Question

CA12.4 (LOS) 1filhQMJ (Accounting for Research and Development Costs)

Cuevas Co. is in the process of developing a revolutionary new product. A new division of the company was formed to develop, manufacture, and market this new product. As of year-end (December 31, 2019), the new product has not been manufactured for resale ( economic viability has not been achieved). However, a prototype unit was built and is in operation.

Throughout 2019, the new division incurred certain costs. These costs include design and engineering studies, prototype manufacturing costs, administrative expenses (including salaries of administrative personnel), and market research costs. In addition, approximately €900,000 in equipment (with an estimated useful life of 10 years) was purchased for use in developing and manufacturing the new product. Approximately €315,000 of this equipment was built specifically for the design development of the new product. The remaining €585,000 of equipment \Vas used to manufacture the pre-production prototype and will be used to manufacture the new product once it is in commercial production.

Instructions

a. How are "research" and "development" defined in IFRS?

b. Briefly indicate the practical and conceptual reasons for the conclusion reached by the IASB on accounting and reporting practices for research and development costs.

c. In accordance with IFRS, how should the various costs of Cuevas describe above be recorded on the financial statements for the year ended December 31, 2019?

d. Discuss the importance of economic viability as it relates to research and development cost accounting.

Answer 1

A)

As per IAS 38.54, research cost is to be treated as an expense. Any expense made in research work is considered as an expense for the business.

Development costs have a condition which needs to be fulfilled to capitalise them. The asset created in development must have technical and commercial feasibility of selling or using the asset. Therefore, it is required that the entity is intending to complete the development of the asset and it is going to be used or sold for future economic benefits.

There are two phases out which, the intangible asset needs to be identified whether it is the research phase or development phase.

The Research Phase:

It is the phase in which the entity cannot possess any intangible asset or create an intangible asset out of it.

The intangible asset never exist or be raised out of the research activities and thus, the activities remain solely as the contributory to obtaining knowledge or searching and selecting applications, theories, materials, devices or designs etc.

The Development Phase:

In this phase, the intangible asset is created or raised out of the activities related to it. However, the asset can only be considered for the application of IAS 38 and treatment of expense in capital nature for the development phase when certain conditions are met:

This includes:

1. The Technical feasibility of creating the intangible asset and its future use or sale of it.
2. The activities related to Development needs to have the intention of completing it and putting it to use or sell.
3. Though the intention is genuine, it is also needed that the intangible asset is able to be used for the business.
4. The projection of internal or external need, usability and positive outcomes of such intangible asset.
5. Availability of resources including financial, technical and other to create it and also to put to use or sell.
6. Such asset has identifiable and reliable measures to recognise the expense attached to its development.

Such development activities include designing, constructing, testing prototypes, tools or using new technology to make dies, moulds, models. Designing, constructing, operating a pilot project for experiment and not for commercial operation also considered being development activity.