Executive Summary This thesis provides and analysis of the current accounting for research and development expenditures, including the tax treatment and their impact on the financial statements. The methods used to analyze this information include reviewing Generally Accepted Accounting Principles, States of Financial Accounting Standards, and the Internal Revenue Code. To better understand the topic, background information including definitions of key concepts, identification of stakeholders, and the perspectives presented in relation to the discussion of expensing or capitalizing R&D will be provided. My research targets the importance of encouraging R&D, whether or not expensing or capitalizing R&D would be preferred, and the effectiveness of the tax credit for increased research activities. The research found that investing in R&D is the key to economic growth and should be encourage. Whether or not R&D should be expensed or capitalized depends on the business, industry, and product life cycle. Lastly, the federal tax credit for increased research activities does provide enough incentive for businesses to continue investing in R&D. Based on the research conducted I recommend that businesses continue to invest in R&D and strive to be innovative so that businesses and the economy grow together. I would also recommend businesses find methods to calculate future economic benefits and useful life because there are obvious future benefits that are not recognized. My last recommendation is that those who utilize the tax credit need to be more aggressive with it and push for congress to make it permanent. This thesis recognizes the limitations of the research and that includes a lack of time due to my class schedule, classwork and work schedule. There was a lack of professionals with R&D experience, leaving a survey out as a method of gathering data. Finally, there was bias among those professionals with such knowledge due to nature of their positions. 2 Overview 2.1 Introduction 2.1.1 Accounting Treatment for Research and Development In today’s economy innovation is essential in the long-term success of any company. R&D is directly related to innovation, making it a huge topic for discussion including the accounting issues involved with R&D. In financial accounting an outlay that is expected to have future benefits is normally capitalized and amortized over the life of the asset under the accrual method. The argument that follows is that research and development should be capitalized because such expenditures certainly bring future economic benefits, however the problem is putting a value on those future benefits. Under Generally Accepted Accounting Principles (GAAP), research and development is treated as an expense instead of a capital investment. The reason is that there is not a system or process in place to predict those benefits (Merrit, n.d.). 2.1.2 Tax Treatment for Research and Development Expenditures As the tax code currently stands, research and development expenditures are treated as an expense that results in a tax benefit at the end of the taxable year for some taxpaying entities. A corporation may elect to deduct R&D expenses as a current business expense. Some of the research and experimental expenses may be deferred and amortized (IRC § 174). Costs that are subject to be amortized are those that were incurred in your trade or business and are not currently being deducted. There is also a federal tax credit specifically for research expenses incurred. There is a 20% tax credit for a certain amount of increased and qualified research expenses on form 6765. There are qualifications that must be met to receive this credit. The qualifications include expenses must meet the qualification as an expense under IRC section 174, the taxpayer has to be searching for additional knowledge that exceeds that of common knowledge, expenses must be used in developing new or improved business pieces, and a substantial amount of your research activities must be a part of the experimentation process (26 USC §174). Companies search for incentives to invest their capital into growth for their business. Investing in research and development gives some companies a huge incentive with the tax credit for increased research and development expenditures, as I referred to above. If a company increases their research and development spending significantly, the benefits are more than just a tax credit. A tax credit for a corporation means a decrease in tax expense, which actually increases the net income, making it much more attractive to current and potential investors. Current investors who want to invest more and potential investors are an asset that companies would like to keep and accumulate. The largest firms have the biggest advantage because of their size and power. Companies with more than 10,000 employees account for about fifty percent of all business R&D (Tyson & Linden, 2012). For some companies the