Development cost
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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).
References
- Jørgensen M., Shepperd M.J., (2007), A Systematic Review Of Software Development Cost Estimation Studies, ”IEEE Transactions on Software Engineering” 33(1, pp. 33 - 53),
- Kuusisto, J. (2008), R&D in services-review and case studies, European Touch, „DG ResearchEuropean Commission”,
- Lome, O., Heggeseth, A. G. and Moen, Ø. (2016), The effect of R&D on performance: Do R&D-intensive firms handle a financial crisis better? „Journal of High Technology Management Research”, 27,
- Lukić R., Lalic S., Kljena D.V., (2018), Research and Development Costs in Retail Trade, pp.4-7,
- Oswald, D.R., Simpson, Vidolovska A., Zarowin P. (2016), Capitalization vs Expensing and the Behaviour of R&D Expenditures,
- Park, C. K., Chung, S. G. and Kim, J. W. (2014),Accounting for R&D Expenditure: To Capitalize or Not to Capitalize? „Life Science Journal”, 11(7s),
- Stamelos I., Angelis L., Morisio M., Sakellaris E., (2003), Estimating the development cost of custom software, ”Information & Management” 40(8), pp. 729-741,
- Zakari M., Saidu S., (2017), The Impact of Accounting Treatment of Research and Development Costs: Evidence from Chemring Group Plc
Author: Barbara Lech
