INTERNALLY GENERATED INTANGIBLE ASSETS VALUATION:

DEBATE AND LITERATURE REVIEW

Andreas GEORGIOUa*
a)
Babeș-Bolyai University, Faculty of Economics and Business Administration,
Cluj-Napoca, Romania

Please cite this article as: Article History:

Georgiou, A., 2022. Internally generated intangible Received: 1 February 2022
assets valuation: debate and literature review. Accepted: 21 March 2022
Review of Economic Studies and Research Virgil
Madgearu, 15(1), pp.59-82. doi: 10.24193/RVM.
2022.15.85.

Abstract: This article contains a literature review around the issue of managerial
discretion when deciding if and how much of an internally developed intangible
asset’s development cost is to be capitalized. The interaction between earnings
management and development cost capitalization is mentioned and the underlying
factors, such as beating earnings benchmarks and meeting debt-covenants are
discussed. In a nutshell, the trade-off between the additional informativeness offered
to investors through signaling and the probability of managerial opportunistic
behavior is debated. The results indicate that some degree of opportunism exists,
intending mainly to beat analysts’ earnings forecasts. However, the market
participants tend to identify such behaviors and thus adapt their equity price
valuations. Also, the market value relevance varies depending on the entities’
origin, previous intangible project success or failure track record and intangible
asset intensity.
Key words: R&D capitalization; value relevance; earnings manipulation
JEL Classification: G32; M21; M41

* Corresponding author. E-mail address: andreas.georgiou@econ.ubbcluj.ro.

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1. Introduction
Historically, the space race during the cold war was the main
catalyst, second only to the arms race, which directed resources from
both global superpowers of that period into technological innovation.
That technological innovation was the progeny of intellectual
capital, which in turn evolved into intangible assets. After the end
of the cold war in the early 90’s, the victor, namely the United States
(US) stagnated and rested on its laurels passing along the mantle
of pioneering innovator to the private sector. In turn, the private
sector fully exploited the achievements of the cold war and thus the
microprocessor paved the way for personal computers and then the
internet revolution (Balaji, 2020).
Traditional “brick and mortar” financial structures and economic
practices gradually lost ground to digital shops, on-line commerce;
supply chain digital visibility replaced the cumbersome process of
verbal or handwritten warehouse stock verification, “just in time”
became the mainstream trend in global supply chain management.
On an everyday basis, mobile phones combined with firmware and
applications changed the way people socialize, either personally or
professionally; altered the way of engaging in commerce, new learning
methods were adopted, navigational aids were introduced, and
communications reached new all-time highs with image and video
sharing and online-meetings.
These devices that became so essential in our everyday lives
are made of glass, metal, silicone, plastic, but at their core, lies the
component which enables these materials to perform all those
tasks; the intellectual capital, the software and the patents which
are undoubtedly extremely valuable components. Which leads to the
actual issue of how can the value of those intangible components best
be presented in the financial statements, without overstating their cost
or understating their contribution to the final product.
This article attempts to review a selection of literature. This selection
of literature investigates the accuracy of information presentation
to stakeholders, mostly investors in relation to internally generated

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intangible assets. Specifically, are stakeholders better informed
regarding the development cost of internally generated intangibles
when that cost is capitalized or expensed? The internally generated
intangible assets of interest are particularly software and technology
patents resulting from hard sciences, mainly math, physics, chemistry.
Can managerial decisions regarding the capitalization or expense
of a project’s development cost result in misleading or inaccurate
information? Are there underlying opportunistic motives that affect
the management’s decision regarding the treatment of development
expenses?
The research method consists of literature review, combined
with quantitative analysis based on graphic illustrations, the themes
of analysis being: (1) relevant journals, (2) annual segmentation of
relevant researches, (3) relevant key terms associated with the article,
(4) the contributions of various countries and regions on the subject.
Section 1 of the article describes the two opposing views, namely
capitalization versus expense of development cost, regarding
internally generated intangible assets and the subsequent discord
around them. Section 2 of the article presents the sample background
and associated quantitative data analysis. Section 3 is a discussion
around the evolving debate regarding the informativeness of
accounting choice involving internally generated intangible assets;
In other words the possible opportunistic element of managerial
choice when capitalization is implemented. Concluding remarks are
in section 4 where the advantages and disadvantages of each policy
are summarized and the potential for further research is founded on
those previous remarks.

2. Intangible assets valuation and

the ongoing debates on the subject
As internally generated intangible assets are our point of interest,
the question remains as to which managerial decision could provide
more reliable information regarding the assets’ value when it comes to
capitalization of development costs or expense. There seem to be scholars
on both sides of the isle, those who are proponents of the balance sheet

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and support the capitalization of development costs combined with
mandatory disclosure and those who would prefer the expense of all
R&D related costs while providing voluntary disclosures (Lev, 2008).
The framework covering the creation of intangible assets by an
entity, separates the creative process into two phases (Negakis, 2015).
The international accounting standard, IAS 38, dictates that during the
research phase all relative costs are expensed as they incur and later
on, during the development phase development costs are capitalized,
as long as they meet certain requirements.
The American accounting standards, US GAAP, provisions,
according to Statement of Financial Accounting Standards (SFAS) 86
are allowing only the capitalization of software development costs, all
other internally generated intangible assets are expensed (Lev, 2008;
Clausen and Hirth, 2016). It is worth mentioning that any acquired
intangible assets are capitalized at cost, meaning the transaction price
value, which acts more or less as a fair value proxy. This is reasonable
considering that under free market conditions the parties engaging in
a transaction are attempting to determine a mutually beneficial price.
Apparently, the buyer would not pay more than what he believes the
asset is worth and in doing so, an element of objectivity is embedded in
the assessment of the asset’s value (Jenkins and Upton, 2001).
The difference between the accounting book value of an entity
and its market value brings up the issue of accounting information
relevance. Jenkins and Upton (2001) provide a list of factors that could
possibly be the cause for this difference. The list includes the market’s
diverging assessment of the underlying value attributed to the items
recognised in the financial statements. Such differences could occur
when the accounting measurement does not present adequately an
asset’s or a liability’s value.
The conflict between conservatism, which requires the immediate
expense of internally generated intangible assets’ development costs
and the forward looking prudence allowing conditional capitalization
became more intense at the turn of the millennium as the economy
was transforming into a more digital, non-material one (Kimouche
and Rouabhi, 2016; Jenkins and Upton, 2001; Corrado et al., 2018).

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This is a transformation that continues even today transcending to
what many describe as the fourth industrial revolution.
Lev (2008) supports the capitalization of certain investments
in intangibles combined with improved standardized disclosures.
The balance sheet is proposed as a better solution than the income
statement when it comes to providing adequate information
regarding the internally generated intangible assets. The mandatory
disclosures could serve as additional information in the notes to the
financial statements, describing perhaps either the intangible assets’
development progress or results from various tests that a software or a
patent design prototype undergoes.
Auditors contribute significantly in external controls and legal
compliance of entities, however in an audit revolving around complex
and sensitive technical data from disciplines outside the area of
accounting, how can an auditor express any kind of opinion regarding
the technical feasibility or the possible future benefits of the project?
Certainly, as per ISA 620, there is always the option of involving an
expert consultant on technology related matters, which would raise the
cost of the audit and perhaps cause confidentiality implications. R&D
is about innovation, so is it realistic to assume that the chief science
officer will accept to provide information about an ongoing project,
and not yet patented since it is still under development, to an external
consultant brought in by the auditor?
Kimouche and Rouabhi (2016) suggest that auditors should be
more cautious when examining the amounts attributed to the values
of intangibles in the financial statements, in order to increase their
reliability. In his research, Agyei-Mensah (2019) investigated the
auditing firm’s impact on the amount of information disclosed by the
audited entity. The context of his research revolves around the concept
that bigger auditing firms promote the disclosure of more information;
although auditing firms advise their clients to ramp-up disclosures,
their motivation is somewhat self-centered because they do not wish
to risk negative exposure and damage to their reputation. The results
of the research show that entities audited by Big 4 companies are
likely to provide more disclosures in comparison to entities audited by

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small auditing firms. However, there is no mention of the quality and
reliability of the abundant additional information.
Lev (2008) mentions that financial statement recognition of
development costs combined with private information resulting
from search activities carried out by analysts are a source of private
information regarding the value of R&D assets included in the equity
values. Large investment funds could afford such analysts, can the same
be true for retail investors or other stakeholders? The standardization
of disclosures could limit the randomness of the disclosed information
according to Lev (2008), resulting in comparable information; he also
counters the argument that standard templates used for disclosures
would not be efficient since they would have to be industry or firm
specific, by pointing out that the templates might be industry specific
like much of the GAAP but not necessarily firm specific.
Lev (2008) seems to prefer the International Financial Reporting
Standards (IFRS) approach to internally generated intangibles than
the US GAAP framework. Jenkins and Upton (2001) are expressing
some concerns as to how relevant are the costs of generating an internal
asset to the asset’s value. Although they are in favor of recognition of
those assets in the financial statements, they support the use of the
“value in use approach” instead of the cost of resources invested in the
development of the intangible assets.
Additionally, concern is expressed regarding the technological
feasibility approach by proponents, as well as, opponents of recognition.
The opponents of recognition claim that this approach is difficult to
apply and incompatible, particularly regarding software development
due to the constantly changing nature of the industry. De Groot et
al. (2012) propose three models of software valuation based on the
amounts required to either repair the defective lines of software code,
replace the portion of corrupted or malfunctioning code or impair
the software using the estimated amounts required for maintenance
without making any code repairs or replacement.
On the other hand, the proponents of recognition claim that the
technological feasibility approach allows a broad range of accounting
choice (Jenkins and Upton, 2001). The alternative to capitalization

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is the expense of the investment in intangibles as it occurs, in this
case the value of the internally generated intangible assets, is to be
determined by the earnings they will create either directly or through
synergies with other tangible or intangible assets. Basu and Waymire
(2014) present the aforementioned view in contrast to capitalization
and matching of future earnings. They express two major concerns,
one regarding the separability of intangible assets from other assets,
either tangible or intangible, and the constant sword of Damocles
hanging over capitalized assets in the form of possible changes in legal
protection, state regulation and various aspects tied to government
interventions. The control of intangibles is complicated when it comes
to organizational capital from a human resource perspective (Einsfelt
and Papanikolaou, 2014).
Penman (2009) also supports that the income statement can
provide all the necessary information regarding internally generated
intangibles without compromising the quality of the information,
while mitigating at the same time any risks deriving from asset
capitalization. Arbitrary managerial decisions could be avoided since
the only available option would be to expense any investment in
research and development.
Ji (2018) builds his research hypothesis upon the reasoning that
managers would recognise excessive intangible assets that do not
comply with the recognition criteria, if the total assets excluding
intangible assets is less than total liabilities. That is apparently done
in order to improve the entities’ financial position towards primarily
creditors. If the income statement approach would be used in such
cases, the managers would not have the optional discretion of
development cost capitalization.
However, expending all costs related to internally generated
intangible assets could lead to earnings manipulation in order to
avoid taxes during fiscal years with high earnings, and it might also
cause discomfort among investors when dividends are not being paid
because research and development expenses are diminishing profits
(Clausen and Hirth, 2016). Cordazzo and Rossi (2020) describe that in
France the firms that capitalize their development expenditures seem

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to exhibit lower return performance and undervaluation in contrast to
those that expense similar expenditures.
These findings are inconsistent with studies conducted in the US
where all internally generated intangible assets are expensed with the
exception of software. They also mention that in the United Kingdom
(UK). Under UK GAAP investors view capitalization as more market
value relevant versus the expense of development costs. Specifically,
capitalization shows a positive relationship with market value, contrary
to expense, which shows a negative relationship. In Italy the results
comparing value relevance between Pre-IFRS and post-IFRS adoption
are mixed.
According to Cordazzo and Rossi (2020) some types of intangibles
like intellectual property and research and development costs seem
affected by the transition from GAAP to IFRS in terms of market
value relevance; their market value relevance seems to decrease after
the adoption of IFRS. The findings of Qureshi (2017) indicate that
market participants value the intangible assets across manufacturing
and non-manufacturing firms as well as across profit making and loss
making firms equally. The effectiveness of research and development
investment is more significant for large than for small firms.
Clausen and Hirth (2016) indicate that research and development
expenditures are more intense in small and new firms, which fit the
profile of start-ups. In this case, it would be reasonable to consider
how massive expense of research and development costs could
affect innovation and technical growth if the income statements of
small start-ups would show extensive losses from their early years.
Such conditions could impede and stagnate investment in start-ups
operating in the technological innovation sector.
The issue is not the quality of the information itself; the
consequential effects that capitalization or expense of development cost
might have on informativeness is the issue. The managerial decision to
capitalize the development cost could have a positive signaling effect
regarding project feasibility or could be used for earnings management
or could even affect the capital structure by increasing leverage
through the use of capitalized intangible assets as collateral (Aboody

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and Lev, 1998; Gatchev et al., 2008). The capitalization or expense
of the development cost could impact the investors’ assessment of an
intangible development project’s success probability. A capitalization
approach to development cost by management could signal a successful
feasibility phase according to Aboody and Lev (1998). This qualifies as
additional information if it is realistic and as misleading if the future
economic benefits do not meet the expectations arising from the
project (Hunter et al., 2012). Additionally, earnings management could
be performed depending on an entity’s revenue situation. Expense
of the development cost as it is incurred can reduce profitability
during the early development stages. On the contrary, capitalization
provides a more gradual distribution of development cost through
amortization, after the project is finalized and its economic benefits
begin to subsequently manifest. Furthermore, capitalization of the
development cost could be used to issue debt through collateralization
of internally generated intangible assets (Clausen and Hirth, 2016).
The quality of the collateral in such cases depends significantly on the
legal protection framework around intellectual property. The creditors’
claims could be decided by litigation. In such an event, the litigation
could hinge on the intellectual property legislation since intangible
assets would serve as collateral (Ciftci and Zhou, 2014). The selection
of researches included in this literature review, largely revolves around
the topics mentioned above.

2. Literature review. A quantitative approach

2.1 Methodology
The literature material consists of 51 articles, the databases used
being Scopus and Elsevier. These databases contain a wide variety of
articles on various sciences from a vast selection of academic journals.
Specifically, in the fields of economics, finance and accounting, which
are the fields most closely associated with our subject, the journals
available are abundant. As a matter of fact, even very recent publications
were available and in the unlikely event where articles were under
review, the abstract could be accessed; in addition, feedback was given
regarding the related articles’ publication status.

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Both databases are user friendly with interesting, helpful and
practical features such as a wide range of search filters and the capability
to extract a selection of articles as a database file for use with literature
analytic tools. The database files come in a wide range of formats,
which essentially means broad compatibility and flexibility. Also the
extracted database files contain valuable statistical information for
every article included, thus making the analysis simpler, practical and
more efficient. The main key words and phrases used in the article
search were: R&D value relevance, development cost capitalization,
intellectual property, intangible asset valuation, accounting for
uncertainty.
These key words were selected because of their relevance to
the research question. The research question revolves around
the accounting standards used to evaluate internally generated
intangible assets, as well as, their efficiency in appreciating the value
of the aforementioned assets in a fair and unbiased manner when
implemented. Terms such as development cost capitalization, R&D
expenses, patents, intellectual property fall within the broader scope
of the associated accounting standards and their contribution in
protecting stakeholders; especially the ones without the knowledge
and the means to conduct their own due diligence. Article searches
containing the phrases “the value relevance of R&D” and “accounting
for uncertainty” are aimed towards articles that point out factors which
could lead to biased R&D value reporting.
The time frame of article publication spans from 1998 to 2021; the
analysis begins with articles published around the year 2000 under
the rationale that the economy started to shift its intensity towards
intangible assets around that time.
This selection of articles is focusing on internally generated
intangibles, particularly software and technology patents resulting
from hard sciences, mainly math, physics, chemistry. Intangibles such
as brands, trademarks, medical patents, human resource capital and
education are mentioned in very few articles mainly in relation to equity
values on a purely informative basis, without of course undermining
their importance.

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The journals selected are revolving around the areas of accounting
and finance, management and intangible assets. Tables showing
descriptive statistics, as well as, networking visualization graphics
generated using the application VosViewer (version 1.6.16; van Eck
and Waltman, 2020) are presented in the bibliographic analysis.

2.2 Analysis results

The tables and figures are shown accompanied by a brief comment
on the analysis results and hence, recommendation for future research.
The first representation is the one indicating each journal’s contribution
to the field of intangible assets’ valuation and can be seen in the Table 1.

Table 1. Source percentages per journal

Journal of Infrastructure Policy and Development

Journal of Accounting Research
Australian Accounting Review
Journal of Engineering and Technology Management - JET-M
Accounting and Business Research
Journal of Management Control
American Economic Review
Revue Francaise de Gestion
Review of Quantitative Finance and Accounting
Journal of Corporate Finance
International Journal of Accounting, Auditing and…
Global Business and Finance Review
Journal of Financial Economics
Corporate Governance (Bingley)
Contemporary Accounting Research
Sustainability (Switzerland)
Australian Journal of Management
Financial Analysts Journal
Journal of Business Finance and Accounting
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%

Source: author’s own processing.

The journals with the highest participation are the Journal of

Corporate Finance, Abacus, Contemporary Accounting Research and
the Journal of Business Finance and Accounting. These journals have
a 6% participation each, followed by a notable participation of 4% by
Accounting and Business research, European Accounting Review,
Advances in accounting, Review of Accounting Studies, Journal of

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International Financial Management and Accounting and finally,
Accounting and Finance. All other journals have a 2% participation
but in total they provide more than 50% of the articles.
This indicates that although some journals are more related to
our study topic thematically, other journals were included as well to
offer additional perspectives and opinions regarding various aspects
of intangible valuation.
The next table illustrates the segmentation of journals per year.
The chronological period is consistent with the mentioned time frame
of the economy’s evolution towards a more digital and intangible
intensive era during the last two decades.

Table 2. Article publications per year

16.00%

14.00%

12.00%
Percentage

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%

Year of publication

Source: author’s own processing. Authors

According to Table 2 most articles were published in 2016 followed

by 2020. The years 2021, 2018 and 2015 can be considered as years
of significant number of publications. The articles were selected in a
progressive way in an attempt to capture the progress of intangible
asset accounting treatment from the year of IAS 38 issuance prior
2000 up to 2021.

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The following figure illustrates the network of terms contained in
the selected articles and how they are linked to each other.

Figure 1. Terms network visualization

Source: author’s own projection

The figure shows two clusters, one in green color including the
terms value and intangible assets; the rest of the most important terms
found within the articles form a larger cluster of six terms depicted in
red color. Research and development are viewed as separate terms and
also as one in the form of R&D, probably because the software cannot
identify the term in its two separate components.
However the links are precise since they are close to each other and
most notably development is closer to capitalization than research. R&D
was not excluded as a term since it was considered too significant in
certain articles where the presence of the two component terms was not
enough to replace the excluded influence of the consolidated term. At
the center of the figure stands the firm, the entity which is the epicenter
of all the other terms, the firm is without a doubt the focal point of all the
other terms since it incorporates any value the intangible asset holds.

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The next two figures images show the bibliographic coupling
analysis network among the countries of origin of the articles and the
bibliographic coupling analysis density.

Figure 2. Bibliographic coupling analysis density

Source: author’s own projection

Figure 2 shows the bibliographic coupling analysis density

regarding the articles’ countries of origin. The most dens is US, this is
to be expected since US GAAP requires internally generated intangible
assets to be expensed with the exception of software development costs
which are capitalized. Evidently, the struggle between the two views
is more intense there than in countries implementing IFRS. Software
capitalization being a main study focus, the opinion of scholars on
their exclusive treatment in contrast to all other internally generated
assets as per US GAAP is quite interesting.
Furthermore, according to WIPO (2021), the US hold the second
place of the Patent Cooperation Treaty (PCT) system for both 2019
and 2020. As a result it is expected that a search including patents and

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intellectual property would turn up articles debating the subject in the
US. China is number one on WIPO’s same chart and it is important
to mention that the articles associated with China are discussing how
capitalization of development costs can manipulate earnings and stock
prices. In addition, the articles demonstrate a connection between
auditor fees and development cost capitalization. The number of
articles investigating some sort of direct or indirect relevance between
auditing and internally generated intangible evaluation amounts to 5,
which is approximately 10% of total articles. This percentage is not
negligible, and in terms of article origin 2 articles originate from China
followed by Australia, France and Ghana with 1 each.
Figure 3. Bibliographic coupling analysis network

Source: author’s own projection

The European countries in Figure 2, Germany, the UK and the

Netherlands are also on WIPO’s chart in places 5, 7 and 10 accordingly.
Australia is not in the top 10 of the PCT system; however, the related
articles express a deep skepticism regarding whether development
costs should be expensed or capitalized and what is the auditor’s role
in appreciating the amount of capitalized development cost.

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In the Figure 3, two clusters of countries are illustrated according
to the bibliographic coupling analysis. The red cluster includes China,
the UK and the US. These countries seem to be more affiliated to
US GAAP and local firms might be operating using the same type of
intangibles, for example software and patented computer technology.
On the other hand, Germany, Australia and the Netherlands form
the green cluster. Australia looks like an oddball in this cluster; however,
the country’s presence in this group might be justified by the rather
critical stance of the articles towards US GAAP when it comes to the
discrimination of internally generated intangible assets being expensed,
instead of being capitalized as in the case of internally developed
software. The US related articles seem to be in the center of this graph,
probably because the US economy is characterized by intangible
intensity, especially in the fields of computer technology. It is sensible
that the pioneer would become an object of study and observation.

3. Discussion
The articles included in this time span, from 1998 to 2021, debate
the expense or capitalization of development costs, the mandatory
disclosures in the financial statements regarding intangible assets,
the sources of intangible investment financing, and the possibility
of earnings manipulation by the management through development
costs capitalization. The focal point is how market participants
react to development cost capitalization in different countries while
transitioning from GAAP to IFRS and also what their reaction is on
a firm level based on R&D intensity, and firm reputation regarding
intangible asset successful or failed development. The reaction of
the market participants to the intangible assets’ development cost
capitalization is viewed as the markets’ interpretation of potential
managerial opportunistic behavior resulting in earnings management.
In their research, Dinh et al. (2016) mention factors that could
trigger managerial opportunistic behavior regarding the capitalization
of development cost associated with internally generated intangible
assets. Furthermore, they present how market participants react to
the previously mentioned choice of capitalization on a national level.

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Specifically, development cost capitalization was found value relevant
before IFRS adoption, under local GAAP that is, in Canada, Australia
and the UK. As indicated in Figure 2, Australia and the UK are
countries with significant density of publications within the current
sample. On the other hand, again according to Dinh et al (2016),
the literature detected opportunistic managerial behavior based on
earnings management in firms residing in France, Italy, Germany and
the US. In the case of the US only the development cost of software
is allowed under US GAAP, still the associated literature indicates
that capitalization reduces earnings quality leading to earnings
discounts by market participants. Again, in Figure 2 Germany and the
US are depicted thus indicating that the current sample is inclusive
of both positive and negative association between development cost
capitalization and stock prices. It is also notable that most US patent
applications derive from the sector of computer technology. China’s
largest number of applications belongs to the digital communications
sector followed by the sector of computer technology (WIPO, 2021).
Apart from a national level, Dinh et al (2016) attempt to identify
factors that could trigger managerial opportunistic incentives tied
to earnings management on a firm level. The factors influencing the
discretionary managerial decision to capitalize development cost
leading to earnings management are benchmark beating; meaning
previous year’s earnings or analysts’ forecasts or a zero profit
benchmark; as well as leverage, which is mentioned also by Clausen
and Hirth (2016), as related to development cost capitalization
through collateralization. The last factor mentioned is profitability
which is closely related to earnings bench-marking, yet it is considered
separately as the zero profit benchmark.
Other important factors are tax incentives. However, since tax
provisions differ from country to country, regardless of the accounting
standards applied, Dinh et al. (2016) do not take them into consideration
in their paper. They do acknowledge the existence of such tax incentives
for earnings management and explain why such incentives do not apply
under German tax regulations. The findings of their research revolve
around the market participants’ assessment of internally generated

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assets capitalization and the managements’ possible opportunistic
involvement (Dinh et al., 2016). Financial analysts seem to generally
consider benchmark beating as a characteristic of healthy growth and in
many cases they seem to be aware of earnings management. However,
they lack the ability to identify and isolate the effects of earnings
management on benchmark beating. That way, Chief Financial Officers
remain inclined and motivated to result in earnings management.
Also, since intangible asset generation, most commonly referred
to as R&D, is a high risk activity, managers are usually treated with
leniency, even if a project that was capitalized ends up in failure. Thus
it would be counter-intuitive for a manager to avoid capitalization of
development cost when it is a relatively non-consequential method for
earnings management.
Furthermore, meeting debt covenants is another incentive for
management to engage in earnings management. The descriptive
statistical data suggests that firms which expense development cost
have a higher average book and market value of equity than firms which
capitalize development cost (Dinh et al., 2016). This is an interesting
finding which might provide a hint regarding the relationship between
capital structure and the managerial decision to capitalize or expense
development cost.
Market participants seem to discount the development cost
capitalization in the case of benchmark beaters overall. Although
benchmark beating serves mostly as an indication of positive growth,
it seems that it is not so appealing to market participants when
development cost capitalization is involved. However, when a firm
achieves to surpass a benchmark without the need of development
cost capitalization, market participants interpret capitalization as
informative (Dinh et al., 2016). It is implied that the reputation of firms,
in terms of successful or failed projects, plays a significant role in the
perception of development cost capitalization by market participants. In
other words, when a firm is relatively successful in generating intangible
assets internally, bonds of trust are formed between the entity and the
market participants; discouraging the possible opportunistic behavior of
managers. At the same time, a positive disposition towards development

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cost capitalization by market participants is established. On the contrary,
for entities with little or no achievements to show in the field of project
development, capitalization is interpreted by market participants as
earnings management causing a backlash in firm valuation.
Dugar and Pozharny (2021) investigate the value relevance of
intangible asset capitalization of a global sample of industries classified
in high intangible intensive and low intangible intensive. Their results
support that the expense of development costs creates a mismatch
between expenses and their associated earnings especially for high
intangible intensity entities. That mismatch, in turn, causes a decrease
in value relevance.
Gong and Wang (2016), claim that value relevance of development
expenses, when transitioning to IFRS, depends on national institutional
factors such as investor protector strength and cultural factors such as
the level of uncertainty avoidance. Also, on a firm basis, they suggest
that entities which report loses are valued differently by market
participants than the ones reporting profits in association with the
capitalization of development expenses. Dugar and Pozharny (2021)
specifically refer to small and loss-making companies as entities,
which invest heavily in R&D activities, with the intention to generate
intangible assets. On the contrary, larger and more profitable entities
do not invest as heavily in similar R&D activities.
From the capital structure’s point of view there is controversy
regarding the sources of funding chosen by entities whose asset values
are opaque (Gatchev et al., 2009). Some entities prefer in this case debt
financing and use equity only as a last resort while others avoid high
debt issuance costs by issuing equity. Gatchev et al. (2009) support the
latter view suggesting that equity is the predominant source of funding
when financing internally generated intangible assets especially when
the entities are small, high growth and less profitable. Specifically,
they found that less profitable firms use less cash but more short
term debt and equity in comparison to more profitable entities. Also
the advantages of tangible asset collateralization are showcased as
a strategy to reduce debt issuance costs. However, collateralization
is possible for intangibles as well, depending on the intellectual

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property protection framework (Aboody and Lev, 1998; Gatchev et al.,
2008). Also, the role of auditors in development cost capitalization is
mentioned, and the relation between creditors’ legal protection and
how patents could be exploited in the form of loan collateral. All these
aspects are in tune with the sources of funding related to internally
generated intangible assets.

4. Conclusion
As the literature indicates, the sources of capital could provide some
insight to the management’s true intention and perception regarding
the feasibility and the potential future benefits of projects devoted
to the generation of internal assets. Capital structure is indicative of
the risk that investors are willing to assume based on the financial
information they have. Unfortunately, the stakes of other interested
parties in an entity that invests in internally generated intangible
assets, may they be employees or perhaps clients and suppliers, cannot
be as easily classified in terms of risk. The investor has a vested interest
in the entity’s successful project development since it is harder for
him or her to walk away, when and if things go south. However, even
investors are not all in the same boat; there are those who have the
means, the knowledge and the experience to discount the capitalized
intangible assets’ value and there are those who would run and invest
in an entity’s software or patent development after a well coordinated
investment campaign. Aboody and Lev (1998) mention a classification
between sophisticated investors and unsophisticated, however they
do not support that development cost capitalization has neutral or
negative effects on investment decisions accordingly.
In terms of investor protection though, some particular categories
of retail investors are considered to be more vulnerable than
institutional investors. In other words, when capitalization of internally
generated intangible assets is viewed with some caveat, then indeed
the information provided could be more representative of a project’s
feasibility and could also distribute the associated development costs
in a way that earnings are not understated during development and
on the contrary, overstated after development. On the other hand,

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opportunistic managerial behavior resulting in earnings management
could be misleading when development cost is capitalized without
substantial probabilities of feasibility and future economic benefits.
Perhaps the more experienced and capable market participants are
able to navigate through the underlying benchmark beating or debt
covenants meeting, however that might not be the case for less adept
investors. Hunter et al. (2012) also point out two aspects of managerial
behavior related to internally generated intangible assets. First, the
disclosure of technical details defending the projects’ feasibility is tied
to the intellectual property protection legal framework, so a partial
and selective disclosure is usually the norm. Second, but perhaps more
concerning, is the lack of proper intangible asset input and output
measurement systems. When these two parameters are taken into
consideration along with the dilemma managers face, - capitalization
or expense of development costs -, the investors’ difficulty to make a
well informed investment decision is even more understandable.
Since value relevance related to internally generated asset
capitalization differs among countries, as indicated by the researches
of Dinh et al (2016) and Gong and Wang (2016) based on a number
of factors, it is reasonable to affirm that the external environment of
the entity affects how market participants view the capitalization or
expense of development cost. However, the firm level inner workings
are perhaps more explanatory of the management’s behavioral patterns.
On the other hand, the investors’ reaction to capitalization or expense
of development costs is reflected in the firm’s capital structure. Does
signaling project success via development cost capitalization attract
more equity or debt? Perhaps it has an adverse effect on investment
strategy, reducing exposure of the firm, despite the implied incumbent
success of the developed intangible asset project. At the end of the day,
no matter what managers decide about the capitalization or expense of
their intangible assets’ development cost, no matter what the auditors’
opinion is regarding the truthfulness and fairness of the financial
statements pertaining those projects, the market participants will
ultimately validate the projects by endorsement or they will renounce
them via abandonment.

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From a quantitative standpoint, the variation of results on a
national level is fairly consistent with the depicted bibliographic
coupling analysis. Although the article sample is more focused in
some geographic areas, the overall underlying firm-year samples are
quite diversified in terms of the firms’ geographical origin. Another
interesting fact is that a significant number of articles attempts
to decipher managerial opportunism regarding development cost
capitalization on a firm level. This is consistent with our illustrations,
which indicates the firm as an epicenter linked to other terms such as
R&D, value, intangible asset and capitalization.

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