May 28 2008

Should You Expense or Capitalize Your Engineering Costs?

Q: At RealNetworks we always expensed (vs. capitalized) engineering expenses (as does MSFT).  What is your philosophy on this engineering accounting practice.

A: (Brad) Subject to approval by the auditors, I always encourage companies I invest in to expense their engineering costs. 

Regardless of the accounting treatment, I think it’s a bullshit practice to capitalize engineering expenses.  In an early stage company, this simply serves to obfuscate the reality of the P&L by transferring real expenses to an asset on the balance sheet which is subsequently depreciated over a multi-year period of time.  The result – investors and managers have to work harder to understand the P&L and the real economic dynamics of the business.  It gets even worse in a mature company, especially one that is public.

However, our good friends the auditors get in the way on this one and encourage some engineering (and R&D expenses) to be capitalized.  Oh well – we need to follow the rules.  But that doesn’t mean we have to like them.