Direct Answer
Research and development (R&D) is spending directed at developing new products, technologies, or improving existing ones, reported as a line item within operating expenses on the income statement. Under US GAAP, R&D is generally expensed as incurred rather than capitalized, so it reduces reported earnings in the period it's spent even though it may generate future revenue. R&D intensity, R&D as a percentage of revenue, varies widely by industry and is commonly used to gauge how much a company is investing in future growth.
Key Takeaways
- R&D is disclosed as its own line within operating expenses on the income statement.
- Under US GAAP, R&D is generally expensed as incurred, not capitalized as an asset.
- Immediate expensing reduces net income in the period the spending occurs, even if the R&D pays off in later years.
- R&D intensity (R&D ÷ revenue) is commonly used to compare investment in future growth, but it varies widely by industry.
- Comparing R&D intensity only makes sense within the same industry, since accounting treatment and typical spending levels differ by sector.
What Is Research and Development (R&D)?
Research and development refers to the money a company spends trying to create new products, new technologies, or meaningful improvements to what it already sells. That can include scientific research, engineering work, prototype development, clinical trials, and software development that hasn't yet reached the stage of being sold or used internally in a way that qualifies for different accounting treatment.
On the income statement, R&D sits within operating expenses, typically below gross profit and alongside other operating costs such as selling, general and administrative expense (SG&A). It is not part of cost of revenue, and it is not a balance sheet asset in most cases, a distinction that matters for how R&D affects reported profitability.
How R&D Is Reported and Expensed
Under US GAAP, R&D is generally expensed as incurred rather than capitalized. In practice. That means when a company spends money on research and development in a given quarter or year, that full amount is subtracted from revenue in calculating operating income and net income for that same period, regardless of whether the research eventually leads to a successful product.
This contrasts with how a company treats, say, a factory or piece of equipment, which is capitalized as an asset on the balance sheet and then depreciated (expensed gradually) over its useful life. R&D generally does not get that treatment: the cost hits the income statement immediately, in full, in the period it's spent.
The practical effect is that a company investing heavily in R&D can show meaningfully lower reported earnings than an otherwise-similar company that spends less on R&D, even if the R&D spending is expected to generate valuable future products or revenue. The expense is real and immediate; the payoff, if any, shows up later and separately.
Worked Example
Hypothetical example, for education only. The figures below are illustrative and do not represent any real company.
Suppose a company reports the following for its most recent fiscal year:
| Income statement line | Amount |
|---|---|
| Revenue | $500 million |
| Cost of revenue | $200 million |
| Gross profit | $300 million |
| R&D expense | $60 million |
| SG&A expense | $140 million |
| Operating income | $100 million |
Here, R&D expense of $60 million is subtracted directly within operating expenses: $300 million gross profit minus $60 million R&D minus $140 million SG&A equals $100 million operating income. R&D intensity for this company is R&D expense divided by revenue: $60 million ÷ $500 million = 12%. That means 12 cents of every dollar of revenue was directed toward research and development in the period.
Why R&D Intensity Matters
R&D intensity, R&D expense as a percentage of revenue, is commonly used to gauge how much of a company's resources are going toward developing future products and technology rather than sustaining what it already sells. A rising R&D intensity over time can suggest a company is stepping up investment in innovation; a falling one can suggest the opposite, though it can also reflect that revenue is growing faster than R&D spending needs to.
Because R&D intensity varies widely by industry, it's typically most useful when comparing companies within the same sector rather than across unrelated ones. A software or pharmaceutical company's R&D-to-revenue ratio and an industrial manufacturer's ratio can differ substantially as a matter of how those industries normally operate, not necessarily as a signal that one company is better managed than the other.
Limitations and Common Mistakes
- Comparing R&D intensity across industries. Because typical R&D spending levels vary so widely by sector, comparing a technology company's R&D intensity directly against a retailer's or a utility's tells you little on its own.
- Treating a lower R&D expense as automatically better for earnings quality. Since R&D is expensed immediately rather than capitalized, a company that spends less on R&D will often show higher near-term earnings, but that isn't necessarily a sign of a stronger business, it may simply be investing less in future growth.
- Ignoring how immediate expensing affects period-to-period comparisons. A company that ramps up R&D spending sharply in one year will show a earnings hit in that same period, which can make year-over-year profitability comparisons misleading if the R&D increase isn't accounted for.
- Assuming all R&D-labeled costs are treated identically. Some development costs, particularly around internal-use software in certain circumstances, can be subject to different accounting treatment than R&D expensed as incurred; the specific facts of what was spent on matter.
Frequently Asked Questions
Is R&D an operating expense?
Yes. Research and development spending is reported as a line item within operating expenses on the income statement, alongside items like selling, general and administrative expense. It reduces operating income in the period it is recorded.
Is R&D expensed or capitalized under GAAP?
Under US GAAP, R&D is generally expensed as incurred rather than capitalized. That means the cost reduces reported earnings in the period the spending happens, even though the research may generate revenue in future periods.
What is R&D intensity?
R&D intensity is R&D expense divided by revenue, expressed as a percentage. It is commonly used to gauge how much of a company's sales it is reinvesting into developing new products, technologies, or improvements to existing ones.
Why does immediate expensing of R&D lower reported earnings?
Because the full R&D cost is subtracted from revenue in the year it is spent rather than spread out over the years the resulting product or technology might generate revenue, net income in that period is lower than it would be if the spending were capitalized and amortized over time.
Does a high R&D intensity mean a company is a better investment?
Not by itself. R&D intensity varies widely by industry, so a high figure in one sector may be normal while the same figure would be unusual in another. It is one input for gauging investment in future growth, not a standalone signal of investment quality.
Where can I find a company's R&D expense?
R&D expense is disclosed as its own line item within operating expenses on the income statement in a company's 10-K or 10-Q filings, which are available through SEC EDGAR.
How does the accounting treatment differ across reporting frameworks?
One framework requires research and development costs to be expensed as incurred with limited exceptions, while another permits capitalising development costs once specified criteria including technical feasibility are met. This means a company reporting under the second can show higher profit and an asset where an otherwise identical company shows neither. Cross-framework margin comparisons require adjusting for this.
What does capitalising research spending achieve in an analysis?
Treating it as an investment amortised over its useful life produces an adjusted profit and an adjusted capital base that reflect the economics of a research-intensive business more closely than immediate expensing. Several analytical frameworks do exactly this. The adjustment requires assumptions about useful life, and it makes the company comparable to a capital-intensive peer.
How should research spending be compared across companies?
As a percentage of revenue for companies at similar scale, and in absolute terms when scale differs substantially, since a large company spending a small percentage may still outspend a smaller one several times over. Absolute spending is what buys capability. Both comparisons are worth making because they answer different questions about commitment and capacity.
References
- SEC EDGAR: search public company 10-K and 10-Q filings to see how a company reports its R&D expense.
- SEC: How to Read a 10-K: investor guidance on locating and interpreting income statement line items, including operating expenses.
- FASB Accounting Standards Codification: ASC 730, Research and Development, governs the general requirement to expense R&D costs as incurred under US GAAP.