Accounting for Research and Development Expenditures Jennifer Ribarsky National Accounts Division, OECD 2014 NBS-OECD Workshop 2 – 5 December 2014

Overview Background Data sources R&D output, investment, price indexes Overview of service lives and depreciation 2

System of National Accounts (SNA 2008) expanded the asset boundary to include research and development (R&D) Other intangible produced assets that are capitalized in the SNA – Software – Entertainment, literary, and artistic originals – Mineral exploration and evaluation What intangible assets are within the asset boundary of the SNA? 3

Research and development consists of the value of expenditures on creative work undertaken... – to increase the stock of knowledge, including knowledge of man, culture and society, and use of this stock of knowledge to devise new applications. – This does not extend to including human capital as assets within the SNA. (SNA ) What is R&D? 4

R&D activities create intellectual property products that have the characteristics of fixed assets: – Ownership rights – Long-lasting – Used in the production process Able to quantify R&D’s contribution to economic growth Why capitalize R&D? 5

Handbook on Deriving Capital Measures of Intellectual Property Products (OECD, 2010) Detailed background and guidance Manual on measuring Research and Development in ESA 2010 OECD questionnaire on IPPs Covered: Research and Development, Mineral exploration and evaluation, Software and databases, Entertainment, Literary and Artistic originals Background material

Most OECD countries have implemented 2008 SNA and capitalised R&D – Australia, Canada, all EU-countries, Iceland, Israel, Korea, Mexico, Norway, New Zealand, and the United States include R&D in their national accounts Only 3 OECD countries have not implemented – 2015: Turkey – 2016: Chile and Japan Implementation of 2008 SNA

Impact of R&D on the level of GDP,

Most R&D is carried out within an enterprise for use within the enterprise – So no market price observable Value of own account R&D estimated through the sum of costs approach – For market producers this includes a mark-up for operating surplus – For non-market producers the cost of capital services only includes the CFC Own account R&D 9

Compensation of employees + Materials & services consumed + CFC + Mark-up for operating surplus (only market producers) = R&D output Sum of costs approach 10

Impact on output and value added: market producer Simplified example: – Purchase of R&D: 10 – Own account production: 40 – Consumption of fixed capital (depreciation): 45 Market producer: – Output: +40 (own account production of R&D) – Intermediate Consumption: -10 – Gross Value Added (= GDP): +50 – Gross Fixed Capital Formation:

Impact on output and value added: non- market producer Simplified example: – Purchase of R&D: 10 – Own account production (= Compensation of Employees): 40 – Consumption of fixed capital (depreciation): 45 Non-market producer: – Output: +35 (sum of costs: ) – Intermediate Consumption: -10 – Gross Value Added (= GDP): +45 – Gross Fixed Capital Formation: +50 – Government Final Consumption: -5 (+35 – 40) 12

Frascati Manual surveys – Intramural expenditures: expenditures made in producing R&D within the unit – Extramural expenditures: expenditures made by a unit in acquiring R&D produced by another unit and any grants provided to others for performing R&D – Sources of the funds used to perform intramural R&D (used in reconciling estimates by performers with those by funders) – Government expenditure on R&D; Business expenditure on R&D; Private non-profit making bodies expenditure on R&D; Higher education expenditure on R&D Overview of data sources 13

Administrative data – government budget & outlay data; – universities and grant information; – tax data (such as tax credits to encourage R&D performance) Overview of data sources (2) 14

International trade in services surveys – Receipts/payments for research and development services (transfer of ownership) and for use of Research and development services Business surveys – Collect information on the costs of inputs as well as the revenue from outputs of businesses – Generally could be used to supplement information from Frascati survey Overview of data sources (3) 15

Steps to derive output of R&D 16

FM intramural expenditures40 add sales licenses to use & non-GFCF licenses to reproduce0 subtract payments for licenses to use IPPs which are capital0 subtract intramural expenditures on own-account software-5 add extramural purchases of R&D to be recorded as intermediate consumption4 add payments for post graduate students not included in FM 0 subtract capital expenditures add CFC & mark-up for market producers6 Total output of R&D44 R&D output 17

Steps to derive total supply, use, and GFCF of R&D 18

Examples of specific source and method issues: Source limitations making it difficult to collect information about external funds to post graduate students No information about trade margins, or taxes and subsidies on products and changes in inventories For some countries all expenditures on R&D have been considered as providing a benefit One country noted lags are not used, e.g. R&D is registered as an investment in the same period as production costs occur so there are no changes in inventories (an acceptable approach) Research and Development: Issues related to sources and methods

Unique nature of each R&D product makes finding a market price equivalent difficult (also most R&D performed on own account) In principle, output, or pseudo output, price indices should be derived for R&D but no consensus on how to calculate. Thus most countries use… Input-cost price index used in deflation – Breakdown into labour and materials costs – Assumes no productivity growth Price index 20

All countries use the PIM (or plan to) Depreciation functions Majority use Geometric; others are Linear, Winfrey Mortality functions Delayed linear, Log-normal, Truncated normal, Weibull Research and Development: Capital stock and depreciation

Approaches can include use of data on average life of patents, surveys, econometric methods, other country’s assumption, or Eurostat default average service life Work at Bureau of Economic Analysis (Wendy Li) uses relationship of R&D contribution to profitability documentpdf/ ?cote=STD/CSTAT/WPNA%282012%297/ADD1&docLa nguage=En documentpdf/ ?cote=STD/CSTAT/WPNA%282012%297/ADD1&docLa nguage=En 7 out of 19 countries reported using the Eurostat default average service life of 10 years Estimating service lives (1)

Service lives examples Service lives can differ based on the type and industry of R&D, e.g. 13 years (basic research), 11 years (applied research), 9 years (experimental development), and for specific industries: 7 years (computer programming), 9 years (electronics), and estimates of 15, 20 and 60 years (chemical and pharmaceutical products). Examples of service lives for aggregate R&D were: 4.6 years, 6.2 years, 7 years, 8 years, 10 years, and 12 years. Detailed service lives for a wide range of industries: Finland, Israel, and United States Continuing research, e.g. Germany, Sweden and UK. Estimating service lives (2)

R&D Service Lives: Pharmaceutical Manufacturing

Historical data Small number of countries have not decided on the approach Where estimates do not exist the most common approach is the use of modelling. For some countries, there is detail at a microeconomic level for recent years, but only macroeconomic data for earlier, so models will be used to derive back data. Other approaches are: backcasting, interpolation or extrapolation based on relative or declining proportions, classification adjustments to align earlier data to earlier collected data. Double counting Nearly all countries take account of, or use approaches to minimise, double counting. Some countries noted that information on this issue was not easily available, but for other countries it was not significant. Research and Development: Specific issues raised in OECD survey

Issues raised included Determining ownership, such as the treatment of R&D by multinational corporations. e.g. is the R&D produced mostly exports or domestic investments? Ensuring consistency between different data sources, e.g. R&D surveys and structural business surveys Choice and sensitivity of the deflation method How to calculate the cost of capital in the R&D output as it could be sensitive to the choice of calculation Capturing information on royalty payments Research and Development: General issues raised in OECD survey

Thank you 27