1. Introduction
Accounting for research and development (R & D) activities is a hot topic. There is a significant divergence in different standards, and almost little progress has been achieved towards convergence on this issue. After consulting IAS 38, SSAP 13 and SFAS 2, our group made some advice on the development of an accounting standard for Research and Development (R&D).
This report will identify the advantages and disadvantages of our group’s recommendations over IAS 38 Intangible Assets (Revised 2004) focusing on definition, accounting treatment and disclosure of R&D.
2. Evaluation
Firstly, the definition of R&D recommended by our group is superior to that is defined in IAS 38. Specifically, although the IAS 38 gives an explanation to identify research and development activities respectively, it is difficult to distinguish the two activities in reality. In other words, there is no clear boundary of research and development activities, and they always come along together. So separating research and development activities artificially and adopting different accounting treatment for them could easily offer opportunity for creative accounting. Specifically, accountants can choose to expense or capitalize R&D cost on the base of diverse understanding of research and development activities, thus leading to profit manipulation. IAS 38 increases the scope for manipulating reported numbers.( Nixon,1998,P272) Conversely, in our recommendation, recognizing research and development costs as a whole rather than separating these into two aspects is more practical .It can avoid the unnecessary classification and simplify the process of accounting practice.
Secondly, there is a big divergence between our recommendation and IAS 38 on how to recognize the R&D costs and the two accounting treatments have both advantages and disadvantages. Our recommendation requires all R&D cost should be charge to expense when incurred in normal companies, while IAS 38 uses selective capitalization method to allow companies to capitalize development costs only meet some particular recognition are criteria based on such factors as technological feasibility, marketability and usefulness and research costs should be written off to expense when incurred. (Gornik-Tomaszewski and Millan, 2005) Our recommendation has some merits. To begin with, expensing can be a conservative accounting treatment in normal company in which R&D is not the prime activity, and it complies with the prudence concept which requires that costs to be written off to expense on the day they are acquired unless there is a reasonably certainty that sales will be made in the future which cover the cost fully. In addition, our recommendation is more objective compared with IAS 38. Particularly, there are many vague words mentioned in IAS 38 such as feasibility, intention, probable future economic benefits and it requires that intangible assets should be capitalized only in certain condition, so it requires a considerable subjective judgment. In other words, it is too flexible. Therefore, this approach can lead substantial differences among similar companies depending on preparer’s understanding of IAS 38 and the choice of capitalization of R&D costs. Furthermore, it is less time-consuming and more economic because it does not need to spend time on many complex items in IAS 38 .Specifically, it has no need to identify R&D activities, and do other treatment of capitalized development costs including revaluation, subsequent accumulated amortization. What’s more, in our recommendation, enterprises are classified to three types and different treatments are required to each type of enterprises .In other words, our treatment is on the base of diverse enterprises not different activities, therefore it ensures comparability in the same type of enterprises since they adopt the same accounting treatment. However, it also has some flaws compared with IAS 38 .At first, expensing neglects the principle of matching. Specifically, the goal of R&D is not to gain current income, and most of the benefits will be shown after a long time. Most intangible assets have to take a lot of development costs in other accounting periods before its completion, and only a small amount of application and registration fees are amortized during the future accounting periods when it is completed. Therefore, pure expensing can not reflect the gains of such expenditure is obtained by several accounting periods. In addition, it will make an influence on enterprises’ annual report. And it may offer the external users with unreal and unreliable accounting information. Specifically, to some enterprises with large development and research expenditures, this approach may not only exaggerate the management fees but also distort the value of the assets, thus it can not reflect the value of the business. Even worse, it may dampen the enterprises’ enthusiasm on development. Preciously, since this approach will inevitably lead to a decline in corporate profits in some enterprises, the managements for their own interests, is likely to reduce R&D efforts to smooth profits. Therefore, this short-term business development will certainly undermine the long-term interests.
Thirdly, our recommendations on disclosure of R&D have both strength and weaknesses. On the one hand, ours are more comprehensive which can help the investors better understand the substance of research and development activities in the enterprises. Particularly, R&D intensity are used to identify whether the information is important or not and to determine whether the disclosure of R&D should be specific or not, which can focus on reporting major events and ignore the relatively minor ones. Meanwhile, both the general disclosure and the forward-looking disclosure are required to be listed in the accounting report, which is helpful for investors to make wise decision. On the other hand, the information we suggested to be disclosed may overly specific to the enterprises’ managers, therefore that may disclose commercial secrets and damage the interests of enterprises.
3. Conclusion
In conclusion, as has been analyzed above, the quality of our recommendations on R&D is high, especially on the aspects of definition and disclosure which is superior to IAS 38 .However, our advice is still not perfect, such as the accounting treatment of R&D. Therefore, it is clear that more effects need to be done to improve the standard.