Treatment of Research and Development Cost

Research and Development (R&D) cost refers to expenditure incurred on discovering new knowledge, developing new products or processes, or improving existing ones. Research is original investigation aimed at gaining scientific or technical knowledge. Development is the translation of research findings into a plan or design for new or improved products/processes before commercial production begins. R&D costs are distinct from regular production costs because their benefits span multiple accounting periods and are uncertain. Cost accountants must carefully decide whether to treat R&D as product cost (inventoriable) or period cost (expensed). The treatment varies based on research type (pure vs. applied), project success probability, and applicable accounting standards (GAAP/IFRS vs. Cost Accounting Standards).

Classification of R&D Costs:

1. Classification by Nature of Activity (Research vs. Development)

Research cost is incurred for original investigation to gain new scientific or technical knowledge without a specific commercial application in mind. It includes pure and applied research. Development cost is incurred to translate research findings into a plan, design, or prototype of a new or improved product/process before commercial production begins. Research costs are typically treated as period expenses, while successful development costs may be deferred and amortized. This classification determines whether cost is inventoriable or written off immediately. Cost accountants must carefully distinguish between both phases.

2. Classification by Identifiability (Direct vs. Indirect)

Direct R&D costs can be specifically traced to a particular research project or product under development. Examples include salaries of project scientists, cost of laboratory materials, patent filing fees, and depreciation of equipment dedicated exclusively to that project. Indirect R&D costs are common to multiple projects and require fair apportionment, such as general laboratory rent, supervisory salaries, central library subscriptions, and administrative support. Accurate classification ensures proper project costing and prevents cross-subsidization between different R&D initiatives. Direct costs are charged to specific projects; indirect costs are pooled and allocated using bases like labor hours.

3. Classification by Relationship to Product (Specific vs. General)

Specific R&D costs are incurred for developing a particular product or process intended for commercial exploitation. These costs have identifiable future economic benefits linked to a single product line. General R&D costs are incurred for basic research or maintaining technical competence without linking to any specific product. Examples include industry-wide research, academic collaborations, and routine literature surveys. Specific R&D may be capitalized and amortized over the product’s life, while general R&D is treated as a period cost. This classification affects inventory valuation and government contract costing significantly.

4. Classification by Success Outcome (Successful vs. Abandoned)

Successful R&D costs lead to a commercially viable product, process, or patent that generates future economic benefits. These costs may be deferred and amortized over the expected benefit period. Abandoned R&D costs are incurred on projects that fail technically or commercially and are terminated before completion. Such costs have no future benefit and must be written off immediately to the Costing Profit & Loss Account as a period loss. This classification requires periodic project review and go/no-go decisions. Cost accountants must track project status continuously to determine appropriate treatment.

5. Classification by Payer (Company-sponsored vs. Customer-sponsored)

Company-sponsored R&D is initiated and funded by the organization for its own benefit, with no guarantee of recovery from any customer. These costs are borne as overhead or deferred product cost based on success. Customer-sponsored R&D is undertaken under a specific contract where the customer agrees to reimburse all or part of the R&D expenditure. Examples include government defense research or custom product development for a client. Customer-sponsored costs are charged directly to that contract or job, not to the company’s overhead pool. This classification prevents double charging and ensures accurate contract profitability analysis.

6. Classification by Time Horizon (Current vs. Deferred)

Current R&D costs are those incurred and charged entirely to the accounting period in which they arise. This includes pure research, failed projects, and routine laboratory upkeep. Deferred R&D costs are successful development expenditures whose benefits extend beyond one accounting period. These are capitalized as a deferred asset and amortized over the product’s expected commercial life (typically 3-7 years). Amortization can be straight-line or unit-of-production method. This classification aligns with the matching principle—costs are recognized as expenses in the same periods as associated revenues. Cost accountants prepare amortization schedules for deferred R&D costs.

Treatment in Financial Accounting (for reference)

As per AS 26 / Ind AS 38 (Intangible Assets)

As per US GAAP (ASC 730)

• All R&D costs are expensed as incurred (no capitalization of development costs)

Treatment in Cost Accounting

Cost Accounting focuses on product costing, decision making, and government contract costing. Treatment differs from financial accounting.

1. Treatment for Product Costing (Inventory Valuation)

2. Treatment for Government Cost Accounting (CAS 420 – US)

Government contracts have strict rules:

• Independent R&D (IR&D): Allocable to government contracts if potential interest exists

• Bid & Proposal (B&P) costs: Allocable to all contracts

• Must be pooled and allocated using a base (e.g., total contract sales)

3. Treatment for Decision Making

CASB (Cost Accounting Standards Board, India) Position

As per CAS-7 (Employee Cost) and general principles:

Amortization of Capitalized R&D

When R&D is capitalized (development cost), it is amortized over the expected commercial life of the product.

Example:

• Development cost capitalized = ₹10,00,000

• Expected product life = 5 years

• Estimated total units = 2,00,000

• Year 1 production = 50,000 units

Journal Entries in Cost Accounting