What do new medicines, faster computers and tastier ice cream flavors have in common? They’re all products of smart people throwing big ideas against the wall not only to see what sticks, but also to figure out how to make ideas become reality. In other words, these products wouldn’t exist without research and development (R&D).

But navigating R&D is daunting. Despite the potentially rewarding opportunities for both business and society at large, R&D is rife with challenges and risks. The pressure to innovate and succeed is immense, often requiring significant financial investments with no guarantee of a return. For businesses looking to optimize their R&D efforts, here’s a rundown of what R&D is, how it works, ways to secure funding and, importantly, a high-level look at how to manage the complex world of R&D accounting.

What Is Research and Development (R&D)?

R&D refers to the innovative activities businesses and other organizations engage in to create new offerings or enhance existing ones. At its core, it involves dedicating time and resources to advancing knowledge, as well as generating novel ideas, products and methods or refining those that already exist. Though common in the business world, R&D isn’t only about the pursuit of commercial gain; it also serves a key role in advancing science, addressing societal challenges and fostering innovation across a wide range of contexts. But in any field, R&D requires a blend of curiosity, strategic investment and a commitment to pushing the boundaries of what’s possible.

There are three main types — or phases — of R&D: basic research, applied research and development. Basic research, the initial phase, focuses on generating new knowledge. Applied research then puts the theoretical insights of basic research into practical applications. Lastly, in development, insights from basic and applied research are transformed into tangible products, services or processes, often through prototyping and testing.

Key Takeaways

  • R&D is crucial for driving innovation, growth and competitive advantage, but it comes with significant costs, risks and challenges that organizations must carefully navigate.
  • The three main types of R&D are basic research, applied research and development. Each plays a distinct role in the innovation process.
  • Effective management of the R&D life cycle, from idea generation to commercialization, is key to a successful endeavor.
  • Government grants, corporate investment, private equity and venture capital are core funding sources for R&D.
  • Proper R&D accounting is critical for financial reporting, tax planning and strategic decision-making. Accounting software can make this easier.

Research and Development (R&D) Explained

In a business context, R&D is a strategic investment aimed at driving innovation, growth and competitive advantage. Companies across various industries allocate significant resources to R&D to develop new products, improve existing offerings, discover cost-effective and sustainable production methods and explore emerging technologies. The specific focus of R&D efforts and the associated level of required investment vary depending on the sector. As of 2022, hardware technology production, software production and the health sector led the charge in terms of R&D expenditure, likely due to these industries’ intense need to constantly innovate.

Of course, R&D isn’t limited to the corporate world. It also plays a vital role in academic and scientific research, where the primary goal is to expand the boundaries of knowledge and understanding. In these contexts, R&D is often driven by curiosity and the desire to solve complex problems, with less emphasis on immediate commercial applications. Governments and nonprofit organizations also engage in R&D to address societal challenges, improve public services and advance fields such as healthcare, energy and environmental sustainability.

Regardless of the sector, R&D is characterized by its systematic approach to inquiry and problem-solving. It involves defining clear ideas; carefully assessing feasibility; prototyping and testing; analyzing results; and ultimately bringing products and services to the public. While this structured approach helps ensure that R&D efforts are focused, efficient and yield meaningful outcomes, the process is inherently uncertain with no guarantee of success. Failure is a common occurrence in R&D, but it’s seen as a necessary step in the journey toward breakthrough innovations.

5 Core Criteria of Research and Development

The National Science Foundation (NSF) defines five key characteristics that distinguish R&D from other types of scientific and engineering work. These criteria — novel, creative, uncertain, systematic and transferable/reproducible — apply broadly to R&D activities across various sectors, including academia, government and business.

  1. Novel: The pursuit of novelty (something new and not resembling something formerly known or used) is a fundamental driver of R&D efforts across all fields. In other words, R&D should aim to pursue new knowledge or apply existing knowledge in innovative ways to develop original concepts.
  2. Creative: Creativity and ingenuity are essential components of R&D. Whether developing cutting-edge technologies, designing innovative products or solving complex scientific problems, R&D professionals must think outside the box and explore unconventional approaches.
  3. Uncertain: Per the NSF’s guidelines, R&D projects generally should involve a degree of uncertainty regarding outcomes, methods or timelines. This uncertainty can stem from not knowing whether the desired result is achievable, how to achieve it or how long it will take. Navigating this uncertainty requires a willingness to take calculated risks, learn from failures and adapt strategies as needed.
  4. Systematic: R&D should follow a structured approach based on scientific methods and principles. This systematic process involves defining objectives, formulating hypotheses, designing experiments, collecting data and analyzing results to draw meaningful conclusions. The overall process also typically involves a review of existing knowledge, experimentation and an analysis of what it’ll take to achieve the project’s goals.
  5. Transferable and/or reproducible: The knowledge, techniques or innovations generated through R&D should be transferable or reproducible by other researchers or organizations. This facilitates collaboration, allows for validation of results and enables the broader application of R&D outcomes. Note that competitive businesses can strategically manage this process to protect their intellectual property; it’s possible to share outcomes in ways that demonstrate value without compromising competitive advantage, such as patenting before publishing or disclosing only high-level findings without revealing underlying data or methodologies.

    6. Types of R&D

    R&D activities can be categorized into three main types: basic research, applied research and development. Each type plays a distinct role in the innovation process, from expanding the boundaries of knowledge to creating practical applications and commercially viable products or services. Organizations may engage in one, two or all three types of R&D, depending on their specific goals, industry and available resources.

    • Basic Research

      Basic research, also known as fundamental or pure research, is driven by curiosity and the desire to expand knowledge in a particular field without a specific application in mind. This type of research aims to understand the underlying principles, phenomena and theories that govern the natural world. Basic research often takes place in universities, research institutes and government laboratories, where scientists have the freedom to pursue questions that may not have immediate practical implications. For example, basic research could involve astrophysicists’ trying to understand the universe’s workings.

      That said, some companies also invest in basic research to stay at the forefront of their industries and identify potential long-term opportunities. Basic research can help businesses build a strong foundation of knowledge that can later be applied to develop groundbreaking technologies, products or processes that lead to a competitive edge. A business might conduct research into the psychology of consumer behavior without directly aiming to develop a specific marketing campaign, for instance. However, not all organizations have the resources or risk tolerance to conduct extensive basic research and may instead lean on basic research conducted by other sources.

    • Applied Research

      Applied research builds upon the findings of basic research to solve specific, practical problems or develop new technologies, products or processes. This type of research is more focused and goal-oriented than basic research because it seeks to address real-world challenges, create tangible benefits for society, benefit businesses or boost the economy. Applied research is commonly conducted by businesses, as well as government agencies and specialized research centers. These organizations might work in collaboration with academic institutions that not only have expertise in the area of focus, but the necessary labs, libraries and equipment to support the practical aspects of applied research projects. The outcomes of applied research can lead to the development of new products, services or technologies that have a direct impact on society and the economy.

      Unlike basic research, applied research aims to develop direct means to an end. For businesses, this can be a path to commercialization. With well-defined objectives and timelines in place, applied research can be used to create a roadmap that will help a company generate tangible results within a reasonable time frame.

      By leveraging the insights gained from basic research and applying them to specific industry challenges, companies can develop innovative solutions that differentiate themselves from competitors by meeting the evolving needs of their customers — or even predicting needs before customers are aware of them. Businesses might use applied research to develop new materials with specific properties, create more efficient manufacturing processes or find ways to improve the effectiveness of medical treatments, for example.

    • Development

      Development is the final stage of the R&D process, where the insights and innovations generated through basic and applied research are transformed into concrete end results. This phase involves the design, prototyping, testing and refinement of new offerings to ensure that they meet the desired specifications, performance criteria and user needs. Examples include a user-friendly mobile app that allows customers to make secure payments, sustainable packaging solutions to reduce environmental impact and AI-based inventory systems that predict stock levels and automate ordering.

      Companies able to engage in all three types of R&D are positioned to create a robust innovation pipeline that consistently delivers value to customers and stakeholders. Alternatively, companies might choose to focus on development while partnering with external research institutions or acquiring startups that have already conducted the necessary basic and applied research.

    The R&D Life Cycle

    The R&D life cycle captures the entire innovation journey, from ideation to commercialization. Understanding each stage — and how they all fit together — can help organizations optimize their R&D efforts to develop new and improved offerings and, in turn, stay competitive. Despite being laid out in five chronological steps, note that it’s not always a fully linear process. The R&D life cycle often involves iterations where insights from later stages inform adjustments in earlier phases, while unforeseen challenges can necessitate revisiting previous work. Flexibility and adaptability are key.

    R&D life cycle
    The R&D life cycle captures the entire innovation journey, from ideation to commercialization.

    1. Idea Generation

      Ideation is the first step of the R&D life cycle. This is where the seeds of innovation are planted, and the groundwork for future products, services or processes is laid. At this point, ideas can also be generated without the immediate concern for practical application, focusing instead on what could be possible or what fundamental questions have yet to be answered.

      Ideas can originate from a variety of sources, including market research, customer feedback, technological advancements, competitive analysis and external collaborations, such as partnerships with academic institutions, joint ventures with research consortia or interactions with industry think tanks. Even a single individual’s novel “lightbulb moment” can spawn an idea worth pursuing. By staying attuned to these sources, businesses can identify opportunities for innovation and develop ideas that address unmet needs or improve upon existing offerings.

      To maximize the potential of idea generation, it’s important to cultivate a creative environment that encourages free thought exchange and brainstorming sessions. This can involve bringing together diverse perspectives from different departments, as well as creating a safe space for employees to share their ideas without fear of judgment. Once a pool of ideas has been generated, organizations should evaluate them based on factors such as alignment with company strategy. This initial screening can help prioritize the most promising ideas for further development in the next stages of the R&D life cycle.

    2. Feasibility Analysis

      After an idea is formed, it’s time to assess its feasibility. This stage involves a deep dive into an R&D project’s technical possibilities, potential market impact and financial requirements.

      On the technical front, the feasibility analysis should assess whether the idea can be practically implemented given the available technology, resources and expertise. This might involve preliminary research to better understand underlying technical hurdles that need to be overcome.

      From a market perspective, the feasibility analysis seeks to validate whether there’s a genuine need or demand for the proposed idea, product or service. This often requires conducting market surveys, analyzing competitors’ offerings and assessing the potential market size and growth prospects.

      Financially, the feasibility analysis aims to determine whether the idea makes economic sense. Here, a company would conduct initial cost estimates, project potential revenue streams and calculate the expected return on investment (ROI).

      Additionally, this stage should include preliminary patent searches to identify any existing intellectual property that could affect the development of the idea and prevent infringement on others’ patents. It’s also a good idea to consider the regulatory landscape that the product, service or process would need to navigate. This ensures that the project is designed with compliance in mind, potentially saving the business from costly legal challenges and redesigns down the road.

      By carefully evaluating the technical, market and financial aspects, feasibility analysis provides a solid foundation for deciding whether to proceed with an idea or pivot to alternative options. It helps businesses make informed decisions and allocate resources effectively in subsequent stages of the R&D life cycle.

    3. Prototype Development

      Once an idea is deemed feasible, the next stage in the R&D life cycle is to transform the concept into a tangible prototype. This is where the theoretical becomes practical.

      Prototype development involves creating a working model or simulation of the proposed product, service or process. This stage generally requires a cross-functional effort that brings together experts from various departments, including design, engineering and manufacturing. The first step is to create detailed designs and specifications, taking into account the insights gained from the feasibility analysis. This may involve selecting appropriate materials, technologies and production methods that align with the project’s goals and constraints.

      Once the designs are finalized, the actual construction of the prototype begins. This is an iterative process, where the initial prototype is tested, evaluated and refined based on feedback from stakeholders and potential users. The goal is to create a functional prototype that demonstrates the key features and benefits of the proposed solution. Rapid prototyping technologies, such as 3D printing and computer modeling, can speed up the development process and enable quick design iterations, significantly reducing time and costs while encouraging innovation.

      Throughout the prototype development stage, it’s essential to remain flexible and adaptable, as unforeseen challenges may arise that require creative problem-solving. By the end of this stage, the team should have a working prototype that’s ready for more rigorous testing and validation in the next phase of the R&D life cycle.

    4. Testing

      With a working prototype in hand, the next critical stage is testing and validation. This is where the prototype goes through broader, more rigorous testing to make sure it meets desired specifications, performance criteria and user requirements.

      The testing phase usually involves a series of structured evaluations designed to assess various aspects of the prototype. This can include functionality tests to verify that the product or service works as intended, usability tests to gauge how easily users can interact with it and durability tests to ensure it can withstand real-world conditions. Depending on the nature of the innovation, testing may also involve compliance with industry standards, safety regulations and environmental guidelines. It’s during this phase that R&D teams are likely to come across issues or challenges that weren’t apparent during the design and development stages.

      Throughout testing, collecting detailed data and feedback is crucial for identifying areas for improvement. This information guides structured feedback loops that enable iterative refinements to align the prototype more closely with user needs and project goals.

      Depending on testing results, the prototype may need to undergo further refinements and modifications. Often, this will take teams back to the development phase, and, in some cases, all the way back to the drawing board: idea generation. Only when the prototype has successfully passed all the necessary tests and validations is it ready to move on to the final stage of the R&D life cycle.

    5. Commercialization

      After a prototype has successfully passed through the testing phase, it’s time to bring it to market via commercialization. This is the final — and in some ways most critical — stage of the R&D life cycle, where all the hard work and innovation are translated into tangible value for the organization and its customers. Commercialization involves a wide range of activities, from developing a go-to-market strategy and setting pricing, to establishing distribution channels and launching marketing campaigns. Given the moving parts involved, the process requires close collaboration among R&D, marketing, sales and other core teams within the company.

      One of the first steps of commercialization is to define the target market and determine the new offering’s positioning. Businesses need to thoroughly understand the competitive landscape and their unique value proposition to craft a compelling brand message. Based on this, the team can develop a comprehensive launch plan that includes pricing strategies, promotional activities and sales targets. At this point, it’s also important to ensure intellectual property protections through patents, trademarks and copyrights.

      As the product or service is rolled out, it’s essential to closely monitor its performance. This includes tracking sales figures, gathering customer feedback and analyzing market trends. Based on these insights, the organization may need to make adjustments to its strategy, such as refining the messaging, optimizing pricing, expanding into new market segments or, if things aren’t going so well, possibly going back to the prototyping phase — though this can be costly and may be avoided if the R&D team conducted thorough feasibility analyses, prototyping and testing.

      Successful commercialization also requires ongoing support and continuous improvement. This could include providing customer training and support, addressing any issues or defects that arise and gathering ideas for future enhancements or iterations. By maintaining a strong focus on customer needs and market dynamics, companies can ensure that their R&D investments translate into long-term commercial success.

    Advantages of R&D

    Investing in R&D can offer a wide range of benefits for businesses, the economy and society as a whole. From driving innovation and competitiveness to fostering sustainable growth, here are a few key advantages of investing in R&D.

    • Innovation and competitive advantage: R&D allows companies to develop groundbreaking products, services and technologies that give them a competitive advantage in the market. This innovation plays a key role in a business’s ability to differentiate itself in the market, respond to changing consumer demands and edge out competition.
    • Market expansion: Through the development of new products and services, R&D enables companies to cater to untapped market segments or expand into new geographic regions. These new products or services, made possible through R&D, support a company’s ability to grow its customer base and unlock new revenue streams.
    • Efficiency and productivity: Advancements in technology and processes driven by R&D can significantly enhance operational efficiency and productivity. From automating tasks to optimizing resource use, the end results of R&D can greatly help companies streamline their operations and achieve cost savings. For example, advances in automation and manufacturing technologies can enhance production efficiency, allowing businesses to produce more with fewer resources.
    • Economic growth: R&D investments tend to have a ripple effect on the economy; the release of novel ideas can stimulate the emergence of new industries while enhancing the competitiveness of existing ones. This innovation-led growth creates job opportunities, boosts exports and drives overall economic prosperity. One 2022 study found that public investments in R&D are crucial for boosting a country’s innovation capabilities, encouraging private-sector R&D investment and contributing to economic growth both immediately and in the long term.
    • Societal benefits: R&D in critical areas, such as healthcare, clean energy and environmental conservation, can lead to breakthrough solutions that address pressing global challenges and improve people’s lives. From developing life-saving medicines to creating sustainable technologies, R&D has the power to positively impact quality of life and well-being.
    • Long-term sustainability: Investing in R&D helps organizations adapt to changing market conditions, customer preferences, technological landscapes and regulatory environments. By using R&D to continuously innovate and improve offerings, businesses can stay relevant and maintain their competitive edge by capitalizing on emerging opportunities. This, in turn, can safeguard long-term sustainability in an ever-evolving business environment.
    • Knowledge expansion: R&D activities contribute to the expansion of knowledge within organizations and society as a whole. Through research and experimentation, R&D teams generate new insights, understanding and expertise that can be applied to future projects and shared with the broader scientific and business communities. This continuous learning and knowledge-sharing fuels further innovation and progress.

    Risks of R&D

    While R&D offers numerous benefits, it also presents various risks and challenges, including financial uncertainty, technical complexity and market unpredictability. Risks include:

    • Financial risk: Put simply, R&D comes with high costs, and it’s never certain if or when that significant investment will yield returns. Companies must carefully manage their R&D budgets and be prepared for the possibility that some projects may not yield commercially viable results. The reality is that high R&D costs can strain financial resources and impact overall profitability.
    • Technical risk: Even with the most thorough planning and expertise, R&D projects can have complex technical challenges and uncertainties. There’s always a risk that technical hurdles may prove insurmountable, leading to project delays, cost overruns or even failure — at the end of the day, the idea just may not be feasible. Navigating technical complexities requires a willingness to adapt, troubleshoot and make tough decisions when necessary.
    • Market risk: There’s no guarantee that a new product or service will be embraced by the market, even if an R&D project is technically successful. Changing consumer preferences, the competitive landscape and market timing can all impact the commercial success of an R&D initiative. Companies must carefully assess market demand, anticipate trends and be ready to pivot if needed.
    • Regulatory and compliance risk: Depending on the industry and nature of the R&D project, there may be significant regulatory and compliance risks to consider. R&D activities in healthcare, energy, pharmaceuticals and telecommunications, for instance, are particularly susceptible. Failing to meet regulatory requirements, obtain necessary approvals or adhere to industry standards can result in costly delays, penalties or project termination. Staying abreast of evolving regulations and ensuring compliance are imperative.
    • Intellectual property (IP) risk: Protecting the IP generated through R&D is essential to maintain competitive advantage and prevent others from copying or infringing upon the company’s innovations. However, the process of securing patents, trademarks and copyrights can be complex, time-consuming and expensive. There’s also the risk of IP disputes or challenges from competitors. Balancing the need to protect IP through patents (which requires public disclosure) and maintaining trade secrets can be challenging and risky.
    • Operational risk: Without impeccable project management capabilities, even the most promising R&D projects can strain an organization’s resources and divert attention and funds from core operations. For instance, the time from research to market can be lengthy, especially in industries like pharmaceuticals, where products must undergo rigorous testing and approval processes. This can tie up resources for extended periods, potentially delaying the realization of ROI and limiting the organization’s capacity to engage in other initiatives. Effective project management, resource allocation and cross-functional collaboration are essential to mitigate operational risks and ensure the smooth execution of R&D activities.

    Sources of R&D Funding

    Part and parcel of R&D is the need for significant financial resources. Fortunately, organizations are often able to tap into various sources of funding to support their R&D efforts, from government grants and corporate investment to private equity and venture capital. These sources can play an important role in enabling businesses, research institutions and entrepreneurs to pursue groundbreaking ideas, develop new technologies and bring innovative products and services to life. But each has its own distinct characteristics to consider.

    • Government Grants

      Government agencies worldwide offer grants to support R&D, particularly in sectors working on innovations in areas of public and national interest, such as health, technology, the environment and education. This might include projects focused on scientific discovery and technological advancements or solutions to societal challenges, such as developing renewable energy resources. Government grants are usually awarded through competitive processes that require an organization to submit a proposal outlining research objectives, methodologies and potential impact. They’re also non-dilutive, meaning recipients don’t have to give up equity or repay the funds. This can be particularly attractive for early-stage startups or businesses that want to maintain control over their strategic direction and decision-making.

      Securing a grant, however, can be a complex and time-consuming process. Businesses — and any organization, for that matter — need to carefully navigate application requirements, ensure compliance with grant terms and conditions and prepare for rigorous grant reporting and accountability measures. And even with significant investment in time and resources to develop a perfect proposal, there’s no guarantee of approval.

    • Corporate Investment

      When a company directly allocates a portion of its resources to internal R&D efforts, it’s considered corporate investment. This type of funding gives a business full control over its R&D agenda. Being able to closely align plans with strategic objectives and market needs can help companies zero in on the new products, services and technologies that will improve efficiency, provide a competitive edge or drive long-term growth. This often involves assessing internal capabilities and identifying potential partnerships or collaborations that can accelerate innovation.

      But corporate investment comes with its own challenges. Because it’s a direct form of investment, a company must use its own funds, often derived from profits, to support R&D efforts. This means companies need to carefully balance the desire for innovation with the pressure to deliver short-term results and sustain day-to-day operations. As such, they should carefully prioritize R&D projects, as well as develop processes to calculate risk, monitor progress, measure ROI and make data-driven decisions about future investments. It’s also important that businesses encourage experimentation, creativity and continuous learning while providing the resources and support that R&D teams need to thrive — otherwise, projects are unlikely to get off the ground.

    • Private Equity

      Private equity (PE) firms typically invest in relatively mature companies seeking growth or operational improvements. These firms often acquire a significant ownership stake with a medium- to longer-term horizon, aiming to increase the value of their investment through strategic enhancements and scaling initiatives. Although not always directly invested in R&D, PE firms can provide substantial financial resources and strategic guidance to support a company’s plans for innovation, particularly when it comes to optimizing operations and expanding into new markets.

      By partnering with a PE firm, established businesses can typically tap into a wealth of industry expertise and a network of contacts who can help accelerate growth, operational efficiency and market expansion. More specifically, these firms tend to bring a wealth of experience in operations, finance and business strategy, all of which can play an invaluable role in helping companies optimize R&D efforts and commercialize new offerings. This can also spawn potential partnerships, new customer bases and even additional funding sources.

      That said, PE isn’t without its trade-offs. Unlike venture capital firms, which focus on early-stage companies in their initial R&D phase (more on that below), PE investors typically engage with companies that have established products or services. This means they enter at a later stage in the company’s life cycle. This mature focus means PE investors may expect quicker returns, potentially influencing companies to prioritize short-term gains over long-term innovation. What’s more, because PE firms typically have a stake in the companies they invest in, they’ll often take an active role in decision-making, influencing the direction of a company’s R&D agenda. If a PE firm seems like the best option, it’s important for a company to choose one that’s aligned with its goals, values and vision.

    • Venture Capital

      Venture capital (VC) tends to specialize in high-risk, high-reward financing for startups and early-stage companies poised for rapid growth and disruptive innovation. VC firms invest in these companies in exchange for equity in the hopes of receiving substantial returns. In addition to providing the financial resources needed to accelerate R&D efforts, VC firms tend to offer deep, industry-specific strategic guidance to help companies navigate the challenges of scaling up and commercializing their innovations. Like PE firms, VC investors can also facilitate strategic connections with potential partners, customers and talent.

      VC often plays a major role in industries that, by nature, require hefty R&D investment to achieve breakthroughs. Such industries include technology and software, health and biotechnology, financial technology, renewable energy and robotics. In these industries, traditional loans are often too risky, given that groundbreaking R&D can carry a high risk of failure.

      Despite its benefits for disruptive startups, VC funding can be a highly competitive process to navigate. To attract investors, companies need to have a compelling value proposition, clear potential for explosive growth, a strong team capable of steering the ship and a viable route to profitability. Businesses should also prepare to cede a significant portion of equity and possibly some operational control in exchange for the capital and support they receive. They should be ready for intense scrutiny and pressure to deliver results, as VC firms are often focused on achieving a high ROI within a relatively short time frame.

    Accounting for R&D

    R&D is typically costly, not to mention risky. It directly affects financial statements, tax liabilities and overall financial health, as well as decisions made by management, investors and other stakeholders. Any organization looking to dive into R&D should be well-versed in R&D accounting, or the specific tracking and reporting of costs associated with R&D activities. But the process is complex.

    One of the key challenges of R&D accounting is determining which costs qualify as R&D expenses and how to properly categorize and record them. Common costs include salaries and wages for research staff, costs of materials used in R&D projects and expenses related to the use of facilities or equipment.

    Under U.S. Generally Accepted Accounting Principles, R&D costs are usually expensed in the period they’re incurred — meaning they’re recognized immediately rather than capitalized and amortized over time. This approach reflects the uncertainty and inherent risk of R&D activities, where the future economic benefits are uncertain. Because R&D costs are typically expensed immediately, they can significantly impact reported profits, especially for companies heavily invested in R&D. This can affect a company’s valuation, earnings per share and other key financial metrics.

    R&D costs must also be expensed under International Financial Reporting Standards (IFRS). However, IFRS offers some flexibility and may allow for the capitalization of certain development costs under specific conditions. This allows companies to better match R&D costs with future economic benefits, rather than just expensing them all upfront.

    Effective R&D accounting plays a crucial role in internal decision-making and strategic planning. By accurately tracking R&D costs and outcomes, businesses can better assess the ROI of their R&D efforts, identify areas for improvement and make informed decisions about future R&D projects and resource allocation. Transparent and accurate reporting of R&D activities can also influence investor perceptions and confidence; investors often view R&D spending as an indicator of a company’s growth potential and innovation capabilities.

    To ensure proper accounting for R&D, businesses should work closely with their financial teams and external advisers, such as accountants and tax professionals, to develop robust systems and processes for tracking and reporting R&D expenses. This may involve implementing specialized financial management software, establishing clear guidelines for categorizing R&D costs and regularly reviewing and updating accounting practices to stay compliant with evolving regulations and standards.

    R&D Tax Credit

    In addition to tax accounting, companies must navigate the tax implications of R&D spending. Many countries offer tax incentives, such as credits or deductions, to encourage businesses to invest in R&D by reducing income tax liabilities to effectively cut the overall costs of R&D. But rules and regulations surrounding these incentives can be intricate, and companies need to carefully track and document their R&D expenses to ensure compliance and maximize tax benefits.

    In the United States, the federal R&D tax credit offers a dollar-for-dollar reduction in a company’s tax liability for certain expenses, such as the design, development or improvement of products, processes or techniques. Businesses of all sizes that spend money on R&D may qualify for this tax credit, as long as the research activities meet the IRS’s stipulations. Additionally, companies must carefully document their R&D activities to demonstrate how they meet the IRS’s criteria. This includes keeping a record of expenses (such as payroll records for employees involved in R&D), project and meeting notes and other relevant documentation, including blueprints, drawings, patents and prototypes.

    Manage the Financials Behind R&D With NetSuite

    In an age when driving innovation, growth and competitive advantage is more important than ever, businesses in most industries would be hard-pressed not to devote time and resources to R&D. But given the high-cost, high-risk nature of R&D, properly accounting for R&D costs is critical for financial reporting, tax planning and strategic decision-making. Fortunately, financial management and accounting tools, such as NetSuite Cloud Accounting Software, can make the process manageable for businesses of any size.

    In addition to comprehensively handling run-of-the-mill accounting tasks, NetSuite is a perfect fit for companies heavily invested in R&D, thanks to its detailed financial tracking, expense categorization and reporting capabilities, which ensure that all R&D costs are tracked and reported accurately. The system’s cash-management functionalities provide companies with real-time access to their current cash position so that decision-makers have the data they need to carefully balance cash for R&D with cash for short-term operations.

    NetSuite’s accounting capabilities — plus its broader ecosystem — are designed to grow with a business, allowing for the addition of new modules and functionalities as an organization’s R&D accounting needs evolve. For example, native integration with NetSuite Project Management can further improve R&D accounting by enhancing a company’s ability to accurately track project-specific time and costs.

    R&D is a complex and multifaceted endeavor that plays a vital role in driving innovation, growth and competitiveness for businesses across industries. Without it, society wouldn’t be where it is today. By understanding how R&D works, its advantages and risks, how to acquire funding and what to consider when accounting for R&D expenses, businesses can make the informed decisions they need to optimize their R&D efforts, minimize costs and set themselves up for success.

    #1 Cloud
    Accounting
    Software

    Free Product Tour

    R&D FAQs

    What is the concept of research and development?

    Research and development (R&D) refers to the innovative activities businesses and other organizations engage in to advance knowledge; generate novel ideas, products and methods; and refine those that already exist.

    Why should companies invest in research and development?

    Though research and development (R&D) can be costly and risky, companies should invest in these efforts because doing so can result in groundbreaking products and services that provide a competitive advantage, support market expansion and promote long-term sustainability. Similarly, R&D that focuses on enhancing processes can boost operational efficiency and productivity.

    What are the three types of R&D?

    The three types of research and development are:

    • Basic research, which focuses on generating new knowledge, often without a specific application in mind.
    • Applied research, which turns insights from basic research into practical applications.
    • Development, in which insights from basic and applied research are transformed into tangible products, services or processes, usually through prototyping and testing.

    What are examples of research and development?

    Examples of research and development are:

    • A university research team investigating the fundamental properties of a new material with potential applications in electronics or medicine.
    • A pharmaceuticals company conducting clinical trials to test the safety and efficacy of a new drug.
    • A technology company developing a new software algorithm to improve the efficiency of its products.
    • A food company experimenting with new ingredients and formulations to create a healthier or more flavorful product.

    Is research and development a good career?

    Research and development can be a rewarding career for individuals who are curious, creative and passionate about innovation. The field offers benefits, including:

    • Constant learning opportunities.
    • Impactful work that can lead to the development of new products, services or solutions that can have a meaningful impact on society, the economy or the environment.
    • Opportunities to collaborate with cross-functional teams that have diverse skill sets.
    • Strong job stability due to the increasing importance of innovation.

    However, R&D careers can be challenging, with pressure to navigate complex issues and deliver results. Success requires technical expertise, creativity, problem-solving skills and resilience.