Accrual vs Amortization
What's better for the bottom line? Expense accruals or Amortization. What is the difference between two and how it impacts the P&L?
Thanks!
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Are you trying to decide whether or not to expense R&D or amortize the cost to develop? Do you have a specific hypothetical situation?
Yes. I am trying to decide whether or not to amortize or accrue the expense this year?
I like to see it amortized, because it smooths earnings
suppose your company offers an enterprise software solution and every ~seven years undergoes a re-write. Although there will probably be annual updates to the software and expenses incurred for such updates, the cyclical nature of R&D related to the re-write would cause earnings to whipsaw if such R&D were to be expensed. By amortizing the R&D, the investment is recognized throughout the life of the software.
Does that make sense?
No I'm still a little fuzzy. Can you talk in contract terms? If there is a change to payment schedule in the contract and the expenses are pushed into second half of the new year. Why would beginning to amortize these expenses be better than continuing to accrue?
Let's be clear, what exactly are you debating on expensing or amortizing?
You cannot amortize expenses, you amortize intangibles just like you depreciate PPE. If you book R&D below the line as an investment, then you would have to book an intangible prior to amortizing. This smooths earnings by recognizing the investment over the amortization period, rather than expensing in the single period it occurred.
Instead of expensing I can depreciate my expense though? Forget about amortization. How does depreciating expense impact earnings?
No, don't forget amortization.
Depreciation is the re-valuing of an asset (tangible asset) throughout it's useful life. Amortization is a similar concept for your intangibles.
Maybe an alternative example can prove more illustrating, and troy1 please interject if I do not understand you correctly:
You have an expense, say $1,000,000, and the expense is related to a one year contract. You are concerned that recording the $1MM as an expense will distort your earnings going forward. You would rather want to recognize this expense over time, say equally each fiscal quarter. Since the contract makes you recognize the $1MM upfront (aka prepaid) you can hold that on your balance sheet (offsetting cash) and then move it over to your P&L each quarter until the $1MM is exhausted...it works similarly to D&A.
Under GAAP there are very few cases when R&D can be capitalized and then amortized down. Almost always firms are required to expense them immediately.
IFRS standards are more lenient about capitalizing development costs, but research costs still must be expensed.
This doesn't relate to your posts Brosef, just wanted to make this clear for others reading.
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