FASB Tax Provision

The FASB's decision to expense rather than to capitalize research and development costs in the early 1970's touches on some very fundamental concepts of accounting.  The logic behind this decision, I believe, lies in the fact that during research and development, significant resources may be used for a product, a process or some other endeavor, but with an indeterminable outcome.  This research and development may or may not ever "bear fruit".  Conservatism tells us to always evaluate the possible negative consequences of any situation that would result in an inflated value of an asset.  This is why we use a lower of cost or market approach regarding the recording of an asset.  Capitalizing research and development costs would give the reader of the financial statements a false value of the assets of the company.  By doing this, we would basically be putting a "hope and a dream" on the books as an asset rather than the using the conservative priority of expensing these costs until they make a material contribution to the company.  Once again, in line with the accounting concepts of materiality as well as conservatism, the reader of the financial statements needs to know that the research and development costs are being expensed rather than capitalized. 

Although taxes may not be under the purview of FASB, the motivation to make decisions for the company based on tax savings may not interfere with GAAP's interpretation of the nature of the transaction.  In other words, some companies, before the standard was revised, may have been motivated by whether or not they want to show a higher net income by capitalizing research and development, or a lower net income by expensing the costs in order to avoid a higher taxable income.  A valid example of this topic can be found in all types of industries. Take the automobile industry, if you will.  Many research efforts, from fuel economy to comfort, safety and numerous other concerns, are constantly under development in order to make the product more attractive and efficient.  Some, such as air bags, turn into wonderful successes.  Other concepts may not prove to be effective and have to be "scrapped".  As the research and development costs are incurred for each of these, however, it is usually impossible to predict which will increase the value of the company’s product line.

The decision to update the rules on research and development nearly 40 years ago gives the investor better information for making decisions both from the uncertainty of research results as well as standardizing the way all companies report their research and development costs.