Subtopics

ASC 730, Research and Development, contains two subtopics:

• ASC 730-10, Overall, which provides guidance on the activities, elements, costs, accounting, and disclosures for research and development
• ASC 730-20, Research and Development Arrangements, which provides guidance on arrangements used to finance research and development.

Scope and Scope Exception

ASC 730 applies to all entities and to “activities aimed at developing or significantly improving a product or service (referred to as product) or a process or technique (referred to as process) whether the product or process is intended for sale or use.” (ASC 710-30-15-3)

ASC 730 does not apply to:

• the costs of research and development activities conducted for others under a contractual arrangement,
• indirect costs,
• activities that are unique to entities in the extractive industries,
• a process for use in an entity's selling or administrative activities,
• routine alterations to existing products and processes,
• market research,
• research and development assets acquired in an acquisition by not-for-profit entity or business combination,
• internally developed computer software and costs incurred to purchase or use computer software unless it is intended for use with R&D activities.

  (ASC 730-10-15-4 and 5)

Note: the following is effective upon implementation of ASU 2014-09, Revenue from Contracts with Customers. ASC 730-20 does applies to arrangements for software development fully or partially funded by a party other than the vendor developing the software, and where technological feasibility has not been established. If the technological feasibility has been established, the guidance in ASC 730-20 does not apply. Neither does it apply to government research and development. (ASC 730-20-15-1A and 4)

Overview

ASC 730 addresses the proper accounting and reporting for research and development costs. It identifies:

• those activities that are to be identified as research and development,
• the elements of costs that shall be identified with research and development activities, the accounting for these costs, and
• the financial statement disclosures related to them.

  (ASC 730-10-05-1)

The central issue in regard to research and development costs is that the future benefits related to these expenditures are uncertain. Given this uncertainty, it is generally difficult to justify classifying them as an asset. Generally, entities should charge them to expense as incurred. (ASC 730-10-05- 2 and 3)

ASC 730-10, Research and Development—Overall

There are three ways in which R&D costs are incurred by a business:

1. Purchase of R&D from other entities
2. Conducting R&D for others under a contractual arrangement
3. Conducting R&D activities for the benefit of the reporting entity.

The accounting treatment relative to R&D depends upon the nature of the cost. R&D costs incurred in the ordinary course of operations consist of materials, equipment, facilities, personnel, and indirect costs that can be attributed to research or development activities. These costs are expensed in the period in which they are incurred unless they have alternative future uses. Examples of such R&D costs with alternative future uses include:

1. Laboratory research to discover new knowledge
2. Formulation and design of product alternatives:
   1. Testing for product alternatives
   2. Modification of products or processes
3. Preproduction prototypes and models:
   1. Tools, dies, etc. for new technology
   2. Pilot plants not capable of commercial production
4. Engineering activity until the product is ready for manufacture.

(ASC 730-10-55-1)

Examples of costs that are not considered R&D include:

1. Engineering during an early phase of commercial production
2. Quality control for commercial production
3. Troubleshooting during a commercial production breakdown
4. Routine, ongoing efforts to improve products
5. Adaptation of existing capacity for a specific customer or other requirements
6. Seasonal design changes to products
7. Routine design of tools, dies, etc.
8. Design, construction, startup, etc. of equipment except that used solely for R&D
9. Legal work related to patents or litigation.

   (ASC 730-10-55-2)

ASC 730-20, Research and Development Arrangements

In many cases, entities will pay other parties to perform R&D activities on their behalf. Substance over form must be used in evaluating these arrangements. A financial reporting result cannot be obtained indirectly if it would not have been permitted if accomplished directly. Thus, if costs are incurred to engage others to perform R&D activities that, in substance, could have been performed by the reporting entity itself, those costs must be expensed as incurred.

An alternative arrangement may consist of a business entering into a limited partnership where the limited partners provide funding and the business conducts the research under a contract with the partnership. Under such an arrangement, the partnership may retain legal ownership of the results of the research. The business may have an option to buy back the results of the research upon payment of a stipulated amount to the partnership.

On the other hand, if the payment is to acquire intangibles for use in R&D activities, and these assets have other uses, then the expenditure is capitalized and accounted for in accordance with ASC 350.

When R&D costs are incurred as a result of contractual arrangements, the nature of the agreement dictates the accounting treatment of the costs involved. The key determinant is the transfer of the risk associated with the R&D expenditures. Risk is not transferred to the other parties if there is a commitment by the business to repay the other parties. Examples of commitments to repay are:

• The entity guarantees repayment regardless of the outcome
• The other parties can require the entity to purchase their interests
• The other parties receive debt or equity securities issued by the entity upon completion of the project, irrespective of the outcome.

  (ASC 730-20-25-4)

If the business receives funds from another party to perform R&D and is obligated to repay those funds regardless of the outcome, a liability must be recorded and the R&D costs expensed as incurred. To conclude that a liability does not exist, the transfer of the financial risk must be substantive and genuine.