Is Research and Development an Operating Expense?

Is research and development an operating expense? Or is it a crucial part of your business? To know the real answer, this article will help you. So, read on.

Is Research and Development an Operating Expense?

To begin, let us define what research and development or R&D is. R&D is a broad term used to describe a company’s efforts to improve its products or services through the use of new or existing technologies. R&D is a vital process in the development of new products and services.

In simple terms, R&D is an investment in the future, an investment that should yield increasing returns over time. This article will help you identify whether R&D is an operating expense or not.

Let us assume that a company has received an order from a customer to develop a new product. The project is approved and work begins on the new product. At this point, R&D costs are incurred but they are not yet expensed because the product has not been completed and delivered to the customer. Let us take a closer look below.

Research and Development as an Operating Expense

Expenses incurred by a company during this stage are considered research and development expenses. These expenses can include salaries paid to employees, material costs incurred in developing the product, prototypes built for testing, etc.

The above-mentioned expenses can be further classified into direct and indirect expenses as follows:

• Direct R&D expenses. Any expenses incurred directly on research and development projects are called direct research and development costs. For example, a company hires a software development firm to develop its new software. Then, that amount paid to the software development firm will be considered as the direct R&D expense of the company. 
• Indirect R&D expenses. Indirect R&D expenses are those which cannot be traced back to any specific project but are still essential for carrying out the R&D functions of a company. Further, it can also be called overhead or administrative expense as it does not contribute directly to the cost of creating a new product. But it is still essential for carrying out the research and development functions of a company. Examples of indirect R&D costs include rent paid for buildings used by all departments including the R&D department. Or salaries paid to employees working in other departments but who also contribute indirectly to R&D work carried out by the company.

Why Is R&D Important?

Why, then, is the R&D department important? This is because it helps the company to be competitive. For example, a company that develops new products, processes, or services quicker than its competitors will have a significant advantage over them. This is because it would be able to get an edge over its competitors due to the time advantage it has.

Also, a company that constantly invests in new product development can fend off competition and earn high profits. Competition is intense in today’s business environment. A company that consistently develops new products, processes, or services and markets them successfully will have an edge over its competitors. So, R&D helps a company to be competitive.