Research and Development
1. Define the terms “research” and “development.”
2. Indicate the problem that uncertainty creates in reporting research and development costs.
3. Understand the method by which research and development costs are handled in financial accounting as has been established by U.S. GAAP.
4. Explain the advantages of handling research and development costs in the required manner.
5. Recognize that many companies will report asset balances that are vastly understated as a result of the official handling of research and development costs.
Question: Many companies create internally developed
intangibles such as copyrights and trademarks. As has been mentioned previously, the historical cost for such
assets is often relatively small, almost inconsequential. However, monetary amounts spent to arrive at ideas
that can be turned into new types of marketable products are often enormous. Such expenditures are essential
to the future success of many companies. In 2008 alone, Intel reported spending $5.7 billion on research and
development in hopes of discovering new products to patent and sell. During the same one-year period, Bristol-
Myers Squibb incurred costs of $3.6 billion on research and development. Those are clearly not inconsequential
amounts. What is meant by the term “research”? What is meant by the term “development”? If a company
such as Intel or Bristol-Myers Squibb spends billions on research and development each year, what accounting
is appropriate? Should the company recognize an asset or an expense or some combination? The outcome is
uncertain, but the money was spent under the assumption that future economic benefits would be derived.
For example, assume that a technological company or a pharmaceutical company spends $1 million in Year
One to do research on Future Product A. The company then spends another $1 million during the period on
development costs for Future Product A. At the end of the year, officials believe that a patent is 80 percent likely
for Future Product A. If received, sales can be made. During that time, the company also spends another $1
million in research and $1 million in development in connection with Future Product B. However, at year’s end,
the same officials are less optimistic about these results. They believe that only a 30 percent chance exists that this
second product will ever receive a patent so that it can be used to generate revenues. According to U.S. GAAP,
what reporting is appropriate for the cost of these two projects?
Answer: Research is an attempt made to find new knowledge with the hope that the results will eventually
be useful in creating new products or services or significant improvements in existing products or services.
Development is the natural next step. It is the translation of that new knowledge into actual products or services
or into significant improvements in existing products or services. In simple terms, research is the search for new
ideas; development is the process of turning those ideas into saleable products.
Reporting research and development costs poses incredibly difficult challenges for accountants. As can be seen
with Intel and Bristol-Myers Squibb, such costs are often massive because of the importance of new ideas and
products to the future of many organizations. Unfortunately, significant uncertainty is inherent in virtually all such
projects. The probability of success can be difficult to determine for years and is open to manipulation for most of
that time. Often the only piece of information that is known with certainty is the amount that has been spent.
Thus, except for some relatively minor exceptions, all research and development costs are expensed as incurred
according to U.S. GAAP (FASB, 1974). The probability for success is not viewed as relevant to this reporting.
Standardization is very apparent. All companies provide the same information in the same manner. The total cost
incurred each period for research and development appears on the income statement as an expense regardless of
the chance for success.
