New flame-proof padding. Expected to cost a total of $800,000 to develop. Expected total revenue $2,000,000 once work completed - probably late 20X6
Project B 150,000
New colour-fast dye. Expected to cost a total of $3,000,000 to complete. Future revenues are likely to exceed $5,000,000. The completion date is uncertain because external funding will have to be obtained before research work can be completed.
Project C 110,000
Investigation of new adhesive recently developed in aerospace industry. If this proves effective then Y Co may well generate significant income because it will be used in place of existing adhesives.
2,200,000 The company has a policy of capitalising all development expenditure where permitted by IAS 38. Explain how the three research projects A, B and C will be dealt with in Y Co's income statement and statement of financial position.
In each case, explain your proposed treatment in terms of IAS 38 Intangible assets and, where relevant, in terms of the fundamental accounting assumptions of going concern and accruals, and the prudence concept.
Answer
Project AThis project meets the criteria in IAS 38 for development expenditure to be recognised as an asset. These are as follows.
(a) The product or process is clearly defined and the costs attributable to the product or process can be separately identified and measured reliably.
(b) The technical feasibility of the product or process can be demonstrated.
(c) The entity intends to produce and market, or use, the product or process and has the ability to do so.
(d) The existence of a market for the product or process or, if it is to be used internally rather than sold, its usefulness to the enterprise, can be demonstrated.
(e) Adequate resources exist, or their availability can be demonstrated, to complete the project and market or use the product or process.
The capitalisation development costs in a company which is a going concern means that these are accrued in order that they can be matched against the income they are expected to generate.
Hence the costs of $280,000 incurred to date should be transferred from research and development costs to capitalised development expenditure and carried forward until revenues are generated; they should then be matched with those revenues.
Project B
Whilst this project meets most of the criteria discussed above which would enable the costs to be carried forward it fails on the requirements that 'adequate resources exist, or their availability can be
demonstrated, to complete the project'.
Hence it would be prudent to write off these costs. Once funding is obtained the situation can then be reassessed and future costs may be capitalised.
Project C
This is a research project according to IAS 38, ie original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge or understanding.
There is no certainty as to its ultimate success or commercial viability and therefore it cannot be considered to be a development project. IAS 38 therefore requires that costs be written off as incurred.
Question
Y Co (2)
Show how the research and development costs in the previous question will be disclosed in the accounts of Y Co. Assume the cost of capitalised development expenditure brought forward is $1,480,000, and that accumulated amortisation of $240,000 was brought forward at the beginning of the year.
(a) Income statement
(b) Statement of financial position (c) Notes to the accounts
Answer
(a) INCOME STATEMENT (EXTRACT)
$ Research expenditure (Project C + 1,420,000) 1,530,000 Development costs (Project B) 150,000 Amortisation of capitalised development costs 240,000 (b) STATEMENT OF FINANCIAL POSITION (EXTRACT)
$
Non current assets
Intangible assets
Deferred development costs 1,280,000 (c) NOTE TO ACCOUNTS
Deferred development costs
$
Cost
Balance b/f 1,480,000 Additions during year (Project A) 280,000 Balance c/f 1,760,000
Amortisation
Balance b/f 240,000 Charge during year 240,000 Balance c/f 480,000
Net book value at 30 September 20X5 1,280,000
Net book value at 30 September 20X4 1,240,000 There is an article on research and development in the Student Accountant dated 7 September 2007. You are recommended to read this article.
Exam focus
point
Chapter Roundup
x
Expenditure on research must always be written off in the period in which it is incurred.Development costs are also usually written off. However, if the criteria laid down by IAS 38 are satisfied, development expenditure can be capitalised as an intangible asset. If it has a finite useful life, it should then be amortised over that life.
Quick Quiz
1 What is the required accounting treatment for expenditure on research? A Write off as an expense in the period it is incurred
B Capitalise and carry forward as an asset 2 Which of the following items is an intangible asset?
A Land B Patents C Buildings D Van
3 Research expenditure is incurred in the application of knowledge for the production of new products. Is this statement
A True B False
4 XY Co has development expenditure of $500,000. Its policy is to amortise development expenditure at 2% per annum. Accumulated amortisation brought forward is $20,000. What is the charge in the income statement for the year's amortisation?
A $10,000 B $400 C $20,000 D $9,600
5 Given the facts in 4 above, what is the amount shown in the statement of financial position for development expenditure?
A $500,000 B $480,000 C $470,000 D $490,000
Answers to Quick Quiz
1 A Research expenditure is always written off as it is incurred. 2 B All the others are tangible assets.
3 B False. This is a definition of development expenditure. 4 A 2% u $500,000 = $10,000.
5 C Deferred development expenditure b/f is $480,000 (cost $500,000 – accumulated depreciation $20,000), then deduct annual depreciation of $10,000 to give figure c/f of $470,000.
Now try the question below from the Exam Question Bank
Number Level Marks Time