Waegenaere et al. (2017) made a summary on the studies that investigate the impact of R&D cost capitalization. In the literature review part, they mentioned that, Tsoligkas and Tsalavoutas (2011) find that capitalized development expenditures are more highly valued than expensed research expenditures for a sample of UK firms between 2006 and 2008, following the adoption of IFRS in 2005. Ahmed and Falk (2006) find that capitalized R&D expenditures are positively associated with future earnings, whereas expensed expenditures show a negative association. Oswald and Zarowin (2007) find that the relation between current stock price and future earnings is stronger for capitalizing firms than for firms that expense R&D, suggesting that capitalization enables firms to communicate success and probable future benefits to the stock market Lev (2001, 95) argues that because operating expenses and investments in internally developed intangible assets are both expensed for financial reporting purposes, a firm has an incentive to reduce intangible investments below the level that would maximize firm value if the intangible investments were capitalized. Kanodia and Mukerji (1996) and Kanodia, Sapra, and Venugopalan (2004) illustrate this intuition formally. Consistent with this, Mohd (2005) shows that capitalization of software development costs decreases information asymmetry between a firm and its investors.

Required:

1. According to your opinion, should we capitalize the R&D costs or expense the costs? (4 marks)

*Hint: You dont need to worry about the current R&D accounting regulations. Your answers will be marked based on your argument procedures, rather than your conclusions. Your answers will be considered as good answers as long as you have made valid argument with strong evidence that support your opinion. To prepare your answer to this question, you first need to identify the reasons why companies may need to invest in research and development activities and define the R&D costs, and then make a thorough discussion on the possible factors that may support and against the capitalization and the expenses of the R&D cost. After that, your conclusion on this issue can be made.

2. Assume that you were a financial analyst that follow the internet industry. You recently noticed that a companys R&D cost capitalization percentage increased significantly over the recent years. Also, the company recently applied for public offering. What are your comments on this increased trend? Will you consider this as a positive sign, or a negative sign? Please specify the possible factors you should investigate to determine whether this trend should be considered as a positive or a negative sign. (5 marks)