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Are research and development costs capitalized or expensed?

Accounting for research and development costs will generally be expensed in the income statement unless there is alternative future use or if the company was hired to perform the research.

If there is an alternative future use, or the company was hired to perform the research, then those costs can be capitalized onto the balance sheet as a non-current asset and amortized over its useful life on a straight-line basis.

The whole point of capitalizing research and development costs is to match the expense incurred with the time period that the benefit is being enjoyed by the company. When we capitalize an expense, it removes the full burden of the expense from a particular period, and spreads the impact over the useful life.

Capitalizing Research and Development Costs

1) Alternative Future Use: Basically, this is just saying that a company would only incur research and development costs if they plan to create a product or service that will be able to generate value in the future. The product could be developed for internal use or it could be developed to sell to customers.

Assuming that there is alternative future use, not 100% of research and development costs can be capitalized. The rules vary depending on what stage the project is in.

Internal use: If the company is producing software intended for internal use, the company can only capitalize costs after the application development stage, and prior to it being ready for use by the company.

To be Sold: If the product is intended to be sold, the company can only capitalize costs incurred after technological feasibility is achieved and prior to the product being released for sale.

2) Contractual agreement: If the company is engaged by a 3rd party to perform research and development (e.g. pharmaceutical company), then the costs to be perform that work can be capitalized.

Expensing Research and Development Costs

R&D costs should be expensed if there not future benefit. Even if there is a future benefit, R&D costs should be expensed if they are incurred prior to the application development stage (internal use) or technological feasibility (to be sold) is achieved. Additionally, once the product is ready for use or can be released for sale, all costs incurred should be expensed.

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