Treatment of Leases the Current Essay

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The U.S. law regarding research and development is problematic because it does not view such R&D as an asset. Yet, the money spent on R&D, in particular during the development stage, functions as an asset does. The investment is made in the early years, with the economic payoff coming later. If the R&D was a physical asset with these characteristics, it could be capitalized. Thus, the inability of American companies to do this represents a distortion in the financial statements -- the investor would benefit if all investments leading to specific payoffs could be treated the same (amortized).

In order to rectify the situation with respect to research and development, GAAP should move towards the international standard. Current U.S. law is a hodge-podge of different rules, which not only lacks clarity but also creates the aforementioned distortion. The move towards the international standard would allow the accounting professional and U.S. companies to reasonably determine a cutoff point where investment in research ceases to be broad (rightly classed as an expense) and begins to be an asset (wherein development costs are amortized).

Ideally, the move towards the international standard would be part of a greater shift towards better recognition of intangible assets on the balance sheet.

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Research and development that leads to intellectual property differs little to the investor from investment in physical assets. They both represent the same thing -- money spent that will generate future revenues. As such, investors would benefit from consistency in the treatment of such assets, be they tangible or intangible. Development costs in particular should be amortized, and the cutoff between research and development can be set at an appropriate point in the product life cycle process.

The tax treatment of both operating leases and of R&D has resulted in inconsistency in financial statements. Both of these inconsistencies derive from treatments that are based more on conceptual differentiation than on functional differentiation. An operating lease is, in concept, different from a liability but it functions the same. Likewise, R&D is conceptually different from a tangible asset but it serves the same basic function. For greater clarity in reporting, both of these issues should be resolved by eliminating the disparities embedded in the current accounting treatment.

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