Capitalization of R&D Costs and Earnings Management: Comparison of Russian and International Practices

Abstract

This Master thesis has a goal of identifying whether the decision of Russian firms to capitalize research and development costs is motivated by earnings management incentives, in particular by profit smoothing incentive and proximity to breaching debt covenants, and analyzing differences between practices in Russian and overseas firms. Both hypotheses are tested through regression model and statistical tools; based on the outcome the optimal accounting treatment of research and development costs as well as implications for investors and other stakeholders are suggested. The theoretical part of the work is based on reviewing existing studies advocating the optimal accounting treatment of research and development costs and on the studies analyzing earnings management with a mean of research and development costs. Empirical part tests based on the sample of Russian publicly listed companies whether the decision to capitalize research and development expenditures is motivated by earning-smoothing incentives and proximity to breaching debt covenants. The statistical analysis of the sample as well as regression analysis is run in order to test correlation between factors. The differences between Russian and international earnings management practices in the field of R&D expenses are analyzed and explained. Finally, the set of recommendations for optimal accounting treatment of research and development costs as well as implications for investors and other stakeholders are suggested.