Research and Development Costs

Prior to 1974, most companies that elected to expense their research and development costs were usually larger companies; conversely, smaller companies tended to capitalize them.  I believe this trend existed for several reasons.  First, by expensing research and development costs, the result is a lower net income, a lower taxable income, and payment of lower taxes than if the expenses had been capitalized.  On the other hand, capitalizing research and development costs results in higher total assets, higher net income, and higher taxable income.  By using this method, small companies would pay a higher tax, but show a better performance.  For larger, well established companies, the changing of the bottom line is much more palatable for the investor than would be the case with smaller less established companies.  Very often smaller companies are growing and are trying to attract new investors or perhaps borrow money from a bank.  In these situations, it favors the smaller company to capitalize research and development costs.  Although income taxes may be higher, the small company will show a larger net income from not having deducted the expenses to arrive at operating income.  In addition, small companies also would have the benefit of showing more assets, as discussed earlier.  A project under development, however, would be an asset that could disappear should the idea on which it is based be considered to be fruitless or non-effective.  Larger, more established companies can often support net income differences because of their size and strength and even reputation.  The smaller, less established companies are fighting for every nickel of the bottom line to support the company and reputation.  This would be especially true if the research and development being undertaken was critical to the continued and ongoing success of the company. 
The option to capitalize no longer exists for research and development costs, for the reasons discussed in part 1, therefore all companies are on an even playing field.  Expensing all research and development costs means that we don't have investors making decisions on a “wing and a prayer”, or based on a potential unfulfilled concept, practice, or notion.