Research and Development: Spending Today for Revenue Later

Spending now for revenue later is one line in an account and two decisions underneath it: what the money went on, and which year carries the charge. Neither is visible from outside. One published year here carries Rs 24,40,000/- more standing cost against Rs 12,90,000/- more contribution, and the Rs 11,50,000/- fall in profit closes exactly on that difference, with three things named and the split across them estimated rather than disclosed.

Underneath that answer sits one awkward fact, and everything difficult about this subject comes out of it. An account is built to put a cost beside the revenue it produced. Ordinary spending obliges: the paper bought in a year is used in that year, and the two sit side by side where anybody can compare them. Spending meant to produce revenue later refuses. Spending meant to produce revenue later arrives in one year and its revenue arrives in another, if it arrives at all, so the two can never be printed side by side. The difficulty is not in the spending. The difficulty is that the cost and the revenue live in different years, and no single statement can show them together.

Because they cannot be shown together, somebody has to decide which year meets the charge, and that decision is made by a person rather than discovered by counting. The money left on a date, and the date is a fact. The year it is charged against is a choice made within written rules. Two businesses spending the identical amount on the identical thing in the identical year can report two different profits, both of them correct, and nothing on the face of either set of accounts announces the difference.

There is a second decision underneath the first, and it is older and harder and almost nobody asks about it. What was the money actually for? An account records that money went out and, at best, the broad heading it went under. An account does not record whether the business was changing its method or simply doing more of what it already did. Both purposes produce the same entry, and the entry is all a reader outside the business ever gets. Where the first decision is at least written down somewhere, the second one is usually not recorded at all.

What happened in a year when a business spent more and earned less?

The arithmetic is more persuasive than any definition, so start there. Anjani Stationers Private Limited, an invented maker of hard-bound registers, published two years side by side, and the two years are worth reading slowly.

The standing baseThe part of a year's cost that stays where it is when the number of registers made and sold moves. Rent, salaries and the like sit in here, and they arrive whether the works is busy or idle. is the part that does not move with volume, and the contribution marginWhat is left out of every hundred rupees of sales once the costs that rise and fall with volume have been taken out. It is worked out in full elsewhere in these notes. is what is left out of each rupee of sales once the costs that do move have gone. The subtraction runs in the open. Rs 12,90,000/- of extra contribution less Rs 24,40,000/- of extra standing cost is Rs 11,50,000/-, and Rs 11,50,000/- is the whole of the fall in operating profit. Nothing at all is left over for a second cause. A business sold more, kept the same margin on every register, and earned Rs 11,50,000/- less, and nothing went wrong in the selling.

Read the drawing twice, once for what it states and once for what it leaves out. The second year sold more, so the second bar is the taller one. The green band inside it, the part that stands still whatever happens, has grown by half again. The dark cap on top is what the year kept, and it has shrunk. Every one of those three movements is published, and none of them requires anybody to guess.

The accounts also say what the Rs 24,40,000/- went on, in six words, and the six words are worth quoting rather than summarising: people, space, and a binding operation the business bought into. The line between what carries a price and what does not is worth marking exactly. The heads those three sit in are on the face of the statement, so a split can be assembled out of them, and it closes: Rs 6,00,000/- more on employee benefits, Rs 11,40,000/- more on the standing part of other operating costs, largely a second warehouse taken that year, and Rs 7,00,000/- more charged as depreciation and amortisation against the assets bought. The three amounts add back to Rs 24,40,000/- to the rupee. But no line anywhere says that is the split. Somebody had to work it out, and they had to work it out precisely because nobody disclosed it. An estimate is not a disclosure, and a price against an accounting head is still not a purpose.

The shape of this is familiar from ordinary life. A household moves to a larger place so that it can take in two lodgers. The larger rent starts on the first of the month, in full, every month. The lodgers arrive over the following year, one of them in April and one of them in November. In that household's first six months it is paying out more and taking in less, and every word of that is true, and none of it means the move was a mistake.

So what is actually being bought when money goes out now?

Strip the phrase research and development back to ordinary language and it means money spent now in the hope of revenue that has not arrived. Two halves, and the halves are not alike. The money is certain, and its date is known to the rupee and to the day. The revenue is uncertain, and its date is unknown even to the people who are hoping for it. A spend for later revenue is a cost with a known date standing beside a revenue with neither, and that mismatch is the whole of the subject.

Notice that nothing in that sentence is about how clever or how difficult the work is. A brilliant change and a dull one land in an account the same way, and so do a change that succeeds and a change that comes to nothing. Difficulty and success are properties of the work. The timing is a property of the money, and the money is the only part of it that reaches a reported yearThe twelve month stretch a set of accounts is drawn up for. Everything the business did is squeezed into that window, and anything that straddles the edge has to be put on one side of it or the other..

The mismatch reaches the reader directly rather than staying an inconvenience for whoever keeps the books. Somebody comparing one year against the next is comparing two years whose costs were incurred for two different futures. The year that spent is being measured against a year that did not, and the measure has no way of saying so. So a business can look worse in the year it is doing the most sensible thing it has done in a decade, and the year afterwards can look better than anybody in it has earned.

The street version is a fruit seller who buys a second cart in March and starts selling from it in September. March carries the whole price of the cart and none of its takings. September carries takings and no cart to pay for. Read March on its own and the seller looks careless. Read September on its own and the seller looks gifted. Neither reading is about the cart.

Where can that spending land in a reported year?

Two shapes, and describing them takes very little space. The first shape charges the whole cost to the year the money left. The year of the spending carries all of it and every later year is clean. The second shape puts the cost on the balance sheetThe statement listing what a business holds and what it must pay. A cost parked here is a cost waiting for a later year to meet it, which is why it belongs on that statement rather than in the year's profit. and charges it in pieces across the years it is meant to benefit, so the year of the spending is protected and each of the later years takes a share.

Look at what changes and what does not. The bank balance moved by the same amount on the same day under both shapes. The supplier was paid the same money. Nothing about the transaction differs. The money that left the business is identical under both shapes, and only the year that meets it moves. Most of the confusion in the subject sits on that one point. A reader who half remembers this treats the second shape as though it softened the payment, and the second shape does not touch the payment.

Here is the limit, said once and without apology. When a business may use the second shape is written down, and the table at the foot names where the current wording lives; anybody who needs it goes and reads it there on the day they need it. A reader has no way of telling which half of a half-remembered rule was the remembered part, so a rule half remembered is worse than a rule looked up.

The drawing below carries no figures at all. Running the Rs 24,40,000/- through the two shapes would mean first deciding that the spend was of the kind the second shape covers, and that decision cannot be made from outside at all. So the two shapes are drawn as shapes.

What does the choice do to somebody comparing two businesses?

The practical reason anybody cares is a comparison between two businesses, so make it concrete. Two businesses spend the same money on the same thing in the same year. One charges it to that year and reports a lower profit. The other carries it and reports a higher one. Both are correct, both are properly prepared, and neither of them has done anything a reader could object to. A difference in reported profit can be a difference in treatment rather than a difference in performance, and nothing on the face of either figure says which.

Three things separate the two, for a reader, and each is worth naming. The cash that left is the same in both. The balance sheets differ, since one of them now carries something the other does not. A charge that was postponed has to be met later, so the years after this one will differ in the opposite direction from the year in question. So the profit line that looks kinder this year is the one that will look harsher next year, on identical spending.

There is a second order effect that catches people, and it is a property rather than a warning. Under the second shape, a business at the beginning of a long run of such spending and a business at the end of one look quite different: the first is carrying a little and charging a little, the second is charging a great deal from years already gone. Under the first shape those two businesses look identical. The shape being read under decides whether a reader can see where in the run a business is standing.

What does spending of that size cost, in the units of the thing being sold?

Rupees hide size. A reader meets Rs 24,40,000/- and files it under large. Filing a figure under large is not a reading. So turn it into the thing the business actually sells. Every rupee of that new standing cost has to be earned back out of what each register leaves behind, and the contribution a registerWhat one register leaves behind after the costs that rise and fall with each register have been paid. The build-up from the price and those volume costs is set out separately in these notes. is Rs 46.20/-.

Divide. Rs 24,40,000/- over Rs 46.20/- is 52,813.85 registers a year of extra selling, simply to stand where the business stood before it spent. Against the 2,50,000 registers the works actually made in the second year, that is 21.13 per cent of everything it produced. Registers are what has to arrive before a year's spending on the part that stands still is paid for, so that spending is best read as a number of registers.

State the convention out loud, in the same breath, and do not let it drift away from the figure. The division above and the one in the next block both price the whole movement at the second year's contribution of Rs 46.20/-. The first year's contribution a register is not published anywhere, and its margin was 42.75 per cent rather than 42.78, so the two years did not carry quite the same amount on each register. A convention travels with both figures or neither figure gets printed. Say it, or say nothing.

And what did the year actually fall short by, in the same units?

The shortfall in operating profit was Rs 11,50,000/-. At the same Rs 46.20/-, that is 24,891.77 registers, or 9.96 per cent of the 2,50,000 the works made. The useful part is watching three figures meet, and the meeting is the teaching.

The extra contribution of Rs 12,90,000/- is 27,922.08 registers at the same Rs 46.20/-. The new standing cost needs 52,813.85 registers. Take one from the other: 52,813.85 less 27,922.08 is 24,891.77. The result is the shortfall to the second decimal, arrived at from a completely different direction. The year delivered roughly half the extra selling its own spending now requires, and the other half is the whole of the fall.

The meeting of those three figures earns a reading worth carrying away, and it is a reading rather than a moral. A change that works and a year that improves are two different events, moving on two different clocks. The published second year has the ability going in at the start and the profit coming out at the end, and the year would look exactly like this whether the spending turns out to have been shrewd or wasteful. The lodgers arrive one at a time. The rent arrives all at once.

Can the accounts say what the money was for?

The question, in the words a reader would actually use, is this. Was that Rs 24,40,000/- a business changing its method, or a business simply doing more of what it already did? One of those would be worth writing about. The other would be an ordinary year of growth. Everything a reader would want to say about this business turns on which it was.

Now answer it honestly. The accounts name three things, and the only amounts standing against them are estimated rather than disclosed: people, space, and a binding operation the business bought into. Take them one at a time. More people can be a larger sales counter serving the same customers in the same way, or it can be somebody hired to do work the business could not do before. More space can be room for more of the same work, or room for work that did not previously exist. A binding operation brought inside can be capacity for volume the business already sells, or a change in how the thing is made. From outside, an innovation spend and an ordinary expansion spend are the same line in published accounts.

The shrug is where the mistake gets made, so say the professional consequence plainly. The reader's honest position here is that they cannot tell, and writing that down is worth more than a classification nobody published. A classification written into a note does not stay a guess. The classification travels onward as though somebody had established it, gets repeated by the next reader, and eventually gets used to forecast something. The word innovation, once written beside a number, is very difficult to take back out.

A neighbour has taken a second shop on the same street. The shutter is visible, the rent can be guessed, and the painters can be seen going in. Nothing on the street says whether the second shop sells what the first shop sells or something the neighbour has never sold before. The shutter says nothing about it, and no amount of staring at it harder will.

Which figures on this subject are published, and which are not?

An absence stated as a list is legible and an absence stated as a sentence is not, so list what is absent, one line each. For the businesses used in these notes there is no amount spent on research or development. There is no such spending expressed as a share of revenue. There is no balance carried as an asset. There is no period over which anything is written down. There is no count of the people doing the work. Five items, and every one of them blank.

Now say what is present, and say it as evidence rather than as consolation. One published movement in the standing base. One published movement in contribution. A subtraction that closes with no residue. And three named things whose split can be estimated to the rupee but was disclosed by nobody. Supplying any of the five missing figures would have meant inventing the only number that mattered.

The last part is what turns this from an apology into a finding. The ordinary situation is exactly this one. Most businesses of this size publish none of the five, and nothing obliges them to. A reader who produces a spending figure anyway has not discovered something about the business. The reader has produced a figure about their own assumptions, and it will be indistinguishable from a real one by the time it reaches the third person who reads it.

How does a careful reader get this wrong, twice over?

What does a reader ask of any research and development line?

Which part of any of this is local, and which part is not?