Question

Question 3

You have been given the following financial data of a research project from the chief researcher of Balloon Ltd:

$

Cost to date (pure research 25%, applied research 75%) 600,000

Cost to develop the product in 2018 900,000

Expected future sales per annum in 2019 3,000,000

Fixed assets purchased in 1 January 2018 for the project:

Cost 7,500,000

Estimated useful life 5 years

Residual value 120,000

The board of directors considers this project to be similar to other projects that the company has undertaken and is confident of a successful outcome.

The company has sufficient resources to complete development and has sufficient capacity to produce the product.

Required:

a Prepare a report to the board outlining the principles involved in accounting for research and development, and

showing what accounting entries need to be made in the financial year 2018.

b Explain what factors need to be taken into account when assessing a research and development project for accounting purposes and

what disclosures are needed for research and development in Balloon’s financial statements.

Answer 1

a. Under US Generally Accepted Accounting Principles (GAAP), Accounting Standards Codification (ASC) 730 - Research and Development, since future economic benefits are uncertain, it is generally difficult to classify R&D costs as asset(s).

The definition of Research and Development is given as below:

Research is planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be helpful in developing new product/service/process or technique or in bringing about a significant improvement to an existing product or process.

Development is the translation of research findings or other knowledge 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. It includes the following:

• conceptual formulation
• design and testing of product alternatives
• construction of prototypes, and operation of pilot plants

However, it does not include :

• routine or periodic alterations to existing products, production lines, manufacturing processes
• other on-going operations even though those alterations may represent improvements
• market research or market testing activities.

Under US GAAP, R&D Costs are expensed  as incurred until technological feasibility is established.

Hence, in Year 2018 following journal entries will be passed:

Research & Development Cost Dr. $1,500,000

To Cash $1,500,000

Disclosures about the nature and possible outcomes both expenses and revenue from R&D needs to be made in the financial statements, as a part of notes.