October 2003

Elaborating on R&D

Although the July 2003 Accounting department, “Accounting and Tax Treatment of R&D: An Update,” is very good and covers all relevant topics, I believe the following paragraph is off the mark:

International Accounting Standard 38, Intangible Assets, provides a view contrary to U.S. treatment of R&D. IAS 38 divides R&D into a research phase and a development phase. It requires that research costs be expensed, but allows development costs to be capitalized and amortized if they produce probable future economic benefits under certain criteria.

The author uses the word “allows” when in fact the IAS requires development costs to be capitalized; it is not an option/decision as suggested by the above paragraph. I have been researching this area for myself and both the IASB and the companies that already follow IAS 38 have reached a similar conclusion. q

Mark Sproul
Journal Editor
Company Reporting

The Author Responds

I welcome the opportunity to elaborate on my article’s brief reference to IAS 38, Intangible Assets. Although SFAS 2, Accounting for Research and Development Costs, requires expensing of all R&D, IAS 38 states that costs incurred during the development phase of R&D should be capitalized as intangible assets and then amortized, a treatment that typically yields higher net income or lower net loss; however, development costs are capitalized under IAS 38 “if, and only if” the following criteria are met:

1. A project’s development phase must be distinguishable from its research phase, for which costs are expensed when incurred under IAS 38 as they are under SFAS 2.
2. Expenditures attributable to the intangible asset must lend themselves to reliable measurement.
3. The company must:

a. intend to complete the intangible asset and use it or sell it and also must demonstrate the technical feasibility of doing so;
b. prove the availability of adequate technical, financial, and other resources to complete the development phase and the firm’s ability to use or sell the asset, offering substantiation such as a business plan and letters from lenders as necessary; and
c. show how the asset will generate probable future economic benefits, including the existence of a market for the asset or its output or, if the item is to be used internally, its usefulness.

Although these reasonable criteria, briefly outlined here, were carefully and justifiably incorporated into IAS 38, my sense is that a company might capitalize development costs only to the extent it is both able and willing to meet all of the standards of proof. This could be a burdensome task, depending on a project’s size, complexity, and other attributes. From this perspective, IAS 38 allows a deferral of expenditures not permitted under SFAS 2. Whether in practice IAS 38 is able to require it may be subject to interpretation on a case-by-case basis.

Joseph R. Oliver, PhD, CMA, CFM, CPA
Professor of Accounting, Texas State University—San Marcos

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