AASB138 : catalyst to changes in managerial decisions and reduced R&D spending?

The Australian accounting standard for research and development (R&D) effective from 1 January 2005 (AASB138) contains more stringent requirements regarding the capitalisation of R&D spending than its predecessor (AASB 1011). The majority of R&D spending now has to be expensed immediately. This affects earnings significantly. Investment in R&D is critical in maintaining competitive advantage and increases a firm’s probability of survival. However, prior research found companies sacrifice long-term value to smooth earnings and that managers cut R&D spending in response to target-driven earnings pressures. Sacrificing long-term value and returns in pursuit of short-term returns is referred to as short-termism. It is possible that AASB 138 could have discouraged managers to invest in R&D activities and that they may have chosen to reduce R&D spending as a means to manage earnings and meet expected profits. This study investigated these issues using financial data of 31 Australian listed firms for financial years from 2001 to 2010. A regression model was used to ascertain if short-termism affected R&D spending. Research intensity ratios were also calculated to determine trends in R&D spending. The study found a marked increase in the significance of short-termism in explaining changes in R&D of companies that capitalised R&D in accordance with AASB 1011. Furthermore, the the median research intensity ratio of companies that capitalised R&D under AASB 1011 declined almost three time that of companies that expensed R&D after the introduction of AASB 138. The study’s findings suggest that AASB138 could have been a catalyst to changes in managerial decisions in pursuit of short-termism that resulted in reduced R&D spending as a means to manage earnings.