R&D

R&D stands for Research & Development, which is an activity that a company undertakes to develop new products or services, or methods of production. R&D is therefore driven by the profit motive, but accounting treatment of R&D is conceptually problematic. To clarify exactly what R&D is from an accounting perspective, FASB has issued precise definitions of both research and development. In the US, GAAP dictates that R&D expenditures be booked as expenses, rather than capitalized. Treating R&D as an expense is conservative. However, conceptually R&D results may be assets that determine a company’s future potential. Some exceptions to R&D accounting rules are made. For example, extraction industries (oil and mining companies) have the option to capitalize and depreciate or amortize certain seemingly R&D expenditures related to their activities, such as drilling and exploration.

The phrase Research and Development (also R and D or R&D) has a special commercial significance apart from its conventional coupling of research and technological development.

In the context of commerce, “Research and Development” normally refers to future-oriented, longer-term activities in science or technology, mimicking scientific research in an apparent disregard for profits.

Statistics on organisations devoted to “R&D” may express the state of an industry, the degree of competition or the lure of scientific progress. Some common measures include budgets, numbers of patents or on rates of peer-reviewed publications.

Bank ratios are one of the best measures because they are continuously maintained, public and reflect risk.

In the U.S., a typical ratio of research and development for an industrial company is about 3.5% of revenues. A high technology company such as a computer manufacturer might spend 7%. Some very aggressive organizations spend as much as 40% and are famous for their high technology. Companies in this category include the “big pharma” such as Merck or Novartis, and the engineering companies like pre-merger Hewlett-Packard, IBM, Pratt & Whitney, or Boeing.

These companies are also famous for their inability to get bank loans because their spending ratios are so unusual that banks correctly interpret their business as extremely risky.

Generally, such firms prosper only in markets whose customers have extreme needs, such as medicine, scientific instruments, safety-critical mechanisms (aircraft) or high technology military armaments. The extreme needs justify gross margins from 60% to 90% of revenues. That is, gross profits will be as much as 90% of the sales cost, with manufacturing costing only 10% of the product price. Most industrial companies get only 40% in revenues.

The high margins more than compensate for the high overhead of the expensive R&D organizations.

Generally, the largest technology companies not only have the largest technical staffs but also more skillfully extract value from them.

On a technical level, the organizations try to use every trick for repurposing and repackaging advanced technologies for multiple purposes and products. They often reuse advanced manufacturing processes, expensive safety certifications, specialized embedded software, computer-aided design software, electronic designs and mechanical subsystems.

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