Research and Development Costs
The financial accounting term research and development costs refer to those expenses associated with investigations into new processes or techniques (research) and the translating of this information into new designs, products, or processes (development).
Companies are required to expense all research and development costs as incurred. If costs are incurred that provide a tangible future benefit, they should be capitalized and depreciated or amortized over their useful lives.
Generally, research and development are defined in the following manner, as part of the Financial Accounting Standards (FASB No. 2):
- Research: a planned search or study aimed at the discovery of new information with the hope that such knowledge will be useful in developing a new product or service, a new process or technique, or in bringing about a significant improvement to an existing product or process.
- Development: the translation of research findings or other information into a plan or design for a new product or process, or for a significant improvement to an existing product or process whether intended for sale or use.
The FASB goes on to state that development includes the conceptual formulation, design, and testing of product alternatives, construction of prototypes, and operation of pilot plants. It also defines what development does not include: routine or periodic alterations to existing products, production lines, manufacturing processes and other on-going operations.
The following guidelines apply unless the items have alternative future use. If so, the item would be capitalized and depreciated (tangible assets) or amortized (intangible assets):
- Materials, equipment, and facilities should be expensed as used, or placed into inventory and expense as consumed.
- Salaries, and other costs associated with personnel working on R&D projects should be expensed as incurred.
- Costs associated with contracts involving the use of professional R&D services should be expensed as incurred.
- If a purchased intangible asset, such as a patent, has alternative future use, it should be capitalized and amortized. If not, then intangibles should be expensed as purchased.
The definition of R&D costs explicitly excludes selling, general, and administrative expenses.