The basis of R&D accounting is that all relevant expenditure should be treated as incurred. You should include most of them in your income statement and show them as operating expenses. The exception is software development costs, as there is the option for these to be capitalised as an Intangible asset.
- Treat the wages and benefits of staff, supervisors, managers and support staff working exclusively on R&D projects as incurred expenses.
- In addition, taxpayers will need to determine an appropriate methodology to identify and allocate costs that are incurred incident to the research.
- R&D amortization for a mobile phone company, however, should be amortized much faster (a smaller number of years) since new phones tend to emerge much more quickly and, thus, come with shorter shelf lives.
- Company A entered into a collaboration arrangement with Company B. Company A paid Company B an upfront fee upon signing the arrangement and will pay Company B a discrete milestone payment of $2 million upon FDA approval.
- As seen previously, the UK allows a choice over capitalisation; this can lead to inconsistencies between companies and, as some of the criteria are subjective, this ‘choice’ can be manipulated by companies wishing to capitalise development costs.
- These are the main categories of R&D expenditure, with an indication of their accounting treatment if they have an alternative future use.
By utilizing the strategies discussed in this article, research and development teams can reduce costs while still achieving their desired results. Additionally, automating analysis processes such as statistical modeling or predictive analytics allows teams to gain insights faster than ever before, helping them make better decisions quickly and efficiently. Download CFI’s Excel template to advance your finance knowledge and perform better financial analysis. Company A has obtained a loan from Company B, another pharmaceutical company, to finance the late-stage development of a drug to treat cancer. Company A enters into a contract research arrangement with Company B. Company B will perform research on a library of molecules and will catalogue the research results in a database.
What Are Product Development Strategies?
Utilizing outsourcing solutions to cut down on labor-intensive tasks can also be beneficial for reducing expenses. Accounting for research and development (R&D) expenses requires careful consideration due to their impact on cash flow statements (accrual vs. cash basis accounting) as well as taxation rules (capitalizing vs. expensing). Company A has appointed Company B, an independent third party, to develop an existing compound owned by Company A on its behalf. Company B will act purely as a service provider without taking any risks during the development phase and will have no further involvement after regulatory approval. Company B will not participate in any marketing or production arrangements. Company A will make a $2 million non-refundable payments to Company B on signing the agreement, and an additional payment of $3 million on successful completion of Phase II testing.
A business using the accrual method of accounting will treat R&D costs as expenses. A business contracted to undertake R&D for another company might treat it as an operational cost. If that business retains an element of financial risk, however, both operational costs and R&D expenses can be involved. Under U.S. GAAP, the majority of research and development costs (R&D) must be expensed in the current period due to the uncertainty surrounding any future economic benefit.
Capitalizing vs Expensing Taxation
In such instance, Company A should capitalize the milestone payment and amortize it over the performance period in a pattern consistent with the pattern of underlying performance. Company A engages a contract research organization (CRO) to perform research activities for a period of two years in connection research and development accounting with a drug compound related to the treatment of HIV. The CRO is well known in the industry for having modern facilities and good practitioners dedicated to investigation. Company A pays the CRO a non-refundable, upfront payment of $3 million in order to carry out the research under the agreement.
