Research costs and development costs

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Research and Development Expenditure

Many businesses in the commercial world spend vast amounts of money, on an annual basis, on the research and development of products and services. 

These entities, including pharmaceutical and motor companies, do this with the intention of developing a product or service that will, in future periods, provide significant amounts of income for years to come.

Definitions

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. 

An example of research could be a company in the pharmaceuticals industry undertaking activities or tests aimed at obtaining new knowledge to develop a new vaccine. The company is researching the unknown, and therefore, at this early stage, no future economic benefit can be expected to flow to the entity.

Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services, before the start of commercial production or use. 

An example of development is a car manufacturer undertaking the design, construction, and testing of a pre-production model.

Accounting Treatment of Research and Development

IAS 38, Intangible Assets, separates a research and development project into a research phase and a development phase.

  • Research phase

    It is impossible to demonstrate whether or not a product or service at the research stage will generate any probable future economic benefit. As a result, IAS 38 states that all expenditure incurred at the research stage should be written off to the statement of profit or loss as an expense when incurred, and will never be capitalised as an intangible asset.

  • Development phase

    Under IAS 38, an intangible asset must demonstrate all of the following criteria:

    • Probable future economic benefits

    • Intention to complete and use or sell the asset

    • Resources (technical, financial and other resources) are adequate and available to complete and use the asset

    • Ability to use or sell the asset

    • Technical feasibility of completing the intangible asset (so that it will be available for use or sale)

    • Expenditure can be measured reliably

If any of the recognition criteria are not met then the expenditure must be charged to the statement of profit or loss as incurred.

Note that if all the recognition criteria have been met, capitalisation must take place:

Dr Intangible non-current assets (SOFP)
Cr Bank/Payables

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