Where Is R&D on Financial Statements?

Research and Development (R&D) is a fundamental business activity involving the innovation and improvement of products, services, or processes. It systematically discovers new knowledge and applies research findings to create new or enhanced offerings. This investment in innovation is important for a company’s long-term growth, competitiveness, and value creation. Understanding how R&D activities are reflected in financial reports offers insights into a company’s commitment to its future.

R&D Expense on the Income Statement

For most companies operating under U.S. Generally Accepted Accounting Principles (GAAP), internal R&D costs are primarily recorded as expenses in the period they are incurred. This expensing approach is due to the inherent uncertainty surrounding future economic benefits from R&D activities. It is difficult to predict which R&D projects will ultimately succeed and generate revenue.

These R&D expenses appear on the income statement, categorized under “Operating Expenses,” “Selling, General, and Administrative (SG&A) Expenses,” or as a distinct “Research and Development Expense” line item. Costs included in R&D expense are salaries and benefits of researchers, materials used in experiments and prototype development, depreciation of equipment dedicated to R&D, and other direct overhead costs. Expensing R&D costs as they occur directly impacts a company’s current period net income and profitability metrics, as these costs reduce reported earnings in the year they are spent.

R&D Assets on the Balance Sheet

While internal R&D costs are generally expensed under GAAP, R&D-related items may be recognized as assets on the balance sheet in certain circumstances. A primary exception occurs with acquired R&D. When one company acquires another, the R&D assets of the acquired entity, such as in-process R&D projects, existing patents, or proprietary formulas, are recognized as intangible assets on the acquirer’s balance sheet at their fair value.

These acquired R&D assets are amortized over their estimated useful lives, meaning their cost is systematically allocated as an expense over the periods they are expected to provide economic benefits. This amortization expense impacts the income statement in future periods. In contrast, International Financial Reporting Standards (IFRS) allow for the capitalization of development costs (but not research costs) if certain criteria are met, such as technical feasibility and the intent to use or sell the asset. This can lead to “Development Costs” or “Intangible Assets” appearing on the balance sheet for companies reporting under IFRS, a distinction from GAAP’s general expensing rule for internally generated R&D.

R&D Activities on the Cash Flow Statement

The cash flow statement provides a different perspective on R&D spending, focusing on actual cash inflows and outflows regardless of their accounting treatment on the income statement or balance sheet. Cash spent on expensed R&D activities, the most common scenario, will be reflected as a cash outflow within the “Cash Flow from Operating Activities” section. This is because these expenditures are considered part of the routine operations of the business.

When a company purchases long-term assets specifically for R&D purposes, such as specialized laboratory equipment or dedicated R&D facilities, the cash outflow for these acquisitions is reported under “Cash Flow from Investing Activities.” Similarly, if a company makes a payment for an acquisition that includes R&D assets, this cash outlay would also be categorized within “Cash Flow from Investing Activities.” The cash flow statement offers insight into the actual cash committed to R&D, which can differ from the R&D expense reported on the income statement due to non-cash items like depreciation or amortization of previously capitalized R&D assets.

Additional R&D Information in Financial Disclosures

While the primary financial statements provide a summary of R&D activities, a more detailed understanding requires reviewing the supplementary information found in the footnotes, also known as the “Notes to the Financial Statements.” These disclosures offer transparency beyond the summarized line items. They include specific accounting policies applied to R&D costs, explaining how the company recognizes and measures these expenditures.

The notes may also provide breakdowns of R&D expenses by category, such as salaries, materials, or depreciation, offering a clearer picture of where the R&D budget is allocated. Information about acquired R&D intangible assets, including their fair value at acquisition, remaining useful life, and amortization schedule, can also be found here. These disclosures may include narrative discussions about the nature of a company’s R&D initiatives or its strategic focus on innovation. Reviewing these notes provides a complete understanding of a company’s investment in innovation and the specific accounting treatments applied.