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Recording Research and Development Costs: GAAP and IFRS
Recording Research and Development costs: GAAP and IFRS
Research by KPMG’s standard as described in their article IFRS vs. US GAAP: R&D Costs is, “Costs related to original and planned investigation undertaken with the prospect of gaining new scientific of technical knowledge and understanding.” In other words, meaning any cost or expense that could potential come from a company performing research on a new method, product or service that they then can provide to its consumers. Development, again by KPMG’s standard as described in their article IFRS vs. US GAAP: R&D Costs as, “Incurred in the application of research findings or other knowledge to plan or design to produce new or substantially improved materials, devices, products, processes, systems or services before the start of commercial product or use.” In other words, it is the cost or expense allocated to the same method, product or service that the respective company incurs while developing or building this method, product or service. Research and Development can cover a wide range of areas within a company or industry. The following are examples fall under research, activities to obtain new knowledge on self-driving technology and search activities for alternatives for replacing metal components used in a company’s current manufacturing process. Meaning, the actual process of gaining information on new alternative methods, products or services that can in return prove to be profitable for a company or industry. The following examples fall under development, design and construction activities related to the development of a new self-driving prototype, and design and construction of a new tool required for the manufacturing of a new product. Meaning, the process of utilizing the newfound research and building the new method, product or service that will in return show potential for profitability.
Now having an understanding of what Research and Development costs are, it is crucial to know how to record them on the financial statements and the potential differences between the Generally Accepted Accounting Principles (GAAP), and the International Financial Reporting Standards (IFRS). GAAP is the US based accounting standards, whereas the IFRS is for international accounting purposes. There are similarities to both in addition to some differences, specifically in R&D cost reporting. According to KPMG, under GAAP, R&D costs are expensed as incurred, while under IFRS, R&D costs are generally capitalized and amortized. This difference adds a “complexity in applying IFRS: distinguishing development activities from research activities, and analyzing whether and when the criteria for capitalizing development expenditures are met” (KPMG). Under GAAP the recording method is straight forward, all one must do is add the cost to the expense account, as it is obtained or incurred. However, under the IFRS, one must distinguish between research and development, then capitalize the cost to the right category, and then finally amortize it over the allotted amount of time.
In addition to the above information, E&Y states there are significant differences for interim financial reporting. Under GAAP, E&Y states in the article US GAAP versus IFRS that, “Each interim period is viewed as an integral part of an annual period. As a result, certain costs that benefit more than one interim period may be allocated among those periods, resulting in deferral or accrual of certain costs.” Meaning, that once a cost is expensed in the correct period, if that cost affects other materials in material fashion, one can continue to allocate these costs to those periods. E&Y states in the same article, “A cost that does not meet the definition of an asset at the end of an interim period is not deferred.” Meaning, that as mentioned before, the intangible asset must be ready for use or sale, before this cost or expense can be deferred.
Finally, it is important to know, when to start capitalizing the development costs under the IFRS standards. One can only begin the capitalize the cost once the intangible asset is complete, ensuring that will be available for use or sale. Under the GAAP method, one would have expensed the development cost too late if they waited to expense it once the asset was ready for use or sale, because it must be expensed as soon as it is incurred. Thus, if the development cost was incurred even in the planning stages, this cost must be expensed, and not held off the financial statements for multiple periods. This in return would cause a material mistake to the accounting records according to the GAAP standards. However, with, under GAAP one can allocate these costs or expenses to multiple periods if the cost is material in each period.
Chen, E., Gavious, I. & Lev, B. Rev Account Stud (2017) 22: 677. https://doi-org.proxy-wcupa.klnpa.org/10.1007/s11142-017-9399-x
“IFRS vs. US GAAP: R&D Costs.” KPMG Institutes, KPMG International, 24 Aug. 2017, www.kpmg-institutes.com/institutes/ifrs-institute/articles/2017/08/overview-of-r-d-under-ifrs.html.
“US GAAP versus IFRS.” US GAAP versus IFRS: the Basics, www.ey.com/Publication/vwLUAssets/US_GAAP_v_IFRS:_The_Basics/$FILE/US%20GAAP%20v%20IFRS%20Dec%202011.pdf.