Accounting Theory (ACNT 1391-6425)
Group Project Paper
Accounting Treatment of Research and Development Costs
Definition of Research and Development
Research and Development activities are the cornerstones to corporations attempting to develop or improve their products or manufacturing methods or facilities. Companies normally undertake these activities with the expectation that the result will generate significant income. This paper will attempt to expound on the accounting treatment of Research and Development costs and problems regarding classification of research and development costs and differences between accounting treatment of research and development as per United States standards and International Standards.
Before we begin to expound the accounting treatment of Research and Development, it is necessary to understand and distinguish Research and Development from other costs.
Financial Accounting Standards Board (FASB) provided the following definitions:
Research: “research is planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service or new process or technique or in bringing about a significant improvement to an existing product or process”
Development: “Development is the translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use. It includes the conceptual formulation, design and testing of product alternatives, construction of prototypes, and operation of pilot plants. It does not include routine or periodic alterations to existing products, production lines, manufacturing processes, and other ongoing operations even though these alterations may represent improvements and it does not include market research or market testing activities.[i]”
Types of businesses which engage in these types of activities:
Enterprises enter into Research and Development with the hope to create new assets or improvements to processes or facilities that will generate future benefits. The types of businesses that enter into Research and Development are mostly Partnerships or Corporations. Mostly Pharmaceutical or Manufacturing companies are the ones that have research and development facilities and enter into these types of activities. Sole Proprietors normally do not engage in research and development as the initial costs are very high and the time period before rewards are reaped is very long. However, research and development might sometimes be the field or area of business that the Sole Proprietor engages in.
Accounting treatment of research and development costs:
The difficulties that arise in accounting for research and development costs can be categorized into two areas: 1) identifying and categorizing costs to a particular project, product or activity and 2) determining the period over which the future benefit will be reaped and the magnitude of the future benefit.
The research and development costs, per suggestions of one study, can be classified into the following:
1. Basic Research: idea generation, or experimentation not specifically aimed at a commercial objective or product
2. New product development: activities aimed towards previously untried products
3. Product improvement: activities aimed at improving existing products or processes.
4. Cost / capacity improvement: activities aimed at reducing operational costs by improving or developing new processes or equipment.
5. Safety, health and convenience: activities aimed at improving working conditions of employees or community[ii]
Classification of research and development costs makes it easier to determine either expensing them or capitalizing them. The authors of...