed-up resources in capital-
ized R&D.
Lastly, we examine the likelihood that firms’ total R&D investments (R&D expense plus
capitalized R&D) are reduced in years that earnings just meet or slightly exceed an important
earnings target. To make inferences about their total R&D investments, we estimate another logis-
tic regression with the variable CUTTOTit as the dependent variable. This is an indicator variable
equal to one when the total of R&D expense and capital expenditures is cut, and zero otherwise.
The independent variables are from equations (2) and (3).17 Results are presented in panel C of
Table 6. The coefficient on TARGETit is insignificant (z-statistic = 1.27, p-value = 0.20) indi-
cating that firms facing an earnings shortfall are not significantly more likely to cut total invest-
ments. At the same time, the coefficient on the test variable, TARGETitTDit, is insignificant
(z-statistic = 1.20, p-value = 0.23), which indicates that firms with high transient institutional
16. In contrast, capital expenditures for firms in non-high-tech industries are not expected to contain significant amounts
of capitalized R&D. Thus, these firms would have less opportunity to reallocate expensed R&D to capitalized
R&D. Consistent with our expectations, we do not find evidence of shifting for these firms (untabulated).
17. The total R&D investment regression does not include the control variables ΔCAPXit and ΔR&Dit as these variables
comprise the dependent variable, CUTTOTit.

TABLE 6
Logistic regression results for R&D expense, capital expenditures, and total investments (n = 26,558)
Panel A: Logistic regression of R&D expense cuts (CUTR&Dit) on economic determinants
Variables Coefficient z-statistic p-value
Primary variables of interest from Bushee (1998)

TARGETit 0.196 2.69 <0.01
TARGETitTDit 0.399 6.47 <0.01
Other variables from Bushee (1998)
TDit 0.252 4.78 <0.01
DDit 0.091 2.04 0.04
QDit 0.048 1.15 0.25
PIHit 0.001 2.06 0.04
TARGETitDDit 0.204 1.64 0.10
TARGETitQDit 0.058 0.55 0.58
TARGETitPIHit 0.003 2.36 0.02
Panel B: Logistic regression of capital investment increases (INCCAPXit) on economic determinants

TARGETit 0.125 2.40 0.02
TARGETitTDit 0.203 3.26 <0.01
TDit 0.067 1.28 0.20
DDit 0.001 0.03 0.98
QDit 0.045 0.63 0.53
PIHit 0.001 1.15 0.25
Panel C: Logistic regression of total investment cuts (CUTTOTit) on economic determinants

TARGETit 0.096 1.27 0.20
TARGETitTDit 0.075 1.20 0.23
TDit 0.012 0.23 0.83
DDit 0.021 0.46 0.64
QDit 0.008 0.18 0.86
PIHit 0.001 1.27 0.21
Notes: Variables are defined in the Appendix. Industry fixed effects are defined at the 2-digit SIC code level.
Standard errors are clustered by firm.
ownership are not more likely to cut total investments in the periods they face the threat of miss-
ing an important earnings target. Overall, the results in Table 6 not only provide evidence consis-
tent with prior research (Bushee 1998), but also suggest that it may be appropriate to examine

cuts in R&D expense in tandem with other associated managerial actions. Although high levels
of transient institutional ownership may encourage managers to focus on short-term earnings
goals by reducing expensed R&D, managers of those firms may also invest freed-up resources in
capitalized R&D expenditures to maintain overall R&D investment.
5. Conclusions
In this study, we examine the academic accounting literature to determine how scholars interpret the
authoritative professional literature for R&D accounting. Although ASC 730 contains both a capital-
ization requirement and an expense requirement, an analysis of R&D studies published in the top
academic journals during the past half-century reveals that they typically focus on the expense
requirement, while largely overlooking the capitalization requirement. The omission of this impor-
tant aspect of R&D accounting may have hindered the development of the academic R&D literature.
Given the differences between how R&D accounting is discussed in the academic literature
and the authoritative professional guidance, we survey and interview financial officers who have
experience with R&D accounting. We find that (i) the capitalization of R&D expenditures is com-
mon and extensive in practice, (ii) when facing an earnings shortfall, financial officers do not
indiscriminately cut R&D expenses, (iii) when cuts to R&D expense do occur, financial officers
often shift R&D expenditures from those that are expensed to those that are capitalized, and
(iv) financial officers do not feel constrained by auditors to make judgments about capitalizing
R&D under the alternative future uses criterion of ASC 730. Our primary conclusion that R&D
expenditures are often capitalized is substantiated with archival data.
This study is subject to certain limitations. First, the survey methodology examines beliefs
rather than actions, and the respondents may not be representative of the underlying population
(Graham et al. 2005). However, we conduct analyses that allow us to conclude that our survey
firms are representative of the larger Compustat universe, thereby increasing the generalizability
of our findings. Second, while our findings generalize broadly to the Compustat universe and do
not appear to be driven by specific industry practices, it is possible that our results may not gener-
alize to specific industries that have unique practices (e.g., biotechnology and life sciences firms
that must comply with complicated, industry-specific rules regarding R&D). Third, respondents
may provide answers that they consider to be socially acceptable rather than providing fully can-
did answers. To mitigate this concern, we use indirect questioning whereby the scenario and
questions focus on a hypothetical firm and management team.
Appendix: Variable definitions
Variable Definition
AQCit Dollar amount of acquisitions scaled by ATAit

AGEit Log of the lag of the number of years the firm has been listed on CRSP
ATAit Average total assets
CAPXit Capital expenditures scaled by ATAit
CASHit Sum of cash and short-term investments scaled by ATAit
CFOit Cash flows from operations scaled by ATAit
CFOBRDit Cash flows from operations before R&D expense scaled by ATAit
CUTR&Dit Equal to one if R&Dit minus R&Dit1 is negative, and zero otherwise
CUTTOTit Equal to one if total investment (R&Dit plus CAPXit) in the current year minus total
investment in the prior year is negative, and zero otherwise
DEPit Total depreciation expense (defined as depreciation and amortization less amortization of
intangibles) scaled by ATAit
DDit Equal to one if the firm is in the top quintile of proportional ownership by dedicated
institutional investors, and one otherwise
(The table is continued on the next page.)

(continued)
Variable Definition
DIVit Total dividends paid scaled by ATAit

FINCFit Cash flows from financing activities scaled by ATAit
INCCAPXit Equal to one if CAPXit minus CAPXit1 is positive, and zero otherwise
LEVit Sum of book value of short-term and long-term debt scaled by ATAit
MBit Ratio of market value of total assets to book value of total assets, calculated as market value
of common equity plus book value of assets minus book value of equity scaled by ATAit
PIHit Percentage of institutional holdings
QDit Equal to one if the firm is in the top quintile of proportional ownership by quasi-indexer
institutional investors, and zero otherwise
R&Dit R&D expense scaled by ATAit
RETit Firm’s annual stock return
SALESit Year-to-year change in net sales scaled by ATAit
SG&Ait SG&A expense (net of R&D expense) scaled by ATAit
SIZEit Log of ATAit
TARGETit Equal to one if the year-to-year change in net income scaled by ATAit is greater than or equal
to zero but less than or equal to 0.010, and zero otherwise
TDit Equal to one if the firm is in the top quintile of proportional ownership by transient
institutional investors, and zero otherwise
TSTKit Dollar amount of stock that has been reacquired and placed into treasury scaled by ATAit
i, t Firm and year subscripts, respectively
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Accounting for R&D: Evidence and Implications*

THOMAS G. CANACE, Wake Forest University

SCOTT B. JACKSON, University of South Carolina†

TAO MA, Texas Tech University

AARON ZIMBELMAN, University of South Carolina

Comptabilisation de la R-D : données probantes et implications

Mots-clés : recherche-développement, capitalisation de la R-D, dépenses de R-D, gestion des

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

Figure 1 R&D activities and accounting treatment under ASC 730

Consensus views on R&D accounting rules in the academic literature

CAR Vol. 39 No. 3 (Fall 2022)

TAR CAR RAST JAR JAE AOS Total

Total search engine hits 122 49 46 78 58 86 439

Contemporary Accounting Research (CAR); Journal of Accounting and Economics (JAE);

CAR Vol. 39 No. 3 (Fall 2022)

3. Survey of ﬁnancial ofﬁcers

CAR Vol. 39 No. 3 (Fall 2022)

Panel A: Respondent demographic information

Age (years) 52.16 53.00 47.00 58.50 8.12

Annual sales ($millions) 2,327.27 250.00 20.00 1,400.00 6,645.23

Results for R&D expenditures

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

Results for hypothetical actions involving R&D investment

R&D expense and earnings targets

CAR Vol. 39 No. 3 (Fall 2022)

Panel A: R&D expense and earnings targets

Likelihood of reducing R&D expense to

Panel B: Reallocation of unspent R&D resources

Use of unspent R&D resourcesa

CAR Vol. 39 No. 3 (Fall 2022)

Reallocation of unspent R&D resources

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

R&Dit ¼ β0 þ β1 DEPit þ β2 CAPX it þ β3 R&Dit1 þ β4 MBit þ β5 LEV it þ β6 CASH it1 þ β7 SIZE it

CAR Vol. 39 No. 3 (Fall 2022)

Variables Coefﬁcient t-statistic p-value

Empirical implications of capitalized R&D

CAR Vol. 39 No. 3 (Fall 2022)

Prob ðCUTR&Dit ¼ 1Þ ¼ α0 þ α1 TARGET it þ α2 TDit þ α3 DDit þ α4 QDit þ α5 PIH it

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

Panel A: Logistic regression of R&D expense cuts (CUTR&Dit) on economic determinants

Variables Coefﬁcient z-statistic p-value

Primary variables of interest from Bushee (1998)

Panel B: Logistic regression of capital investment increases (INCCAPXit) on economic determinants

Variables Coefﬁcient z-statistic p-value

Primary variables of interest from Bushee (1998)

Variables Coefﬁcient z-statistic p-value

Primary variables of interest from Bushee (1998)

CAR Vol. 39 No. 3 (Fall 2022)

Appendix: Variable deﬁnitions

AQCit Dollar amount of acquisitions scaled by ATAit

(The table is continued on the next page.)

CAR Vol. 39 No. 3 (Fall 2022)

DIVit Total dividends paid scaled by ATAit

CAR Vol. 39 No. 3 (Fall 2022)

CAR Vol. 39 No. 3 (Fall 2022)

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