Development cost

From CEOpedia | Management online

Development costs are costs incurred for activities aimed at developing a company in many aspects. These can be amounts spent on research projects, patents and certificates, research and innovation. Development costs may be capitalized in the form of intangible assets if these activities were successful and a decision was made to implement them. Their return on income must be very probable. The key determinant of competitiveness and market expansion of an enterprise is not only the efficiency of its current (operational) control but also taking optimal strategic actions in terms of its innovativeness, which translates into the growth of the company. An important role in this area is played by research and development works, which often generate significant costs for the organization (I. Stamelos, 2003, pp. 729-741).

Sources of Development cost

Research work:

Industrial research activities are aimed at acquiring new knowledge and skills to develop new products, processes, and services or to bring about significant improvements in existing products, processes and services. Development activities, in turn, are the acquisition, combining, shaping and using existing scientific, technological and business knowledge and skills to plan production and create and design new, altered or improved products (processes, services), excluding work involving routine or periodic changes to products, production lines, manufacturing processes, existing services and other operations in progress, even if such changes may be of an improvement nature, and excluding work involving routine or periodic changes to products, production lines, manufacturing processes, existing services and other operations in progress, even if such changes may be of an improvement nature:

  • developing prototypes and pilot projects and demonstrating, testing and validating new or improved products (processes, services) in an environment of "real-world operating conditions" model with the primary objective of further technical improvement,
  • developing prototypes and pilot projects which can be used commercially where the prototype or pilot project is a final product, ready for commercial exploitation and too expensive to produce for demonstration and validation purposes only.

According to International Accounting Standards (IAS 38) Intangible Assets, research is an innovative and planned search for solutions, undertaken with the aim of acquiring and assimilating new scientific and technical knowledge. Development, on the other hand, is the practical application of research findings or other knowledge in planning or designing the production of new or substantially improved materials, equipment, products, processes, systems or services prior to the start of serial production or application (M. Jørgensen, M.J. Shepperd, 2007, pp. 33-53).

Development work:

Development work involves combining the results of research work with technical knowledge in order to introduce a new or modernized product, a new technology or a new organizational system into production. The systematic development work carried out shall be based on the existing knowledge obtained as a result of research activities and practical experience and shall aim at producing new materials, products or devices, initiating new and significant improvements in existing processes, systems and services (R. Lukić, et all., 2018, pp. 4-7). Businesses engaged in research and development typically carry out this activity alongside their core business. Examples include industrial companies with their own R&D facilities: laboratories, R&D facilities, and centers, research and technology departments, construction and technology offices, technology development facilities, study and design offices (M. Zakari, S. Saidu, 2017, pp. 2-5).

Development cost reduction

Entrepreneurs conducting research and development activity (i.e. creative activity, including scientific research or development works, undertaken in a systematic manner in order to increase knowledge resources and use knowledge resources to create new applications) are entitled to income tax reduction (J. Kuusisto, 2008, pp.15). A taxpayer earning revenue other than income from capital gains shall deduct from its tax base tax-deductible expenses incurred in research and development (hereinafter 'qualified expenses'). The amount deducted in a tax year shall not exceed the amount of income received by the taxpayer from income other than income from capital gains. In simplified terms, eligible costs include, inter alia:

  • Employee costs (salaries and surcharges),
  • materials and raw materials,
  • depreciation write-offs on fixed assets and intangible assets used in the research and development activity, excluding passenger cars and structures, buildings and premises, which are separate property.

The amount of the tax preference in question depends on the entrepreneur's status (determined on the basis of the criterion of its size) and the type of expenses incurred. Entrepreneurs conducting research and development activities, who intend to take advantage of the deduction, are obliged to separate the costs of this type of activity in their accounting books (J. Kuusisto, 2008, pp. 15-16).

Accounting of development costs

In accounting terms, research expenditure is recognized as an expense on the date it is incurred. These costs are not capitalized - at the stage of research, the company is not able to prove the existence of an intangible asset that will generate probable future economic benefits. On the other hand, the costs of successfully completed development works are classified as intangible assets, provided, however, that:

  • these costs were incurred for the enterprise's own needs (for the entrepreneur's business purposes), before the start of production or application of the technology,
  • the product or manufacturing technology was strictly defined and the development costs related to it were reliably determined,
  • the technical suitability of the product or technology has been established and documented and on this basis, the undertaking has decided to manufacture these products or to use the technology,
  • the costs of development work were covered, as expected, with revenues from the sale of these products or the use of technology.

At the stage of development works, the entity is able to prove the existence of an intangible asset that will generate probable future economic benefits. It can do so e.g. by proving the existence of a market for the products created by an intangible asset or for the asset itself, proving the usefulness of the asset if it is to serve the company itself, or by developing a business plan specifying the necessary technical and financial measures, as well as the entity's ability to provide them (O. Lome,et al.,2016,pp.65-77). As at the balance sheet date, the costs of successfully completed development works are subject to measurement at acquisition or production cost, less depreciation or amortization write-offs, as well as impairment losses (D.R. Oswald, et all., 2016, pp. 16-19).

Amortization of development costs

For balance sheet purposes, costs completed with a positive result of development works are written off over the period of their economic usefulness. If in exceptional cases it is not possible to reliably estimate the period of economic usefulness of the results of completed development works, then the period of making write-downs may not exceed five years. Such a fixed asset of a company is also subject to tax depreciation, which is a tax-deductible cost. Taking this into account requires that the costs of development work may be classified as tax-deductible costs as an alternative :

  • in the month in which they were incurred or starting from that month in equal parts in the period not longer than 12 months,
  • a one-off payment in the tax year in which it is completed,
  • through depreciation write-offs on intangible assets (C. K. Park, et all., 2014,pp. 107-111).

Examples of Development cost

  • Research and Development (R&D) Expenses: R&D expenses are the costs associated with researching and developing new products, processes, or services. This can include the cost of materials, labor, and overhead associated with these activities. Examples of R&D expenses include salaries, laboratory equipment, and software.
  • Product Development Costs: Product development costs are incurred when designing and testing new products. This includes costs such as salaries, materials, prototypes, and legal fees.
  • Design and Engineering Costs: Design and engineering costs are incurred when designing, engineering, and testing new products. This includes costs such as salaries, materials, prototypes, and legal fees.
  • Marketing and Advertising Costs: Marketing and advertising costs are incurred when promoting a product or service. This can include costs such as salaries, advertising, promotional materials, and digital marketing.
  • Training Costs: Training costs are costs associated with training staff or employees in order to keep them up to date on new products and processes. Examples of training costs include tuition and materials.
  • Licensing Fees: Licensing fees are costs associated with obtaining the rights to use a product or service. This can include costs such as license fees, legal fees, and other associated costs.

Advantages of Development cost

Development costs are an essential part of running a successful business, as they enable a company to stay ahead of the competition and remain innovative. The following are some of the advantages of investing in development costs:

  • Increased Efficiency: Investing in research and development activities can help improve company efficiency and productivity, as well as reducing costs in the long run.
  • Competitive Advantage: By investing in research and development, a company can be better equipped to respond to the changing market conditions and stay ahead of the competition.
  • Innovation: Development costs can help a company stay ahead of the market by creating innovative products and services that customers demand.
  • Brand Recognition: Investing in development costs can help a company build a strong brand identity and recognition in the marketplace.
  • Cost Savings: Development costs can help a company develop more efficient processes, which can help reduce costs in the long run.

Limitations of Development cost

Development costs can be a major expense for a company, and as such, must be carefully considered and managed. There are several limitations associated with development costs that should be taken into account:

  • High cost: Development costs can be expensive, and there can be a large amount of risk involved in investing in them. Companies must consider the potential return on their investment before committing to a development project.
  • Time constraints: Development projects can take a long time to complete, and the timeline may not match up with the company's goals. Companies must carefully manage their timelines to ensure they are able to complete their projects in a timely manner.
  • Limited resources: Companies often have limited resources to devote to development projects, and must carefully prioritize their projects to ensure they are utilizing their resources as efficiently as possible.
  • Uncertainty: Development projects can be unpredictable and there is no guarantee that the desired outcome will be achieved. Companies must plan for potential failures and have contingency plans in place in case a project does not turn out as expected.

Other approaches related to Development cost

Development costs can encompass a wide range of investments aimed at improving a company's operations and performance. This can include:

  • Research and development expenditures, such as those incurred for developing new products and services, improving existing ones, and researching potential business opportunities.
  • Costs associated with obtaining and maintaining patents, copyrights, and other intellectual property rights.
  • Expenses related to obtaining and maintaining quality assurance and safety certifications.
  • Investments in training and professional development of employees.
  • Costs related to developing and maintaining relationships with customers and suppliers.

In summary, development costs can include a variety of investments aimed at improving the efficiency, quality, and overall performance of a company's operations.


Development cost — recommended articles
Resources and capabilities — Capital restructuring — Intangible asset — Functional strategy — Research and development definition — Outsourcing — Project feasibility study — Investment project — Business concept

References

Author: Barbara Lech

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