Is R&D Included in SG&A on an Income Statement?
Understand how companies classify and report their spending on innovation and daily operations for accurate financial analysis.
Companies incur various costs to operate and expand. These expenditures are presented on financial statements to show a company’s financial performance. Understanding how these costs are classified and reported is important for stakeholders to assess a business’s efficiency and strategic investments. Financial statements, particularly the income statement, categorize these expenses to show how they impact profitability over a specific period. This presentation helps analyze a company’s operational health and resource allocation.
Understanding Research and Development (R&D) Expenses
Research and Development (R&D) expenses represent costs a company incurs to discover new knowledge or to create and significantly improve products, processes, or services. These activities are forward-looking, aiming to generate future economic benefits. Under U.S. Generally Accepted Accounting Principles (GAAP), R&D costs are generally expensed in the period they are incurred. This practice reflects the inherent uncertainty of whether R&D efforts will ultimately lead to commercially viable products or services.
Typical R&D costs include salaries for personnel directly engaged in research and development activities, the cost of materials and supplies consumed in experiments, and depreciation of equipment and facilities used for R&D. For instance, a pharmaceutical company’s spending on clinical trials for a new drug or a technology company’s investment in developing a new software feature would be classified as R&D. While U.S. GAAP mandates expensing most R&D costs as incurred, International Financial Reporting Standards (IFRS) differentiate between research and development phases. Under IFRS, research costs are expensed, but development costs can be capitalized as an intangible asset if specific criteria are met, such as technical feasibility and the ability to reliably measure the expenditure.
Understanding Selling, General, and Administrative (SG&A) Expenses
Selling, General, and Administrative (SG&A) expenses encompass the operating costs of a business that are not directly tied to the production of goods or services or to research and development activities. These costs are considered overhead, necessary for the overall functioning of the company. SG&A includes three main components covering distinct aspects of a company’s operations.
Selling expenses are those directly related to marketing, promoting, and distributing a company’s products or services. Examples include advertising campaigns, sales commissions paid to staff, and costs associated with shipping and delivery. General expenses cover the broader operational costs of the company, such as executive salaries, rent for administrative offices, utility bills for non-production facilities, and general office supplies. Administrative expenses are typically associated with the management and support functions of the business, including legal fees, accounting services, and the costs of running the human resources department.
How R&D and SG&A are Reported on Financial Statements
When presenting financial performance, companies generally report Research and Development (R&D) expenses and Selling, General, and Administrative (SG&A) expenses as distinct line items on their income statements. Under both U.S. GAAP and IFRS, R&D costs are typically not included within the SG&A category. This separation provides transparency, allowing stakeholders to differentiate between a company’s investment in future innovation and its operational overhead.
The rationale for separate reporting lies in the nature and purpose of these expenses. R&D is often viewed as an investment in a company’s future capabilities, reflecting its commitment to developing new technologies, products, or processes that can drive long-term growth and competitiveness. Conversely, SG&A expenses represent the ongoing costs of running the business, which are essential for current operations but do not necessarily generate future intellectual property or significant new revenue streams directly. By reporting these categories separately, investors and analysts gain a clearer understanding of how a company allocates its resources, assesses strategic priorities, evaluates operational efficiency, and gauges potential for future growth from R&D investments.