This GAAP Review Series is designed for the accountant or practitioner who needs a detailed review of standards that apply to nonspecialized companies. The series provides a comprehensive study of FASB Statements and Interpretations and APB Opinions that apply to all companies and presents implementation guidelines and disclosure illustrations.
GAAP Review Series — Part 3
Objectives:
Prerequisite: Experience in financial reporting.
Also available in the GAAP Review Series:
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Chapter 1 - Accounting for Research and Development Activities and for Computer Software
Learning Objectives
After completing this chapter you will be able to
• Understand the guidance in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 730, Research and Development (SFAS No. 2).
• Identify research and development activities and determine whether research and development costs should be expensed or capitalized.
• Account for research and development arrangements in which a company receives funding or loans and advances funds for the research activity.
• Classify and measure computer software costs.
• Determine the amount of software revenue to be recognized.
• Understand the impact of computer software costs on financial reports.
Introduction
Research and Development
FASB ASC 730, Research and Development (SFAS No. 2), applies to all companies that incur research and development costs, but it does not apply to the following:
• Research and development activities that are performed for other entities under contract
• Indirect costs that are reimbursable under a contract
• Unique activities in the extractive industries, such as prospecting and drilling
Research and Development Arrangements
FASB ASC 730 (SFAS No. 2) also applies to all companies that are parties to research and development arrangements in which funding is provided in total or in part by other entities. The actual research may be performed by the entity itself, unrelated entities, or by the entities funding the research. The guidance does not apply to research and development arrangements sponsored by a governmental agency.
Computer Software
FASB ASC 985, Software (SFAS No. 86), applies to all companies that develop or purchase computer software for the purpose of leasing, selling, or marketing in some form to other entities. The software may be marketed either as a separate product or as part of a product or process. This guidance does not apply to the following items:
• Computer software for internal use
• Computer software developed for others under a contractual arrangement
Module 1 – Research and Development Costs
FASB ASC 730, Research and Development (SFAS No. 2), provides generally accepted accounting principles for the proper accounting of research and development costs. The statement defines research and development and specifies what activities should be classified as research and development activities. In addition, the statement specifies when the cost of a research and development activity should be expensed and when it should be capitalized and amortized.
Note that this guidance does not apply to R&D activities performed for other entities under contract, indirect costs that are reimbursable under contract, or prospecting and drilling activities of natural resource extraction companies.
What Constitutes a Research and Development Activity
The definitions of research and development are critical because costs related to these activities generally must be expensed and they must be disclosed separately in the financial statements if material in amount. Other similar costs, e.g., many types of administrative activities, may be capitalized if they meet satisfy the definition of an asset.
The glossary to the FASB ASC defines Research and Development as follows:
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 (referred to as product) or a new process or technique (referred to as process) or in bringing about a significant improvement to an existing product or process.
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. Examples of research and development activities are efforts to discover new knowledge through laboratory research; preproduction prototypes design, construction, and testing; and product or process alternative test and/or evaluation.
Examples of activities not considered research and development are tool, jig, mold, and die design on a routine basis; existing product design changes that is seasonal or periodic; troubleshooting related to breakdowns during commercial production; and market research and testing.
Accounting for Research and Development Activities
Costs classified as research and development are expensed in the accounting period incurred. However, it may be difficult to determine when a cost is research and development. Listed below are examples of when selected costs are considered research and development costs:
• Expensed as Research and Development in Accounting Period Incurred
– Material and equipment with no alternative use
– Salaries and wages
– Intangible asset purchased from others with no alternative use
– Contract services provided by outside entities
– Reasonable allocation of overhead costs
• Capitalized and Amortized to Research and Development
– Material and equipment with an alternative use
– Intangibles purchased from others with an alternative use
If the asset has an alternative future use, the item is capitalized and the amortization or depreciation recognized as research and development costs.
If research and development activities are ongoing when a business combination is consummated using the acquisition method, an acquirer recognizes all tangible and intangible research and development assets acquired in the business combination. Prior guidance required an acquirer to measure and immediately expense tangible and intangible assets to be used in research and development that had no alternative future use. A research and development asset was recognized as such only if it had an alternative future use.
Disclosure Requirements
The total amount of research and development costs charged to income should be disclosed for each accounting period that an income statement is prepared.
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