Definition:
Research and development (R&D) costs are the costs you incur for activities intended to develop or improve a product or service. They are listed on the income statement under Operating Expenses and can be expensed or capitalized. Companies with large R&D departments usually list the cost out separately, while other companies with infrequent R&D costs choose to group them under general and administrative costs.
Example:
Research and development costs on new internal software to better manage projects would be expensed since it will not generate revenue. However, research and development costs on software that is sold to customers would be amortized. R&D costs can have a large impact on profitability.
Book Excerpt:
(Excerpts from Financial Intelligence, Part Four Toolbox)
R&D expenses that do not result in an asset likely to generate revenue should be recorded as an expense on the income statement.
You can see the potential for subjectivity here. Some software companies, for example, are famous for spending considerable sums on R&D, then amortizing those sums over time, thus making their profits look higher. Others choose to expense R&D as it is incurred – a more conservative approach. Amortization is fine if the R&D is actually expected to generate revenue, but not if it isn’t.
