R&D Costs in EBITDA: Treatment and Adjustment

Research and development costs create some of the most nuanced accounting judgments in financial due diligence. How they are classified — expensed through the P&L or capitalised on the balance sheet — has a direct and significant impact on reported EBITDA, and inconsistent treatment across periods can make earnings appear more or less stable than they really are.

The Accounting Framework

Under IAS 38, research costs must be expensed as incurred, while development costs may be capitalised if specific criteria are met:

Technical feasibility of completing the asset
Intention to complete and use or sell the asset
Ability to use or sell the asset
How the asset will generate future economic benefits
Availability of adequate resources to complete development
Ability to reliably measure expenditure

In practice, the boundary between research and development — and between development costs that meet the IAS 38 criteria and those that do not — involves significant judgment. Different companies apply the threshold very differently, even within the same industry.

Under US GAAP (ASC 730), all R&D costs are generally expensed as incurred, which creates a systematic difference between IFRS and US GAAP comparisons.

Impact on EBITDA

Whether R&D costs are expensed or capitalised has a direct impact on reported EBITDA:

Expensed R&D reduces EBITDA in the period incurred.
Capitalised development costs do not hit EBITDA in the period of spend; instead, they sit on the balance sheet and are amortised over the useful life of the resulting asset. The amortisation charge falls below EBITDA (in D&A).

A company that capitalises more R&D than its peers will report a higher EBITDA, all else equal. This is not necessarily improper, but it must be understood when making cross-company comparisons or assessing run-rate earnings.

FDD Analysis of R&D

Understand the Policy

Request and review the company's R&D accounting policy. Understand:

What proportion of total R&D spend is capitalised versus expensed
Whether the policy has changed during the review period
What the capitalisation criteria are and how robustly they are applied

A policy change that increases capitalisation rates between periods will inflate EBITDA trends. This is a red flag for earnings quality.

Review the Capitalised Development Cost Balance

Look at the balance sheet and P&L together:

Is the capitalised balance growing? This may indicate ongoing investment, but it could also indicate failure to amortise or derecognise stale projects.
Are impairments being taken? Write-offs of capitalised R&D suggest that the original capitalisation criteria were not genuinely met.
What is the amortisation period? A very long useful life assumption defers the earnings impact of failed projects.

Consider Consistency of Treatment

In businesses with a mix of product development cycles, some projects may be at early research stage and others at late development stage. If the company has reclassified projects or changed their stage assessment, EBITDA may not be comparable across periods.

Normalisation Considerations

In some cases, FDD teams present an EBITDA figure that adds back all capitalised R&D amortisation and subtracts total R&D spend (effectively putting all R&D costs on a cash/expensed basis). This produces a more conservative view of underlying earnings and is used when capitalisation policies are aggressive or inconsistent.

Why This Matters for Technology and Life Sciences

In software, biotech, pharmaceutical, and clean technology businesses, R&D can represent a very large proportion of total costs. The difference between a capitalising and an expensing business can be 5 to 15 percentage points of EBITDA margin. Buyers need to understand this before applying a multiple.

Accounting policy analysis — including R&D treatment — is part of a rigorous QoE review. Our programme includes 8+ realistic case studies and 150+ EBITDA adjustment examples to build that analytical depth. Full access for €119.99.