| Generally Accepted Accounting Principles (GAAP) limit managers' discretion in capitalizing expenditures that give rise to intangible assets. SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or otherwise Marketed, requires firms to capitalize computer software development expenditures (hereafter, SD expenditures) once a product reaches technological feasibility. In practice, some firms choose to expense all SD expenditures, while other firms opt to capitalize at least some of their SD expenditures. I exploit variation in the expense/capitalization decision to explore my research question. If a manager has no information or acts opportunistically in her capitalization decision, the amounts capitalized and subsequently amortized should provide little or no information regarding future cash flows. However, if a manager bases her capitalization decision on private information about the future benefits the software is expected to generate, then I anticipate observing a positive relation between the capitalized asset and future cash flows. My findings suggest that managers' capitalization policies convey at least some information about the intangible assets' future benefits. I find a positive and significant association between capitalized SD expenditures and future cash flows. Further, the amortization schedule managers provide in the footnotes of their financial statements is also informative as the association between capitalized SD expenditures and future cash flows differs with the length of the stated amortization period. The positive relationship between future cash flows and SD expenditures is stronger when incentives to convey private information are higher, however lower when incentives to act opportunistically are greater Finally, results suggest that firms that expense all SD expenditures opt not to capitalize SD expenditures for products that have reached technological feasibility. These findings have implications for standard setters, auditors, financial statement preparers, and investors as firms begin to adopt International Financial Reporting Standards (IFRS) in 2010. A move to IFRS will expand managers' opportunities to capitalize R&D expenditures. |
