Consistency of Treatment of R&D in the National Accounts and the Balance of Payments

Summary

Under ESA 2010, R&D expenditure is recognised as investment and is included as gross fixed capital formation in the national accounts, adding to a country’s capital stock. As a consequence, intermediate consumption does not include R&D expenditure, nor is R&D expenditure included in the calculation of gross operating surplus. On the other hand, depreciation of the capitalised R&D asset is considered an expense item when calculating net operating surplus. 

The CSO has found that this generally results in a higher net operating surplus than recorded typically under ESA95 standards where R&D expenditure was treated as an ancillary cost to the production of the enterprise.

To achieve consistency between the two accounting systems (national accounts and balance of payments) the CSO is now implementing a modification to the calculation of profits in the balance of payments.

This modification is visible in the reinvested earnings of multi-national enterprises in the current account, with a corresponding flow in the financial account, in the balance of payments.¹ 

As this aspect of the impact of the capitalisation of R&D was not specified in the balance of payments manual (BPM6) or the Compilation Guide, the CSO has confirmed this treatment with Eurostat and other balance of payments compilers.

Reinvested earnings and R&D expenditure in the balance of payments

The CSO collects detailed company data in its combined trade in services and balance of payments survey form. The survey forms collect information on imports and exports of services, including R&D and detailed profit and loss data.

The reporting companies who submit survey forms to the CSO generally treat expenditure on R&D as an expense in their profit & loss accounts for the balance of payments. Under ESA2010, R&D expenditure is capitalised and thus the initial cost of R&D is not treated as an expense item in the national accounts. Although over time the depreciation offsets the initial cost, there is a timing difference that affects the profit. In Ireland where R&D expenditure can be significant, the impact at any given period can be large.

There are two effects of this treatment that cause the company calculation of profit to be different from a national accounts approach.

1. Because R&D expenditure is recognised as an asset under ESA2010 it is not one of the cost items in the calculation of operating surplus in the national accounts. The company accounts however include expenditure in R&D as a cost.

2. Consumption of fixed capital or depreciation is applied on all produced assets (including intangibles and R&D) in the national accounts. However, company accounts do not show depreciation on R&D expenditure.

The reinvested earnings are the direct investor’s share of retained earnings (net profits after tax and after dividends). Capitalising R&D expenditure has the following effect on profits and consequently on reinvested earnings in the balance of payments:

Reinvestment income outflows are increased by the value of R&D expenditure in the period and decreased by the depreciation on R&D assets purchased in previous periods. These data are estimated from the survey data and using the national accounts calculations of R&D depreciation.²

Revision to previously published data

The CSO is implementing a modification to reinvested income flows to reflect this treatment. The adjustment, to allow for the impact of R&D on the calculation of profits, affects the current and financial account in the balance of payments, it also impacts the net factor flows and the gross national income in the national accounts. The impact is to decrease gross national income. There is no impact on GDP.

The effect is to reduce GNI by around 2 percentage points in the years 2015-2017 with a lower impact to prior years’ data.

¹The components affected are current account, primary income, direct investment (1B2112) and financial account, direct investment (3112).

²The CSO is also aware that the treatment may apply to companies whose reinvested earning are recorded as inflows to Ireland. Information on these activities is not so readily available, and no adjustments have been implemented to inflows in the balance of payments.