8 3 Research and development costs
Investor B commits a specified dollar amount to fund the research and development of the selected compounds. In exchange for the funding, Investor B will receive royalties on future sales of product resulting from the compounds being developed. Investor B will not be repaid if the compounds are not successfully developed (i.e., the transfer of financial risk for the research and development is substantive). Investor B does not participate in any of the development or commercialization activities. Company A should initially recognize the raw materials acquired for the production of trial batches as inventory since the raw materials have alternative future use in the production of other approved drugs. Treatment of capitalised development costs Once development costs have been capitalised, the asset should be amortised in accordance with the accruals concept over its finite life.
UK TREATMENT OF R&D
During the research phase, costs are expensed as incurred, reflecting the uncertainty and exploratory nature of these activities. However, once a project moves into the development phase, costs can be capitalized if certain conditions are met. These conditions include demonstrating technical feasibility, the intention to complete the asset, the ability to use or sell the asset, and the availability of adequate resources to complete the development.
8 Donation payment for research
Company A should assess whether the contractual arrangement with Investor B meets all of the characteristics of a derivative, and if so, whether any of the scope exceptions to derivative accounting are applicable. Since Investor B would only receive royalties on future sales (assuming the development is successful), the settlement provisions under this contract are based on specified volumes of items sold. Therefore, the royalty exception would apply and Company A would not account for this arrangement as a derivative.
Methodologies
This transparency helps build trust and confidence in the company’s strategic direction and its commitment to innovation. Companies must establish clear guidelines for recognizing and measuring R&D costs, ensuring that these policies are applied uniformly across all projects. This consistency not only aids in internal financial management but also enhances the comparability of financial statements over time, providing stakeholders with a reliable basis for evaluating the company’s performance. Company A partners with Investor B, an unrelated financial investor, for the development of selected compounds that are in Phase II development.
Amortisation must only begin when commercial production has commenced (hence matching the income and expenditure to the period in which it relates). Treatment of capitalised development costs SSAP 13 requires that where development costs are recognised as an asset, they should be amortised over the periods expected to benefit from them. Amortisation should begin only once commercial production has started or when the developed product or service comes into use. So far we have established that expenditure on R&D can fall into the category of intangible assets. Under UK accounting standards, intangible assets are accounted for using the rules from FRS 10, Goodwill and Intangibles.
- Investor B will not be repaid if the compounds are not successfully developed (i.e., the transfer of financial risk for the research and development is substantive).
- IFRS also emphasizes the importance of impairment testing for capitalized development costs.
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- The plant and facility will be used to produce the device, at commercially viable levels, once regulatory approval has been obtained.
However, this approach requires careful consideration of the amortization period and the potential for future impairments, which can affect long-term profitability. On the other hand, expensing R&D costs reduces EBITDA, providing a more conservative view of current profitability but potentially understating the company’s future earnings capacity. If at any point Company A does not expect the goods to be delivered, the capitalized prepayment should be charged to expense.
ASC 808, Collaborative Arrangements, provides guidance on reporting requirements and income statement classification for transactions between participants in a collaborative arrangement. Guidance related to determining whether a liability exists for research and development funding arrangements is provided in ASC 730–20, Research and Development Arrangements. In this example, Company A has no explicit or implicit obligation to repay any of the funds and therefore determines that the arrangement is an obligation to perform contractual research and development services. If Company A exercised the buy-back option, it would reacquire the rights to commercialize the intangible asset. Since exercisability of the buy-back option is only triggered upon regulatory approval, the payment made by Company A to reacquire the rights would be capitalized when the option is exercised and then amortized over the useful life of the right.
While the definition of what constitutes ‘research’ versus ‘development’ is very similar between IFRS and US GAAP, neither provides a bright line on separating the two. Instead, a company needs to develop processes and controls that allow it to make that distinction based on the nature of different activities. Countries like Canada and the United Kingdom offer generous R&D tax incentives, which can include refundable tax credits or enhanced deductions. In Canada, the Scientific Research and Experimental Development (SR&ED) program provides tax credits that can be refunded even if the company is not currently profitable, offering a lifeline to startups and smaller firms. The UK’s R&D Tax Relief program allows companies to deduct a significant portion of their R&D costs from their taxable income, with additional benefits for small and medium-sized enterprises (SMEs).
The plant and facility will be used to produce the device, at commercially viable levels, once regulatory approval has been obtained. Even though R&D can be an intangible asset in the UK, accounting for R&D is governed by its own accounting standard – SSAP 13, Accounting for Research and Development. Expect future articles addressing the definition of a business under finalized amendments to IFRS and any differences from US GAAP, and the accounting for IPR&D. Receive the latest financial reporting and accounting updates with our newsletters and more delivered to your inbox. In-depth analysis, examples and insights to give you an advantage in understanding the requirements and implications of financial reporting issues. KPMG’s multi-disciplinary approach and deep, practical industry knowledge help clients meet challenges and respond to opportunities.
For government-sponsored research and development grants, the AICPA industry guide, Audits of Federal Government Contractors, addresses the accounting for certain best-efforts research and development cost-sharing arrangements. Company A, a commercial laboratory, is manufacturing a stock of 20,000 doses (trial batches) of a newly-developed drug using various raw materials. The doses can only be used in patient trials during Phase III clinical testing, and cannot be used for any other purpose. The agreement stipulates that Company A will be permitted to use Company B’s technology in its own facilities for a period of three years. Company A will make a non-refundable payment of $3 million to Company B for access to the technology.
