Research and Development Defined
Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.
Development is the application of research findings to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems, or services, before the start of commercial production or use.
Reporting R&D Costs
R&D costs may be expensed. A cost which cannot be deducted in the year in which it is paid or incurred must be capitalized. The general rule is that if the acquired property's useful life is longer than the taxable year, then the cost must be capitalized. The capital expenditure costs are then amortized or depreciated over the life of the asset. Choice of the appropriate accounting treatment for such costs should be guided by the degree of certainty of future benefits and the principle of matching revenues and expenses.
Some companies conduct R&D activities for other entities under a contractual arrangement. In this case, the contract usually specifies that all direct costs, certain specific indirect costs, plus a profit element, should be reimbursed to the enterprise performing the R&D work. Because reimbursement is expected, such R&D costs should be recorded as a receivable. It is the company for whom the work has been performed that reports these costs as R&D and expenses them as incurred.
It should be emphasized that R&D activities do not include routine or periodic alternatives to existing products, production lines, manufacturing processes, and other ongoing operations even though these alterations may represent improvements. For example, routine ongoing efforts to refine, enrich, or improve the qualities of an existing product are not considered R&D activities.
Reporting R&D Activities
The costs associated with R&D activities and the accounting treatment accorded them are as follows: expense the entire costs, unless the items have alternative future uses (in other R&D projects or otherwise), then carry as inventory and allocate as consumed, or capitalize and depreciate as used.