Capitalization versus Expensing: Evidence on the Uncertainty of Future Earnings from Current Investments in PP&E versus R&D

Abstract

Accounting standards reflect a trade-off between relevance and reliability. This trade-off is intensely debated in the context of the accounting standard for R&D costs. However, almost all of the empirical research focuses only on the relevance of accounting disclosures about R&D costs. Little systematic evidence exists on the reliability of future benefits from R&D outlays. We propose and implement a new method to estimate the relation between investments in R&D and the uncertainty of future benefits from those investments. The empirical analysis compares the relative contributions of current investments in R&D and PP&E to future earnings variability using a sample of more than 50,000 firm-year observations. Evidence is strongly consistent with the hypothesis that R&D investments generate future benefits that are far more uncertain than benefits from investments in PP&E. Our results, together with the evidence on value relevance of R&D from previous research, should be helpful in the current discussion on accounting for R&D.