ASC 730 Directive for Research & Development Costs

Accounting Standards Codification (ASC) 730 provides the guidance for how companies account for their research and development (R&D) costs under U.S. Generally Accepted Accounting Principles (GAAP). The standard’s objective is to create a uniform approach to R&D accounting. This ensures that financial statements are consistent and comparable from one company to another.

The guidance establishes the framework for identifying which activities qualify as R&D, how the associated costs should be treated, and what information must be disclosed. The guiding principle is that because the future economic benefits of R&D activities are uncertain, a conservative approach is justified. This prevents companies from selectively capitalizing costs, which could otherwise distort financial results.

Scope of Research and Development Activities

ASC 730 defines “research” as a planned search or critical investigation aimed at discovering new knowledge. This knowledge may be useful in developing a new product, service, or process, or in bringing about a significant improvement to existing ones. “Development” is the translation of research findings or other knowledge into a plan or design for a new or significantly improved product or process.

Activities that fall within the scope of R&D include:

• Laboratory research focused on obtaining new knowledge
• The conceptual formulation and design of product or process alternatives
• The design, construction, and testing of pre-production prototypes and models
• The design of tools, jigs, molds, and dies involving new technology

If an activity is part of a systematic effort to create or substantially improve a product or process before it is ready for commercial production, it is likely considered R&D. Conversely, many activities are explicitly excluded from the definition of R&D, such as:

• Routine or periodic alterations to existing products and production lines
• Routine quality control testing of products
• Market research and testing activities
• Troubleshooting in connection with commercial production breakdowns
• Engineering follow-through in an early phase of commercial production

Accounting for R&D Costs

The main directive of ASC 730 is that all R&D costs must be charged to expense in the period they are incurred. This rule is based on the principle that the future benefits of such expenditures are too uncertain to be capitalized as an asset on the balance sheet. This immediate expense recognition ensures that a company’s income statement reflects the full cost of its innovation efforts in the period those resources are consumed.

The types of costs that must be expensed as R&D include:

• Salaries, wages, and other related costs of personnel engaged in R&D
• Materials and supplies consumed in R&D activities
• The cost of services performed by other entities
• A reasonable allocation of indirect costs, such as utilities and general overhead

For tangible assets like machinery and equipment acquired for R&D, the accounting treatment depends on their future use. If an asset has an alternative future use beyond the current R&D project, its cost is capitalized, and the related depreciation is included as an R&D expense. If the asset has no alternative future use, its entire cost is charged to R&D expense immediately.

Exceptions and Special Accounting Scenarios

While ASC 730 generally requires expensing R&D costs, there are exceptions for business acquisitions and software development. These scenarios are governed by different accounting standards that override the general guidance.

Acquired In-Process Research and Development

When a company acquires another business, the transaction is accounted for under ASC 805, Business Combinations. Any ongoing R&D projects acquired, known as in-process research and development (IPR&D), are not expensed. Instead, IPR&D is recognized as an asset at its fair value, separate from goodwill, and is capitalized on the balance sheet.

After the acquisition, capitalized IPR&D is treated as an indefinite-lived intangible asset. This means it is not amortized but is tested for impairment annually, or more frequently if events indicate its value may have declined. If the R&D project is completed, the asset becomes a finite-lived intangible and is amortized over its useful life. If the project is abandoned, the capitalized amount is written off as an expense.

Computer Software Development Costs

Accounting for computer software development costs is another exception, with specific rules depending on the software’s intended use. Costs to develop software that will be sold, leased, or marketed to external parties are governed by ASC 985-20. For this software, all costs incurred to establish “technological feasibility” are expensed as R&D. Technological feasibility is established when the company has completed all planning, designing, coding, and testing activities necessary to establish that the product can be produced to meet its design specifications.

Once technological feasibility is reached, subsequent costs to get the software ready for sale are capitalized as a software asset. These capitalized costs are then amortized over the software’s estimated economic life. A similar, though distinct, set of rules applies to software developed for internal use. For this type of software, capitalization begins when management authorizes and commits to funding the project, and it is probable that the project will be completed and the software will be used for its intended function.

Required Financial Statement Disclosures

ASC 730 mandates disclosures to ensure that users of financial statements can understand a company’s investment in research and development. Companies must disclose the total amount of R&D costs charged to expense for each period for which an income statement is presented.

This disclosure is made in the notes to the financial statements. It provides a clear, aggregate figure that allows investors and analysts to track R&D spending over time and compare it against other companies. The figure disclosed should represent the total of all costs included under the scope of ASC 730, such as salaries, materials, and depreciation on assets used in R&D. For companies with significant software development activities, the disclosed R&D expense will include costs incurred before technological feasibility is established.