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April 10, 2006
Capitalizing R&D
Yesterday, New York Times columnist Louis Uchitelle picked up on part of the Corrado, Hulten and Sichel studies of intangible assets. The main point of Uchitelle's column - "Seizing Intangibles for the G.D.P." - was that the share of profits going to labor are even smaller (and hence inequality even greater) when intangibles are properly factored in -- i.e. R&D is capitalized rather than expensed.
The numbers show that the profit portion of the gross domestic product has risen mildly in recent years, while the wage-and-salary share has shrunk slightly. There is evidence, however, that because of the way the G.D.P. is calculated, the actual shift is much more pronounced."We know that income inequality is quite substantial," said Harry J. Holzer, a labor economist at Georgetown University, "and this new evidence suggests that it is worse than we thought."
But Uchitelle made another important comment:
The approximately $300 billion spent each year on R & D is a big concern of the bureau's economists. Until now, it has been counted as an expense, reducing the profit total within the G.D.P. Starting in September, however, the bureau will publish an experimental G.D.P. account that parallels the standard quarterly report, except for one change: R & D will be counted as capital investment rather than as an expense.
This seemingly minor technical shift will have a major impact. The accounting profession has long been talking about expensing R&D costs. In fact, the International Accounting Standard Board (IASB) is taking a first step toward this, in a major difference from the US Financial Accounting Standards Board (FASB). As I stated in our working paper Reporting Intangibles: Lessons from the US Experience, this will create a natural experiment to see how capitalizing create R&D cost will affect corporate accounting. At the very least, this movement by economists in charge of macroeconomic statistics toward capitalization of R&D in the national accounts may give a new push for similar capitalization of R&D in business accounting.
Once that happens, there are a number of other types of intangibles (which are outlined in the C-H-S papers) that might also be candidates for capitalization - which may be the accountants' worse nightmare. When everything can be capitalized, what happens to the rules? For this reason, the profession seems to have been resisting any change to what I call the "hard asset" philosophy.
Unfortunately (or fortunately) the business world continues to evolve, and intangible assets are a major part of that evolution. The accountants can not hold it back forever. But they can prepare with better rules.
Which makes FASB's reinstatement of its suspended 2002 intangibles project all the more urgent. And the work of the Enhanced Business Reporting Consortium all that more important.
As we talk about competitiveness in our political debates, I hope we don't forget these types of almost invisible efforts to get the rules right.
Posted by Ken Jarboe at April 10, 2006 3:13 PM
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