Wednesday, March 6, 2013


PAS 38, paragraph 52, provides that to assess whether an internally generated intangible asset meets the criteria for recognition, an entity classifies the generation of the asset into a research phase and a development phase.
Research is original and planned investigation undertaken with the prospect of gaining scientific or technical knowledge and understanding.
Otherwise stated, a research activity is undertaken to discover new knowledge that will be useful in developing new product or that will result in significant improvement of existing product.
Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved material, device, product, process, system or service, prior to the commencement of commercial production.
Simply stated, a development activity involves the application of research findings to develop a new product.
Paragraph 53 provides that if an entity cannot distinguish the research phase from the development phase, the entity shall treat the expenditure as if it were incurred in the research phase only.
Research activities include:
  1. a.       Laboratory research aimed at discovering or obtaining new knowledge.
  2. b.      Searching for application of research finding and other knowledge.
  3. c.       Conceptual formulation and design of possible product or process alternatives
  4. d.      Testing in search or evaluation of product or process alternatives. 
Development activities include:
  1. Design, construction and testing of preproduction prototypes and models
  2. Design of tools, jigs, molds and dies involving new technology
  3. Design, construction and operation of a pilot plant that is not of scale economically feasible for commercial production
  4. Design, construction and testing of a chosen alternative for new or improved product or process
Normally, research and development activities occur prior to the beginning of commercial production and distribution of product or process.
Examples of activities that relate to commercial production do not result to research and development activities include:
  1. Engineering follow through in an early phase of commercial production
  2. Quality control during commercial production including routine testing
  3. Trouble shooting in connection with breakdowns during production
  4. Routine on-going efforts to refine, enrich or improve qualities of existing product
  5. Adaptation of an existing capability to a particular requirement or customer need
  6. Periodic design changes to existing products
  7. Routine design tools, jigs, molds and dies
  8. Activity, including design and construction engineering, related to construction, relocation, rearrangement or start up of facilities and equipment.
PAS 38, paragraph 54, provides that no intangible asset arising from research or from the research phase of an internal project shall be recognized.
In other words, expenditure on research or on the research phase of an internal project shall be recognized as expense when it is incurred.
The reason is that at the research phase of a project, an entity cannot be certain that future economic benefits would probably flow the entity.
At the research phase, an entity cannot demonstrate that an intangible asset exists that will generate probable future economic benefits.
In contrast, development cost is incurred at a later stage in a project and the probability of success may be more apparent.
Accordingly, development cost may be expensed or capitalized depending on whether certain criteria or conditions are met.
Thus development cost may qualify as intangible asset if and only if the entity can demonstrate all of the following:
  1. The technical feasibility of completing the intangible asset so that it will be available for use or sale.
This is achieved when a prototype or model is produced.
The entity has completed the testing of the model and it is now convinced that it has a product to sell or use that is significantly better than any other product available in the market. The entity plans to file a patent application for the product.
  1. The intention to complete the intangible asset and use or sell it.
  2. The ability to use or sell the intangible asset.
  3. How the intangible asset will generate probable future economic benefits. 
Among other things, the entity shall demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself.
  1. Availability of resources or funding to complete development and to use or sell the asset.
  2. The ability to measure reliably the expenditure attributable to the intangible asset during its development.
Explain the accounting for “acquired in-process R and D project”.
An in-process research and development project acquired separately or in a business combination is recognized as an asset cost, even if a component is research. 
Subsequent expenditure on that project is accounted for as any other research and development cost which may be expensed or capitalized depending on the recognition criteria for an intangible asset.
Accordingly, the subsequent expenditure is recognized as an expense if it is a research expenditure.
The subsequent expenditure is added to the carrying amount of the in-process research and development project if it is a development expenditure that satisfies the recognition criteria for an intangible asset.
Otherwise, the subsequent development expenditure is recognized as an expense.
The AICPA Financial Accounting Standards Board stipulated that expenditures for research and development which have alternative future use, either in additional research projects or for productive purposes, can be capitalized. 
This exception permits the deferral of costs incurred for materials, equipment, facilities and purchased intangibles related to research and development activities but only if an alternative future use can be identified. 
The cost of materials subsequently used, the depreciation on the equipment and facilities, and the amortization of the purchased intangibles would then be charged to research and development expense. 
 Cost incurred in creating an computer software product shall be charged to expense when incurred until a technical feasibility has been established for the product.
Actually, this the research stage where there is so much uncertainty about the future economic benefits. Accordingly, all the research costs shall be expensed outright.
As a minimum, technological feasibility is established, capitalizable software costs include the cost of coding and testing and the cost to produce masters. 
The costs incurred to actually produce the software from masters and package the software for sale shall be charged as inventory. 
The amortization method for a computer software shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.
If such pattern cannot be determined reliably, the straight line method is used.
  1. As a rule, computer software is classified as an intangible asset.
Under US GAAP, a computer software is classified as technology-based intangible asset.
  1. Computer software purchased for resale shall be treated as inventory.
  1. A computer software purchased as an integral part of a computer controlled machine tool that cannot operate without the specific software shall be treated as property, plant and equipment.
However, if the computer software is not an integral part of the related hardware, if it classified as an intangible asset.
Under SIC 32, a web site that has been developed for the purpose of promoting and advertising an entity’s products and services does not meet the requirement to be recognized as an intangible asset.
Therefore, web site development cost shall be expensed when incurred. 

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