What Are Research and Development (R&D) Expenses?

Research and development (R&D) expenses are associated directly with the research and development of a company's goods or services and any intellectual property generated in the process. A company generally incurs R&D expenses in the process of finding and creating new products or services.

As a common type of operating expense, a company may deduct R&D expenses on its tax return.

Key Takeaways

  • Research and development (R&D) expenses are direct expenditures relating to a company's efforts to develop, design, and enhance its products, services, technologies, or processes
  • The industrial, technological, health care, and pharmaceutical sectors typically incur the highest degree of R&D expenses.
  • The IRS offers tax breaks for R&D expenses, and these may also be deducted on corporate tax returns.

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Understanding Research and Development Expenses

Research and development is a systematic activity that combines basic and applied research in an attempt to discover solutions to new or existing problems, or to create or update goods and services. When a company conducts its own R&D, it often results in the ownership of intellectual property in the form of patents or copyrights that result from discoveries or inventions.

An important component of a company's research and development arm is its direct R&D expenses, which can range on a spectrum from relatively minor costs to several billions of dollars for large research-focused corporations. Companies in the industrial, technological, health care, and pharmaceutical sectors usually have the highest levels of R&D expenses. Some companies—for example, those in technology—reinvest a significant portion of their profits back into research and development as an investment in their continued growth.

Large companies have also been able to conduct R&D through acquisition, by investing in or subsidizing some of those smaller companies' costs or acquiring them outright.

Real World Example of R&D Expenses

Tech companies rely heavily on their research and development capabilities; so they have relatively outsized R&D expenses. In a constantly changing environment, it's important for such a company to remain on the bleeding edge of innovation. Facebook (FB), for example, invests heavily in the research and development of products such as facial recognition, virtual reality, and predictive AI chatbots. These endeavors allow Facebook to diversify its business and find new growth opportunities as technology continues to evolve.

Facebook's 2017 acquisition of Oculus Rift is an example of R&D expenses through acquisition. Facebook already had the internal resources necessary to build out a virtual reality division, but by acquiring an existing virtual reality company, it was able to expedite the time it took them to develop this capability.

Reasons to Conduct R&D

Businesses conduct R&D for many reasons, the first and foremost being new product research and development. Before any new product is released into the marketplace, it goes through significant research and development phases, which include a product's market opportunity, cost, and production timeline. After adequate research, a new product enters the development phase, where a company creates the product or service using the concept laid out during the research phase.

Some companies use R&D to update existing products or conduct quality checks in which a business evaluates a product to ensure that it is still adequate and discusses any improvements. If the improvements are cost-effective, then they will be implemented during the development phase.