Unit 13 Financial Reporting Solution Assignment

Research and Development accounting

Introduction

The present era is the commercial world where the monetary transactions and other activities of commercial nature are very crucial for any business entity or organization. As a result more emphasis is being laid on the accurate and fair reporting of these financial transactions used by the users of financial information as the stakeholders of business to make decisions commercially and in a rational manner. This Financial reporting assignment is done on the basis of legal and regulatory reporting applicable to the particular business or entity. It has been observed in the recent years that R&D expenses are being reported at a relatively larger amount. This report evaluates the reporting framework in UK as well as internationally for R&D treatment by making recommendation for better approach using examples.

Definition of R&D

Research and development refers to as the undertaking of activities by a business which aims at investigation of certain fats and evidences with the objective of improving existing products or services and procedures of the business or to develop and launch new proposed products and services. The research of the technological aspects and methods is being conducted and the results and findings are applied for development.

Accounting predicament

This relates to the recording of expenditure incurred by the business or entity for the purpose of research and development in the books of accounts. The accounting of research and development expense depends on the nature of expense whether it is capital expense or revenue expense. The capital expenditure on research and development it can be recognised as an intangible asset if certain specified criteria for the same are met, otherwise it is treated as revenue expense and is charged from profit and loss for the year in which it is incurred by the business. The accounting treatment of research and development expense of both capital and revenue nature is prescribed under the accounting standards through UK GAAP (SSAP 13) at UK level and IAS 38 at international level. In statement of profit and loss research and development expenditure is charged as expense under the head extra-ordinary items whereas in Balance Sheet it is included under the head ‘Intangible Assets’ under the head Fixed Assets. The capitalised amount can be amortized during the life of the intangible asset and is charged from profit or loss every year under the head ‘Depreciation and Amortization expense’. The basis to decide that whether such cost shall be treated as an asset or expense is that economic benefit arise to the entity as a result of incurring such costs. The R&D cost contains two elements which have different accounting treatment viz. research expenses and development expense (Berry & Jarvis, 2011). The following example illustrates the bifurcation of these costs into expense and asset:

Treatment of R&D under UK GAAP (SSAP 13)        

This accounting framework divides the R&D cost into three categories which are pure research, applied research and development. These three elements have three different treatments due to the nature of these costs and economic benefits they are expected to result. As per the accrual concept, the treatment of expense related to the pure research and applied research phase is made by charging it as expense in the profit and loss account since it will not result in future economic benefits for the business. The mount incurred in the development phase can be capitalised as intangible asset only if the expense meets the prescribed specifications (Atrill & McLaney, 2013). The amount of development expense can be deferred only to the extent up to which the recovery of such expense in the form of monetary benefits is assured. If the recovery of such expense is not reasonable the expense is treated as revenue expense and is charged from profit and loss account.

Treatment of R&D under International Accounting Standard (IAS 38)

The IAS 398 divides the R&D costs in two categories research phase and development phase. The costs incurred in the research phase cannot be capitalised and they are recognised as expense in the books as and when they are incurred by the business (Alexendra & Britton, 2014). The amount of expense incurred during the development phase of the intangible asset can be recognised as capital asset under the head intangible asset and the amount can be amortized during the life of such asset only if all the following criteria are met by the business or entity:

• It is technically feasible to complete the asset and the entity has the intention to complete the asset for its future use or resale purpose.
• The intangible asset will generate future economic benefits for the small business.
• The entity has sufficient technical, financial and other resources to complete the development processor to use or sell the intangible asset developed.
• The expenditure incurred for or attributable to the development of asset could be reliably measured

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Evaluation of better approach

Both the approaches suggest he same treatment for the cost incurred during the research phase of intangible asset development or research expenditure which is to recognise the expense as and when it is incurred in accordance with the accrual concept of accounting. In relation to the expense incurred for the development phase, there is a slight difference in the treatment specified under UK GAAP and IAS. The UK GAAP (SSAP 13) suggests the treatment of development expense as intangible asset if it results in future economic benefits whereas IAS 38 suggest meeting of many other specifications also for the qualification of development expense as intangible asset and its deferment in future years.

The amount incurred for the development expense is a very high amount and thus its proper reporting and chargeability in the books of accounts of company may create a huge impact on the profits and financial resources position of the company. Therefore the reliability in terms of measurement and expected future benefits along with the intention of the business to use the intangible asset and its capability to develop the intangible asset fully shall also be considered while deciding about the treatment of the development expense. Hence the approach used under IAS 38 can be considered better since it specifies more criteria for capitalising the amount of development expense which ensures accurate and fair reporting (Walton & Walter, 2013).

For example, if a company incurs £150,000 as development expense for development of its existing product which is a drug and it is expected that this drug can be used as a substitute for high cost medicines, then it is reasonable that this will result in future economic benefits to the company. But if the company does not possess the technical equipment which can be used for manufacturing medicine from such drug or if the government bans the manufacturing of such medicine by using this drug, the future economic benefits will not arise. In this case the capitalization made under the suggested treatment of UK GAAP cannot be considered correct. Thus IAS 38 suggests a better approach.

Conclusion

From the analysis and evaluation of the two approaches for recognising and amortizing the R&D expense under UK GAAP and IAS, it can be concluded that the treatment method and criteria suggested by IAS 8 is more relevant and appropriate as illustrated from the example of development expense incurred for preparing a drug which can be used for producing low cost medicine.

References

Alexandra, D. & Britton, A. (2014). International Financial Reporting and Analysis. Andover: South-Western Cengage Learning. Retrieved from http://lib.myilibrary.com/ProductDetail.aspx?id=549474
Berry, A. & Jarvis, R. (2011). Accounting in a Business Context. South-Western Cengage Learning. Retrieved from http:// http://lib.myilibrary.com/ProductDetail.aspx?id=328474
Walton, P. & Walter, A. (2013). Global Financial Accounting and Reporting: Principles and Analysis. Andover: South-Western Cengage Learning. Retrieved from http://lib.myilibrary.com/ProductDetail.aspx?id=458683