R&D Accounting Discretion as an Income Smoothing Tool: An Empirical Analysis of German Listed Companies

Abstract

Capitalization of development costs is compulsory according to IFRS if a set of criteria is fulfilled. However, this obligation is considered as a de facto right for capitalization since the criteria are quite subjective, allowing for a certain degree of flexibility. Hence, the question arises whether managers use research and development (R&D) accounting to conduct earnings management in terms of income smoothing. Using a sample of German listed companies, the study conducts several regression analyses to test whether there is a negative relationship between R&D capitalization and different income smoothing proxies. Results show that the hypothesis is supported independent of the income smoothing proxy used. The study proofs that managers indeed use R&D capitalization judgments to conduct income smoothing.

Keywords: R&D capitalization; income smoothing; earnings management; R&D accounting; development costs.