Learning Outcomes
After studying this article, you will be able to explain the distinction between research and development activities under IAS 38, identify the criteria for recognising internally generated intangible assets, and distinguish which costs are capitalised or expensed. You will also be able to apply these recognition rules to exam-style scenarios and avoid common pitfalls in ACCA Financial Reporting questions.
ACCA Financial Reporting (FR) Syllabus
For ACCA Financial Reporting (FR), you are required to understand how intangible assets are accounted for according to IAS 38. In particular, focus your revision on:
- The definition and recognition of intangible assets
- The difference between research and development expenditure
- The specific criteria for capitalising development costs
- The initial and subsequent measurement requirements for intangible assets
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Which stage—research or development—allows for the capitalisation of costs as an intangible asset under IAS 38?
- List three of the six criteria that must be met before development expenditure may be recognised as an intangible asset.
- True or false? Expenditure on research activities is always written off to the statement of profit or loss.
- A company spends $200,000 on testing a new process before deciding to proceed with commercial production. How should this expenditure be treated?
Introduction
IAS 38 Intangible Assets sets the standards for recognising and measuring intangible assets, including those developed internally. Understanding how to distinguish between research and development phases, and knowing when (and how) to recognise costs as an asset, is regularly examined in ACCA FR. Candidates must know the six recognition criteria for development costs and be able to apply them to typical exam scenarios.
Key Term: intangible asset
An identifiable non-monetary asset without physical substance, controlled by the entity, from which future economic benefits are expected to flow.
The Nature of Intangible Assets
Intangible assets include examples such as software, patents, trademarks, licences, and brand names. Their defining features are a lack of physical form and the expectation of future economic benefit.
IAS 38 requires assets to be identifiable, meaning they are either separable (can be sold or transferred) or arise from contractual or legal rights.
Key Term: identifiable
An asset is identifiable if it is separable or arises from contractual or other legal rights.
Internally Generated Intangible Assets
Most internally generated intangibles—such as brands, mastheads, or customer lists—cannot be recognised because their costs cannot be distinguished from running the overall business. The major exception is development expenditure, if strict criteria are satisfied.
Research vs Development
IAS 38 separates internal projects into two sequential phases:
- Research phase: Activities aimed at gaining new knowledge or understanding without a specific commercial application in place.
- Development phase: Application of research findings to produce new or substantially improved products or processes prior to commercial production or use.
Key Term: research
Original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.Key Term: development
Application of research findings or other knowledge to a plan or design for the production of new or substantially improved products or processes before commercial production or use.
Accounting Treatment: Research and Development
- Research expenditure: Always expensed as incurred in the statement of profit or loss. Never capitalised as an asset.
- Development expenditure: Can only be capitalised as an intangible asset if, and only if, all recognition criteria are met.
Key Term: capitalise
To recognise an expenditure as part of the cost of an asset in the statement of financial position rather than expensing it immediately.
IAS 38 Criteria for Recognising Development Costs
IAS 38 states there are six recognition criteria. All must be met:
- Technical feasibility: Completion of the intangible asset is technically feasible so it will be available for use or sale.
- Intention to complete: The entity intends to complete the asset and use or sell it.
- Ability to use or sell: The entity has the ability to use or sell the asset.
- Probable future economic benefits: The asset will generate probable future economic benefits (e.g., by demonstrating potential market or internal utility).
- Adequate resources: The entity has sufficient technical, financial, and other resources to complete the development and to use or sell the asset.
- Reliable measurement: Expenditure attributable to development can be measured reliably.
If any criterion is not met, costs must be expensed as incurred. Any amount written off cannot later be reinstated as an asset, even if criteria are subsequently met.
Exam Warning A common mistake in the FR exam is capitalising research costs or development costs before all six criteria have been satisfied. The examiner will look for clear application of the correct criteria—ensure you cite them.
Worked Example 1.1
Scenario:
Nova Co is designing a new product. In Year 1, they spent $80,000 on initial investigations and feasibility studies. Management approved a development plan in Year 2, spending a further $150,000 on creating prototypes. The product launched in Year 3.
How should the $230,000 be treated in the financial statements?
Answer:
The $80,000 spent on investigations and feasibility studies is research expenditure, so is expensed in Year 1.
The $150,000 spent after project approval relates to development. If all six criteria were met when work began, the $150,000 is capitalised as an intangible asset and amortised from Year 3 onwards. If not all criteria were satisfied at the time, any expenditure prior to criteria being met is expensed.
Costs that Cannot Be Capitalised
Certain expenditures are always expensed, not capitalised:
- Research phase costs
- Staff training costs
- Marketing and promotional expenditure
- General overheads not directly attributable to development
- Expenditure incurred after commercial production has started
Worked Example 1.2
Scenario:
Beta Ltd incurs the following costs in developing new software:
- $120,000 on preliminary studies
- $350,000 on software development (after demonstrating technical feasibility and market demand)
- $40,000 on staff training to use the new software
- $90,000 on launching an advertising campaign
How should each cost be treated?
Answer:
Preliminary studies ($120,000) are research and must be expensed.
Software development ($350,000) may be capitalised as an intangible asset if all six criteria are met.
Staff training ($40,000) and advertising ($90,000) must both be expensed.
Initial and Subsequent Measurement
Recognised intangible assets are initially measured at cost. After initial recognition, a choice is permitted between the cost model (cost less amortisation and impairment) and, rarely, the revaluation model (if an active market exists).
Amortisation is charged over the useful life if the asset is considered to have one; if indefinite, perform annual impairment reviews instead.
Derecognition and Reinstatement of Expenses
Once development costs are expensed, they cannot be reinstated as assets in a later period, even if it becomes clear that the project is successful.
Common Exam Queries
-
Which costs can be capitalised when a development project starts in one year and the recognition criteria are not met until a later period?
Only costs incurred after all six criteria are demonstrably met can be capitalised. Earlier costs are written off. -
What about depreciation of plant used in development?
Depreciation on equipment used exclusively for a qualifying development project during the period when the criteria are met is capitalised as part of development costs.
Summary
IAS 38 draws a firm line between research and development phases. Expenditure incurred during research is always written off; development costs can only be capitalised once all six strict criteria are fulfilled. Correctly identifying and applying these rules is essential for producing financial statements that meet IFRS requirements and for exam success.
Key Point Checklist
This article has covered the following key knowledge points:
- Define "intangible asset" and explain what makes an asset identifiable under IAS 38
- Distinguish research and development phases for internally generated intangibles
- State the six IAS 38 recognition criteria required to capitalise development expenditure
- Identify which costs must be expensed and which can be capitalised
- Explain that costs expensed in prior periods cannot be later reinstated as assets
Key Terms and Concepts
- intangible asset
- identifiable
- research
- development
- capitalise