Understanding the Recent Changes in Mandatory Capitalization of Research and Development Expenses

By: Shuchita Lotlikar

In recent years, there have been discussions and changes regarding the capitalization of Research and Development (R&D) expenses. The Financial Accounting Standards Board (FASB) has revised its standards, and the Internal Revenue Service (IRS) has also provided guidance on the issue. In this article, we will explore these changes and their impact on companies.

First, it is essential to understand what R&D expenses are. R&D expenses are the costs incurred by a company in its efforts to develop new products, services, or processes. These costs include wages, salaries, materials, and overhead expenses. In the past, companies could choose whether to expense these costs in the period in which they were incurred or to capitalize them on the balance sheet and amortize them over several years.

As per FASB, the capitalization of materials, labor and other costs relevant to research must be capitalized if the research activities have an alternative future use, whether the research has the potential to generate future economic benefits, and whether the company has the ability to develop or improve the asse. Also, the corresponding depreciation or amortization should be booked as R&D expense periodically. The costs which do not generate any future economic benefits should be expensed.

The FASB's changes have been made to improve the consistency and comparability of financial statements. By capitalizing more R&D expenses, companies will have a better representation of the value of their assets and a more accurate portrayal of their financial health.

The IRS has also provided guidance on the capitalization of R&D expenses for tax purposes. The IRS allows companies to claim a tax credit for qualified R&D expenses, but these expenses must meet specific criteria. The criteria include whether the research is technological in nature and whether the research is intended to develop new or improve products.

The changes in the mandatory requirements of capitalization of R&D expenses will have a significant impact on companies' financial statements and tax returns. Companies will need to carefully evaluate their R&D expenses to determine which costs should be capitalized and which should be expensed. The changes will also require companies to provide more detailed disclosures in their financial statements regarding their R&D activities.

In conclusion, the mandatory requirements of capitalization of R&D expenses have changed in recent years. The FASB has revised its accounting standards, and the IRS has provided guidance on the issue. These changes will impact companies' financial statements and tax returns, requiring companies to carefully evaluate their R&D expenses and provide more detailed disclosures. Companies that can adapt to these changes will be better positioned to demonstrate their financial health and attract investors.