US GAAP research and development for pharmaceutical companies: PwC

R&D amortization for a mobile phone company, however, should be amortized much faster (a smaller number of years) since new phones tend to emerge much more quickly and, thus, come with shorter shelf lives. The starting point for companies applying IFRS is to differentiate between accounting for research and development costs that are related to ‘research’ activities versus those related to ‘development’ activities. While the definition of what constitutes ‘research’ versus ‘development’ is very similar between IFRS and US GAAP, neither provides a bright line on separating the two.

Even though R&D can be an intangible asset in the UK, accounting for R&D is governed by its own accounting standard – SSAP 13, Accounting for Research and Development. Equally, the argument exists that it may be impossible to predict whether or not a project will give rise to future income. As a result, both the UK and International Accounting Standards provide accountants with more information in order to clarify the situation. R&D spending can vary widely from one year to another, which has a significant impact on a company’s profitability. Many businesses in the technology, healthcare, consumer discretionary, energy, and industrial sectors experience this problem.

Research and Development (R&D): Definition in Business

Because R&D also is a key component of innovation, it requires a greater degree of skill from employees who take part. This allows companies to expand their talent pool, which often comes with special skill sets. M&As and partnerships are also forms of R&D as companies join forces to take advantage of other companies’ institutional knowledge and talent. Many small and mid-sized businesses may choose to outsource their R&D efforts because they don’t have the right staff in-house to meet their needs.

The CRO is well known in the industry for having modern facilities and good practitioners dedicated to investigation. Company A pays the CRO a non-refundable, upfront payment of $3 million in order to carry out the research under the agreement. The CRO will have to present a quarterly report to Company A with the results of its research. Company A has full rights to the research performed, including the ability to control the research undertaken on the potential cure for HIV. The CRO has no rights to use the results of the research for its own purposes. Company A and Company B enter into an agreement in which Company A will in-license Company B’s technology to manufacture a compound to treat HIV.

R&D – DEFINITIONS

Company A, a commercial laboratory, is manufacturing a stock of 20,000 doses (trial batches) of a newly-developed drug using various raw materials. The doses can only be used in patient trials during Phase III clinical testing, and cannot be used for any other purpose. Company A will pay Company B $3 million only upon completion of the contracted work.

Substantial portions of the company’s clinical trials are contracted with third parties, such as CROs. The financial terms of these contracts are subject to negotiations, may vary from contract to contract and may result in uneven payment flows and timing of expense recognition. For example, CROs commonly require payments in advance of performing clinical trial management services. These advance payments are commonly nonrefundable and made three to six months prior to the start of the research and development activity. Capitalizing these costs so that they are reported as assets is logical but measuring the value of future benefits is extremely challenging. Without authoritative guidance, the extreme uncertainty of such projects would leave the accountant in a precarious position.

What Types of Activities Can Be Found in Research and Development?

As a general rule of thumb, the more technical the industry’s products/services are, the more outsized R&D spending will be. While R&D costs can easily accumulate over time (and often not create any results of any significance), the R&D can pay off if there is a breakthrough that can directly lead to long-term profitability and a sustainable competitive advantage. In this example, Company A has no explicit or implicit obligation to repay any of the funds and therefore determines that the arrangement is an obligation to perform contractual research and development services.

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Academic research and accounting practice

Research and development costs include all amounts spent to create new ideas and then turn them into products that can be sold to generate revenue. Because success is highly uncertain, accounting has long faced the challenge of determining whether such costs should be capitalized or expensed. GAAP requires that all research and development costs (with a few minor exceptions) be expensed as incurred. This official standard prevents manipulation and allows decision makers to see the amount spent by management for this essential function. However, this method of accounting means that companies (especially in certain industries) often fail to show some of their most valuable assets on their balance sheets.