GAAP Review Series - Part 3

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: 

• Understand FASB standards that impact research and development activities for computer software, share-based compensation, pension plans and postretirement and postemployment benefits
• Apply recent FASB pronouncements for these selected areas
• Prepare disclosures related to these selected areas

Prerequisite:  Experience in financial reporting.

Also available in the GAAP Review Series:

• Part 1
• Part 2
• Part 4

Chapter 1

Accounting for Research and Development Activities and for Computer Software

Learning Objectives

After completing this chapter you will be able to

• Identify research and development activities.
• Determine whether research and development costs should be expensed or capitalized.
• Account for research and development arrangements in which a company receives funding.
• Account for research and development arrangements in which a company loans and advances funds for the research activity.
• Classify computer software costs.
• Measure computer software costs.
• Determine the amount of software revenue to be recognized.
• Understand the impact of computer software costs on financial reports.

Introduction

SFAS No. 2 – Accounting for Research and Development Costs

SFAS No. 2, Accounting for Research and Development Costs, 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

SFAS No. 68 – Research and Development Arrangements

SFAS No. 68, Research and Development Arrangements, 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 unrelated enterprises, by the entities funding the research, or by the enterprise. The standard does not apply to research and development arrangements sponsored by a governmental agency.

SFAS No. 86 – Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed

SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, 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. SFAS No. 86 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

SFAS No. 2, Accounting for Research and Development Costs, 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 SFAS No. 2 does not apply to &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. R

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.

SFAS No. 2 defines research as"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 or a new process or technique or in bringing about a significant improvement to an existing product or process." Development is defined as "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" (paragraph 8).

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; trouble- shooting 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 (paragraph 12). 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 is research and development costs.

If research and development activities are ongoing when a business combination is consummated using the purchase method, FASB Interpretation No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method, specifies the proper accounting. The provisions of SFAS No. 141, Business Combinations, should be used to value the research and development assets, and the provisions of SFAS No. 2 should be used to account for the research and development assets acquired in the combination.

Note. In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 (an entity may not apply it before that date). SFAS No. 141(R) supersedes FASB Interpretation No. 4. SFAS No. 141(R) requires an acquirer to recognize all tangible and intangible research and development assets acquired in a business combination. Previously, FASB Interpretation No. 4 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 (paragraph 13).

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