R&D Is An Investment, Not An Expense – How capitalizing R&D impacts understanding corporate profitability (GILD, FB, BA, DHR)

• In several of our recent Seeking Alpha articles, discussions in the comments section have focused on R&D capitalization, so we thought a piece focusing on this issue and its impact would help further the conversation for the entire investing community.
  
• Investors often assume issues around R&D only matter for technology and biotech/pharma “R&D intensive” industries, but this issue touches companies across sectors, including in Tech, Healthcare, Industrials, Energy, and Consumer Discretionary to name a few.
  
• Expensing of R&D flies in the face of one of the most basic of accounting principles, the matching principle, which states that expenses should be recognized at the time of related revenue. Capitalization solves this issue – but IFRS guidance on expensing and capitalizing parts of R&D only muddle the issue more.
  
• R&D capitalization does not mean that the impact of R&D magically vanishes from the income statement. Rather – capitalized R&D is amortized over its life, similar to how PP&E is depreciated.
  
• This adjustment represents the smoothing of the R&D investment stream’s impact and the recognition of the investment made on the balance sheet.