Accounting practices can get in the way of delivering value

1st June 2007
Simon Baker

R&D expenditure can expensed or capitalised. When it’s expensed, the total expenditure is declared as expense in the current period, reducing current profits by that amount. When it’s capitalised, part of the expenditure is declared as expense in the current period and part is declared as expense in future periods, increasing current profits and reducing future profits. Capitalisation can provide a signal to investors about future benefits of current R&D projects, whereas expensing can reveal strategic information about R&D to competitors. I’m not an accountant and I admit there’s much more to this than I currently understand, but I’m wondering if the motivation to use capitalisation is to give the perception of greater current profits. Is this short-termism?

“Short-termism refers to the excessive focus of some corporate leaders, investors, and analysts on short-term, quarterly earnings and a lack of attention to the strategy, fundamentals, and conventional approaches to long-term value creation. An excessive short-term focus combined with insufficient regard for long-term strategy can tip the balance in value-destructive ways for market participants, undermine the market’s credibility, and discourage long-term value creation and investment. Such short-term strategies are often based on accounting-driven metrics that are not fully reflective of the complexities of corporate management and investment.” – Breaking the Short-Term Cycle: Proceedings of the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics Symposium Series on Short-Termism. (Via Slow Leadership)


There’s something here that resonates with me: Excessive focus on the short-term combined with insufficient regard for long-term strategy and value creation can actually begin destroying value. There does seem to be a tendency to view accounting measurements as reality and not accounting conventions.

There’s got to be something wrong when the financing process for projects is so focused on capitalisation of R&D that it actually degrades a project’s ability to create value and generate profit by delivering product to customers quickly and repeatedly. Isn’t this an implicit acknowledgement by the organisation that it expects the project to fail, by being late and over budget? Isn’t this approach largely about damage limitation? I don’t call that being set up for success. You’re beaten before you start.

If a process to support capitalisation adds significant waste in the form of an inventory of every conceivable requirement (detailed up front and captured within huge specification documents), it has got to be partly responsible for the failure. Hasn’t it? And when the process gets in the way of generating sales revenue the alarm bells must be ringing. Right? If it were my money I’d want it spent on creating working software and getting it to the market pronto. Capitalisation is important but it should never be as important as getting product to customers. Only when you deliver functionality that customers want can you secure their loyalty and continued custom, and make money.

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