Residual Income and R&D

I am trying to work through some ways they may try to trick us with equity valuation concepts. One area that comes to mind is residual income valuation (NI - (BVE x Re)) and how book value of equity should be adjusted to get the appropriate numbers. For example, situations where the clean surplus accounting equation are violated need to be adjusted correctly.

The Schweser materials are unclear regarding how R&D expenses should be treated as it related to residual income calculations and clean surplus violations but in going back and searching through a few previous posts (there’s only a few related to R&D and Residual Income) it seems like people are mixed on how you treat R&D.

So my question is this: When calculating residual income and a firm has R&D expenses that are either capitalized or expensed, what is the right way to treat them? Do you CAPITALIZE the R&D so assets and equity are higher or do you expense them so assets and equity are lower?


Capitalize them if they are meaningful and can be reliably measured for feasibility and life.

You do not usually adjust the book value of equity to dirty surplus accounting if it proves to be significant and persistent, You use another valuation method entirely.