how an entity would apply these rules in practice.
1244 Chapter 17
Example 17.6: Research phase and development phase under IAS 38
Entity K is working on a project to create a database containing images and articles from newspapers around the
world, which it intends to sell to customers over the internet. K has identified the following stages in its project:
(a) Research stage – gaining the technical knowledge necessary to transfer images to customers and
assessing whether the project is feasible from a technological point of view;
(b) Development stage – performing market analysis to identify potential demand and customer
requirements; developing the ability to exploit the image capture technology including configuration of
the required database software and acquiring the required data to populate the database, designing the
customer interface and testing a prototype of the system; and
(c) Production stage – before and after the commercial launch of the service, debugging the system and
improving functionality to service higher user volumes; updating and managing the database to ensure
its currency.
The above can be summarised as follows:
Project
(a) Research stage
Commercial launch
(b) Development stage
(c) Production stage
IAS 38
Research phase
Development phase
31/12/2016
31/12/2017
31/12/2018
31/12/2019
The activities in the research stage included under (a) meet the definition of research under IAS 38 and would
be accounted for as part of the research phase of the project, as an expense.
The activities in the development stage included under (b) meet the definition of development under IAS 38.
However, whilst K has started to plan the commercial exploitation of its image and data capture technology, it will
not be immediately apparent that the project is economically viable. Until this point is reached, for example when
the entity has established there is demand for the database and it is likely that a working prototype of the system
will be available, the development activities cannot be distinguished from the research activities taking place at the
same time. Accordingly, the initial development activities are accounted for as if they were incurred in the research
phase. Only once it becomes possible to demonstrate the existence of an intangible asset that will generate future
income streams, can project expenditure be accounted for under IAS 38 as part of the development phase.
There may be a period after the commercial launch of the service that would still be accounted for as part of
the development phase. For example, activities to improve functionality to deal with higher actual customer
volumes could constitute development. This does not necessarily mean that K can capitalise all this
expenditure because it needs to pass the double hurdle of:
• the presumption in IAS 38.20 that ‘there are no additions to such an asset or replacements of part of it’;
and
• the six criteria in IAS 38.57 for recognition of development costs as an asset (see above).
Activity to ensure that the database is up-to-date is a routine process that does not involve major innovations
or new technologies. Therefore, these activities in the production stage do not meet the definition of ‘research’
or ‘development’ and the related costs are recognised as an expense.
As the above example illustrates, the guidance in IAS 38 seems to take a somewhat
restricted view as to how internally generated intangible assets are created and managed
in practice, as well as the types of internally generated intangible assets. It requires
Intangible
assets
1245
activity to be classified into research and development phases, but this analysis does not
easily fit with intangible assets that are created for use by the entity itself. The standard
therefore does not address the everyday reality for software companies, television
production companies, newspapers and data vendors that produce intangible assets in
industrial-scale routine processes.
Many of the intangible assets produced in routine processes (e.g. software, television
programmes, newspaper content and databases) meet the recognition criteria in the
standard, but no specific guidance is available that could help an entity in dealing with
the practical problems that arise when accounting for them.
Generally, entities disclose little detail of the nature of their research and development
activities and the costs that they incur, instead focusing on the requirements of IAS 38
that must be met before development expenditure can be capitalised.
Extract 17.5: L’Air Liquide S.A. (2017)
Accounting principles [extract]
5. NON-CURRENT
ASSETS
[extract]
b.
Research and Development expenditures
Research and Development expenditures include all costs related to the scientific and technical activities, patent work,
education and training necessary to ensure the development, manufacturing, start-up, and commercialization of new
or improved products or processes.
According to IAS 38, development costs shall be capitalized if, and only if, the Group can meet all of the following
criteria:
•
the project is clearly identified and the related costs are itemized and reliably monitored;
•
the technical and industrial feasibility of completing the project is demonstrated;
•
there is a clear intention to complete the project and to use or sell the intangible asset arising from it;
•
the Group has the ability to use or sell the intangible asset arising from the project;
•
the Group can demonstrate how the intangible asset will generate probable future economic benefits;
•
the Group has adequate technical, financial and other resources to complete the project and to use or sell the
intangible asset.
When these conditions are not satisfied, development costs generated by the Group are recognized as an expense
when incurred.
Research expenditure is recognized as an expense when incurred.
c.
Internally generated intangible assets
Internally generated intangible assets primarily include the development costs of information management systems.
These costs are capitalized only if they satisfy the criteria as defined by IAS 38 and described above.
Internal and external development costs on management information systems arising from the development phase are
capitalized. Significant maintenance and improvement costs are added to the initial cost of assets if they specifically
meet the capitalization criteria.
Internally generated intangible assets are amortized over their useful lives.
The difficulty in applying the IAS 38 recognition criteria for development costs in the
pharmaceutical industry are discussed further at 6.2.3 below. Technical and economic
feasibility are typically established very late in the process of developing a new product,
which means that usually only a small proportion of the development costs is capitalised.
1246 Chapter 17
When the development phase ends will also influence how the e
ntity recognises
revenue from the project. As noted at 4.4 above, during the development phase an entity
can only recognise income from incidental operations, being those not necessary to
develop the asset for its intended use, as revenue in profit or loss. [IAS 38.31]. During the
phase in which the activity is necessary to bring the intangible asset into its intended
use, any income should be deducted from the cost of the development asset. Examples
include income from the sale of samples produced during the testing of a new process
or from the sale of a production prototype. Only once it is determined that the intangible
asset is ready for its intended use would revenue be recognised from such activities. At
the same time capitalisation of costs would cease and the related costs of the revenue
generating activity would include a measure of amortisation of the asset.
6.2.3
Research and development in the pharmaceutical industry
Entities in the pharmaceutical industry consider research and development to be of
primary importance to their business. Consequently, these entities spend a considerable
amount on research and development every year and one might expect them to carry
significant internally generated development intangible assets on their statement of
financial position. However, their financial statements reveal that they often consider
the uncertainties in the development of pharmaceuticals to be too great to permit
capitalisation of development costs.
One of the problems is that, in the case of true ‘development’ activities in the pharmaceutical
industry, the final outcome can be uncertain and the technical and economic feasibility of
new products or processes is typically established very late in the development phase,
which means that only a small proportion of the total development costs can ever be
capitalised. In particular, many products and processes require approval by a regulator such
as the US Food and Drug Administration (FDA) before they can be applied commercially
and until that time the entity may be uncertain of their success. After approval, of course,
there is often relatively little in the way of further development expenditure.
In the pharmaceutical sector, the capitalisation of development costs for new products
or processes usually begins at the date on which the product or process receives
regulatory approval. In most cases that is the point when the IAS 38 criteria for
recognition of intangible assets are met. It is unlikely that these criteria will have been
met before approval is granted by the regulator.
Extracts 17.6 and 17.7 below illustrate some of the difficulty in applying the IAS 38
recognition criteria for development costs in the pharmaceutical industry.
Extract 17.6: Merck Kommanditgesellschaft auf Aktien (2017)
Notes to the Consolidated Financial Statements [extract]
(55) Research and development costs
Research and development costs comprise the costs of research departments and process development, the expenses
incurred as a result of research and development collaborations as well as the costs of clinical trials (both before and
after approval is granted).
The costs of research cannot be capitalized and are expensed in full in the period in which they are incurred. As
internally generated intangible assets, it is necessary to capitalize development expenses if the cost of the internally
generated intangible asset can be reliably determined and the asset can be expected to lead to future economic
Intangible
assets
1247
benefits. The condition for this is that the necessary resources are available for the development of the asset, technical feasibility of the asset is given, its completion and use are intended, and marketability is given. Owing to the high
risks up to the time that pharmaceutical products are approved, these criteria are not met in the Healthcare business
sector. Costs incurred after regulatory approval are usually insignificant and are therefore not recognized as intangible assets. In the Life Science and Performance Materials business sectors, development expenses are capitalized as soon
as the aforementioned criteria have been met.
Reimbursements for R&D are offset against research and development costs.
Extract 17.7: Bayer AG (2017)
Consolidated Financial Statements [extract]
Notes to the Consolidated Financial Statements of the Bayer Group [extract]
4 Basic principles, methods and critical accounting estimates [extract]
Research and development expenses
For accounting purposes, research expenses are defined as costs incurred for current or planned investigations
undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development
expenses are defined as costs incurred for the application of research findings or specialist knowledge to plans or
designs for the production, provision or development of new or substantially improved products, services or
processes, respectively, prior to the commencement of commercial production or use.
Research and development expenses are incurred in the Bayer Group for in-house research and development activities
as well as numerous research and development collaborations and alliances with third parties.
Research and development expenses mainly comprise the costs for active ingredient discovery, clinical studies,
research and development activities in the areas of application technology and engineering, field trials, regulatory
approvals and approval extensions.
Research costs cannot be capitalized. The conditions for capitalization of development costs are closely defined: a
key precondition for recognition of an intangible asset is that it is sufficiently certain that the development activity
will generate future cash flows that will cover the associated development costs. Since our own development projects
are often subject to regulatory approval procedures and other uncertainties, the conditions for the capitalization of
costs incurred before receipt of approvals are not normally satisfied.
In the case of research and development collaborations, a distinction is generally made between payments on contract
signature, upfront payments, milestone payments and cost reimbursements for work performed. If an intangible asset
(such as the right to the use of an active ingredient) is acquired in connection with any of these payment obligations,
the respective payment is capitalized even if it is uncertain whether further development work will ultimately lead to
the production of a saleable product. Reimbursements of the cost of research or development work are recognized in
profit or loss, except where they are required to be capitalized.
6.2.4
Internally generated brands, mastheads, publishing titles and customer
lists
IAS 38 considers internally generated brands, mastheads, publishing titles, customer
lists and items similar in substance to be indistinguishable from the cost of
developing a business as a whole so it prohibits their recognition. [IAS 38.63-64]. As
discussed at 3.3 above, the same applies to subsequent expenditures incurred in
connection with such intangible assets even when originally acquired externally.
[IAS 38.20]. For example, expenditure incurred in redesigning the layout of
newspapers or magazines, which represent subsequent expenditure on publis
hing
titles and mastheads, should not be capitalised.
1248 Chapter 17
6.2.5
Website costs (SIC-32)
SIC-32 clarifies how IAS 38 applies to costs in relation to websites designed for use by
the entity in its business. An entity’s own website that arises from development and is
for internal or external access is an internally generated intangible asset under the
standard. [SIC-32.7]. A website designed for external access may be used for various
purposes such as to promote and advertise an entity’s own products and services,
provide electronic services to customers, and sell products and services. A website may
be used within the entity to give staff access to company policies and customer details,
and allow them to search relevant information. [SIC-32.1].
SIC-32 does not apply to items that are accounted for under another standard, such as the
development or operation of a website (or website software) for sale to another entity
(IAS 2 and IFRS 15); acquiring or developing hardware supporting a website (IAS 16); or in
determining the initial recognition of an asset for a website subject to a leasing arrangement
(IFRS 16). However, the Interpretation should be applied by lessors providing a web site
under an operating lease and by lessees considering the treatment of subsequent
expenditure relating to a web site asset leased under a finance lease, [SIC-32.5-6], because the
related website asset will be carried on the entity’s statement of financial position.
Under SIC-32, an intangible asset should be recognised for website development costs if
and only if, it meets the general recognition requirements in IAS 38 (see 3.1 above) and the
six conditions for recognition as development costs (see 6.2.2 above). Most important of
these is the requirement to demonstrate how the website will generate probable future
economic benefits. [SIC-32.8]. The Interpretation deems an entity unable to demonstrate this
for a website developed solely or primarily for promoting and advertising its own products
and services. All expenditure on developing such a website should be recognised as an
expense when incurred. Accordingly, it is unlikely that costs will be eligible for capitalisation
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 246
