Research and Development Costs – Accounting Treatment and Capitalization Rules

Research and development (R&D) costs refer to expenditures incurred in the process of innovating new products, processes, or services. These activities are essential for long-term growth but present complex accounting challenges due to their uncertainty and the difficulty of measuring future benefits.

This article outlines how R&D costs are treated under U.S. GAAP (ASC 730) and IFRS (IAS 38), covering recognition, capitalization rules, and the differences in treatment between the two frameworks. Practical examples and journal entries are included.

1. What Qualifies as R&D?

Research: Original investigation aimed at gaining new knowledge or understanding.

Development: Application of research findings to create new or improved products or processes.

✦ Research examples: ✦ Laboratory research on new chemical compounds ✦ Exploring alternative materials or formulas ✦ Investigating new scientific concepts

✦ Development examples: ✦ Designing prototypes ✦ Constructing pilot plants ✦ Testing product alternatives before commercial production

2. U.S. GAAP – Expense as Incurred (ASC 730)

Under GAAP, all R&D costs must be expensed as incurred, with very few exceptions.

✦ No capitalization of internal R&D allowed

✦ Applies to all entities, including software and biotech firms

✦ Only materials, equipment, or facilities with alternative future use may be capitalized

To record R&D payroll: Dr. R&D Expense – $40,000 / Cr. Wages Payable – $40,000.

To capitalize lab equipment with alternative use: Dr. Lab Equipment – $60,000 / Cr. Cash – $60,000.

Amortization begins once the asset is used in another project.

3. IFRS – Research Expensed, Development Capitalized (IAS 38)

IFRS distinguishes between the research phase and the development phase:

✦ Research phase → Expense as incurred

✦ Development phase → Capitalize if all six criteria are met

Capitalization criteria under IFRS:

✦ Technical feasibility

✦ Intention to complete

✦ Ability to use or sell

✦ Probable future economic benefits

✦ Availability of resources

✦ Reliable measurement of costs

To capitalize development costs (IFRS): Dr. Intangible Asset – $80,000 / Cr. Salaries Payable – $80,000.

Once capitalized, development costs are amortized over the asset’s useful life.

4. Software Development – Special Considerations

For software, both GAAP and IFRS have tailored rules.

U.S. GAAP (ASC 985-20):

✦ Before technological feasibility: Expense

✦ After feasibility and before release: Capitalize

✦ After release: Amortize capitalized costs

To capitalize post-feasibility coding: Dr. Software Development Asset – $120,000 / Cr. Cash – $120,000.

IFRS: Follows the same research vs. development rule under IAS 38.

5. Disclosures

Disclosures for R&D activities must include:

✦ Total amount of R&D expense recognized during the period

✦ Capitalized development costs (IFRS only)

✦ Amortization method and period for any capitalized intangibles

✦ Description of significant projects and assumptions

✦ Criteria used to determine feasibility or capitalization

Income statement example (GAAP): ✦ Research and Development Expense – $350,000

Balance sheet example (IFRS): ✦ Intangible Assets – Development Costs – $500,000