Terms Beginning With 'r'

Research and Development

What is Research and Development (R&D)?

Research and Development is a crucial exercise undertaken by organisations, businesses, and Government. It is essentially the development of next-generation solutions, new knowledge and technologies. 

In a popular feud between legendary investor Warren Buffet and futuristic entrepreneur Elon Musk, the topic of moat (competitive advantages) and innovation took a great amount of head-scratching among their followers. 

Mr Musk told that if moats are the only defence against the rising competition, the defence will not last long. He stressed that the pace of innovation is the ‘fundamental determinant of competitiveness’. 

Innovation comes from R&D, which is also a precursor to achieve competitive advantages. In a business context, it may refer to the activities undertaken by a firm to develop a new product, services or processes. 

Businesses also undertake R&D to improve the processes that already exist. Research and Development include considerable risk because of the underlying uncertainties, specifically the uncertainty on achievement of expectations. 

Research and Development remain crucial for new product development, improving existing products, and stay competitive in the business. It can be undertaken in almost every industry, but there are some R&D intensive industries like life sciences, biotechnology, pharmaceuticals, automotive, software and technology. 

What are the types of R&D?

Research and Development start with basic idea generation, which helps to identify new opportunities. Afterwards, the process of exploring and identifying feasible ideas comes into play. 

Basic Research 

As the name suggests, basic research aims to assess the subject and build on the body of knowledge relating to the subject. In this stage, the complications are relatively lesser, and the undertaken research does not have commercial or practical application. 

Basic research is all about acquiring knowledge and applying the knowledge to building understanding and intelligence. This subject matter further helps to build a foundation for additional R&D projects and provides a basis for strategic business decisions. 

Applied Research 

Applied research is the next level of research in the process of the R&D. It has more directed objectives and aims to determine methods to address a specific research problem. The processes under applied research are generally focused on specific commercial objectives. 

Applied research includes applying new technology, penetrating into a new market, cutting costs, or improving safety. This part of the research further provides a base for the development phase of the research project. 

Development Phase

The development phase is initiated after the outcomes of research are utilised for the production of specified products. This phase also includes the design and development of prototypes.

The basic difference is between development and manufacturing or production. The development is the research phase that emphasises on the generation of knowledge and process required for production and manufacturing, whereas manufacturing involves utilisation of plans and research to produce commercial products.

Accounting treatment of Research and Development

R&D process is an expensive procedure. Companies incur substantial costs to undertake R&D to develop their products or services. Ultimately, the products or services developed by the firm through R&D will translate into revenues. 

International Financial Reporting Standards (IFRS) provides guidance on how companies can treat the costs associated with R&D in IAS 38 – Intangible Assets. When certain criteria are met, the accounting standard allows the companies to capitalise expenses on R&D; otherwise, the costs are expensed as incurred on the income statement. 

Internally generated intangible assets are usually capitalised and amortised under IFRS standards. Firms are required to distinguish expenses into two categories, research activities and development activities. 

After the expenses are distinguished, the companies could be able to capitalise some expense provided that the criteria are met. Expenses during the research activities could be costs incurred in the original and planned investigation, which would result in the achievement of scientific knowledge or technical understanding. 

Under development activities, the expenses incurred by the companies related to the utilisation of knowledge or process, planning design or production for the product, and before the start of commercial production. 

According to IFRS, the companies have to expense the cost of research and development in the income statement when the process in the research phase. However, they can capitalise the expenses in the development phase after the below criteria are met. 

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Among the above criteria, the crucial one is the technical feasibility of the project. Companies are required to evaluate the technical feasibility of the project. When companies have undertaken R&D for new product development, it becomes difficult to assess the technical feasibility of the project. 

When firms are able to capitalise R&D expenses, they are no longer required to capitalise the expenses at once on the income statement, and amortisation is adopted to capitalise the expense spread over the years. 

What is the importance of R&D? 

In an economic sense, the emphasis on Research & Development in an economy brings long term structural changes. It is crucial for the economies to continuously undertake R&D to bring a positive change in the lives of its citizens. 

Research and Development bring new ideas, new innovation and process to better than the existing process in the country. Economic policies of the Governments also emphasise on R&D and provide incentives to the companies as well as other organisation engaged in the processes. 

In a business sense, R&D remains crucial to stay competitive and ahead of competitors in the market. To remain competitive does not only mean spending on R&D but to stay open and responsive to the developing trends in the market. 

Research and Development are also about the thorough analysis of current conditions in the market. The dedicated department for this cause helps the companies to prepare for the future as it provides ideas and futuristic information, which support decision making. 

When a business is allocating capital for R&D, it is essentially investing capabilities and technologies, which would help to bring favourable benefits for the firm. R&D helps to develop new products and enhance existing processes. 

 

 

 

What is an Absolute Advantage? Absolute advantage is one of the key macroeconomic terms, which is based on the principles of Capitalism and is often utilised in international trade-related decisions. Absolute advantage refers to the competence of a company, region or country to produce goods or services in an efficient manner compared to any other economic entity. The efficiency in production can be achieved by: Production of the same quantity of good or services as produced by other entity by utilising fewer amount of resources Production of a higher quantity of good or services as produced by other entity by using the same amount of resources What is the Significance of Absolute Advantage? Different countries or businesses possess a different set of ability owing to their location, soil composition, weather, infrastructure, or human resource skills. When applied in the right direction, various factors may pan out to offer more cost-effectiveness and hence build absolute advantage of the entity in comparison to others.  The absolute advantage remains one of the critical determinants for the choice of the goods or services to be produced. Absolute advantage in a particular area often translates into profitability in the area. The profit margin increases by the achievement of cost efficiency, allowing the entity to ensure higher profitability over the competitors.  For example, let us assume that the US can produce ten high-quality aircrafts utilising a specific amount of resources. China, on the other hand, can build 6 similar quality aircrafts using the same amount of resources. Thus, in the production of an aircraft, the US holds Absolute Advantage Let’s say the US has the ability to manufacture a certain amount of steel using 10 tonnes of iron ore. China, on the other hand, can produce the same quantity of steel using 8 tonnes of iron ore.Here, China here holds Absolute Advantage in the production of steel.  How Countries Build Absolute Advantage? While natural conditions, which include climatic factors, geometry, topography, cannot be altered for achieving absolute advantage, the countries use the underlying factors strategically in their favour. Furthermore, factors of production are focused at by many companies or nations for building absolute advantages.  Some of the strategies for building absolute advantage includes: Development of Technological Competencies- The implementation of innovative or latest technological innovations allows the entities to lower their production cost, facilitating absolute advantage.  Enhancing Skills of Human Resources- The improvement in the cost-efficiency, along with the quality of the products, is targeted through imparting varying skill development programs. Many countries subsidize or aid the apprentice or labour training for enhancing the absolute advantage in trade.  Improving Infrastructure- The infrastructure enhancement in the form of road, telecommunications, ports, etc. can be useful in enhancing the cost-effectiveness across different industries.  What Do We Understand by Comparative Advantage Vs Absolute Advantage? Evaluating the comparative advantage introduces the concept of opportunity cost, which is the deciding factor to determine the production of particular goods or services. Opportunity cost refers to the potential benefits associated with the next best possible alternative which is missed out when one option is chosen over another.  The Absolute advantage simply considers the capability of a business or region to deliver goods or services in the most efficient manner. The Comparative Advantage, however, also takes into account the benefits that are forgone if an entity decides for production of a particular product or services.  Comparative advantage, based on the notion of mutual benefits, is often used in international trade deals. The Comparative advantage has been the major factor driving the outsourcing of services in search of cheap labour.  Understanding through an Example For instance, country A can produce ten televisions with the same amount of resources with which it can make 7 laptops. The opportunity cost per television is 7/10 or 0.7 laptops. Meanwhile, the opportunity cost per laptop is 10/7 or 1.42 television.  It highlights that country A is forsaking the production of 0.7 laptops if it is deciding to manufacture one television. On the other hand, it is missing out the opportunity to manufacture 1.42 televisions for every single laptop manufactured.  Now, say Country B’s opportunity cost for producing a television is 0.5 laptop, and that of producing laptop is 2 televisions. Then, country B will have a comparative advantage in making televisions, and country A will have comparative advantage in producing laptops. It has to be noted that despite country A having absolute advantages in both the products, it would be mutually beneficial for both the countries if country B produces television while country A produces laptops. Do You Know About Absolute Advantage Theory by Adam Smith? The concept of Absolute Advantage was indicated by Adam Smith in his book called ‘Wealth of Nations’ which focusses on International trade theory. Adam Smith, in his book attacked on the previous mercantilism theory, which mainly stressed for economies to maintain trade surplus in order to command power.  The Absolute Advantage theory considered that the countries possess different ability with respect to the production of varying goods or services. It argued that it is not necessary that a state may hold an absolute advantage in the production of all goods, and here the relevance of trade comes into play.  It advocates that countries should produce those goods over which they hold a competitive advantage. It would allow the countries to make the same amount of goods using few resources or in less time. The theory propagates the relevance of trade for economic sustainability.  What Are the Limitations of the Absolute Advantage Theory? The assumptions used in the Absolute Advantage Theory by Adam Smith may limit the application in real bilateral trade. The limitations of the theory by Adam Smith include: Smith assumed that the productive capabilities of a country could not be transferred between the two countries. However, in practical terms, the competitive scenario aids the nations to acquire new capabilities and acquire new resources, especially in the technological and human resource skill aspects.  The two-country trade which was used as a basis for the theory does not consider the trade barriers levied. The present scenario, however, is strikingly dominated by trade wars between economies. Nations impose huge tariffs, import duties and other type of barriers to promote local manufacturers.  Absolute Advantage theory assumes that the trade between the two nations will take place only if each of the two economies holds an absolute advantage in one of the commodities traded. However, in general, countries despite not holding absolute advantage are engrossed in international trade, boosting their economic setup.

Difference between actual and an expected return. For example, if a stock increased by 7% because of some update, but the average market only increased by 3% and the stock has a beta of 1, then the abnormal return was 4% (7% - 3% = 4%)

Ability-to-Pay Taxation The neoteric trending concept in which the tax is levied as per the taxpayer’s economic ability to pay. It is based on the concept that a person who earns more should pay more taxes and the one earning less should pay less.  

In the recent past, the absolute return approach of Investing has turned out to be one of the fastest-growing investment strategies worldwide. A lot of financial advisors talk about such investments providing absolute returns. So, what exactly are the “Absolute Returns” and are they are promising? What is meant by Absolute return? Absolute return computes the increase or decrease, in an asset over a period of time, as a proportion of the original investment amount. The focus here is only on that specific asset or portfolio and not related market events. Absolute returns only consider the price movement for any specified time period. Absolute return, reckons an investment’s performance without considering the expanse of time for which investment was committed. Absolute returns can be computed for a quarter, semi- annual, annual period, 3-year duration or more. Absolute Returns are independent of Market movements and thus do not draw relative comparisons. It is one of the most commonly used investment performance metric in Hedge Funds and Mutual Funds. How to compute Absolute return? Suppose an investor Mr. Rich, invested AUD 50,000 5 years back, and the current value of his investment is AUD 75,000. The Absolute return on Mr. Rich’s investment would be 50 %, calculated using- Copyright © 2021 Kalkine Media Pty Ltd Copyright © 2021 Kalkine Media Pty Ltd So, Copyright © 2021 Kalkine Media Pty Ltd Absolute returns are just returns from point of time to other. The notion of an 'absolute return' seems very attractive to get investors’ attention as it ignores the relative market movement and promises an appreciation with zero correlation to markets. Anyhow, Absolute Return technique of computing investment yields is an apt way of calculating return on investment, predominantly in the early stages. There are numerous other types of return metrics an investor can look for later on. Major 4 types mattering most to investors being –  Absolute Return, Relative Return, Total Return & CAGR. What is the difference between Absolute Return, Relative Return, Total Return & CAGR? Absolute return refers to the gain/ loss in a single investment asset/ portfolio but to comprehend how their investments are acting relative to various market yardsticks, relative return is taken into consideration.   Relative return is the excess or deficit an asset achieves over a timeframe matched to a market index. Benchmark Return – Absolute return, gives the Relative return also called sometimes as alpha. Example, if S&P index gives a 10% return during a given period and one’s investment portfolio gives an absolute return of 12% then relative return on investment is positive/ excess 2%. Total returns take into account the effect of intermittent incomes as well as dividends. For example, in an equity investment of AUD 200 having current value AUD 240, the company also declares a dividend of AUD 10 during the year. Total returns will take into account this $10 dividend too. Thus, Total returns on the investment of AUD 200 now will be 25.00% = {(240+10-200)/200} x 100 Absolute and Total returns are easy to calculate as performance metrics, but the real challenge is when comparisons are drawn based on time period of return. Here comes in CAGR, it takes into account the term of the investment too, thus giving a more correct and comparable picture. It is computed as: CAGR (%) = Absolute Return / Investment period (equated in years) Consider for example, two investment options: One where investor earns absolute returns of 10% in 24 months and another where investor earns 5% absolute returns in 9-month duration. So, CAGR would be- For option one: CAGR = 5.00% i.e.  10%/2 (24 months/12 months is equals to 2 years) For option two: CAGR = 6.66% i.e. 5%/0.75 (9 months/12 months is equals to 0.75 years) What’s wrong with just measuring investment performance using Absolute Returns? Absolute returns will only tell an investor how much his/her investments grew by; they do not tell anything about the speed at which investments grew. When people talk about their real estate investments and say, “I bought that house for X in the year 2004. It’s worth 4X today! It has quadrupled in 17 years.” This is an application of absolute return. The drawback here is that it takes into account only the capital appreciation and doesn’t draw comparison with options having different time horizons. Investors can rely on this measure of investment performance only if they are looking for higher returns, without bothering how fast they were generated. Absolute return also doesn’t convey much about an investment compared to relative markets. Then, why do Hedge Fund/ Mutual Fund Managers choose an Investment strategy based on Absolute returns? Absolute returns should be used at times when investors are willing to shoulder some risk in exchange for a prospective to earn excess returns. This is irrespective of the timeframe and Fund administrators who measure portfolio performance in relation of an absolute return typically aim to develop a portfolio that is spread across asset categories, topography, and economic phases. They are looking for below mentioned points in their portfolios- Positive returns- An absolute returns approach of investment targets at producing positive returns at all costs, irrespective of the upside & downside market movements. Independent of yardsticks- The returns are in absolute terms and not in comparison to a benchmark yield or a market index. Diversification of portfolio- With the intention of distribution of risk, among different investment options producing positive returns in diverse ways a mixed bag of absolute return assets give a diversified investment portfolio. Less volatility- The total risk of investment is spread across the different asset held in such a portfolio. Ensuring less overall volatility in collective returns. Actively adjustable to market movements– Usually, investments look for positive returns with zero market correlation. Market shares a negative correlation with absolute return investments and vice versa. In any investment atmosphere, there are varied investment strategies and goals. Absolute return investment strategies are looking to avoid systemic risks using unconventional assets and derivatives, short selling, arbitrage and leverage. It is appropriate for investors who are prepared to bear risk for short and long-term gains.

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