Be aware of capitalised R&D

In the last report, CDA were carrying $42M of capitalised R&D on new products - this has increased from 23M three years ago. All of this has to be amortised or written off at some future time - it is 24 cps.

Capitalising development costs of new products and amortising it once you start selling the products is a valid accounting treatment - but it is sometimes used to massage profits. I am not inferring this is the case with CDA and there is no evidence pointing this way, but I am always cautious when I see capitalised expenses accumulate quickly in the balance sheet. Most auditors do not have the technical skills to assess whether expenses really were spent on new product development - but if forecast sales of a new product does not eventuate as planned, they will call for impairment of the capitalised costs.

In the last two years, capitalised expenses were $8M each year (that is, new capitalised less amortised). If the company followed a policy of expensing R&D instead of capitalising, then EBIT would have been 8M less in both years. Eventually a steady state should be reached where new capitalised costs balance the amount amortised - a continually increasing capitalised value indicates that the company is rapidly expanding or replacing it's product range. But this can't last for long - if a product's lifecycle is short, then the amortisation period should be correspondingly short.

I have been a past investor of CDA and have done well from this stock - but I am staying out at the moment until I see more clarity on this issue.