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Nowadays, markets require transparency and reliability to keep active. The quality of information provided by companies is rather important in today's economic circumstances and the quality of accounting standards in return, directly affects the quality of this information (source from: FCAG). Thus, to create a standard for accounting items which can be applied by all companies is an inevitable trend. Since perfection can never be met, this idea cannot be realized in a world of reality. The Ruritanian Accounting Standards Board (RASB) is currently developing an accounting standard for research and development (hereafter, R&D) and will apply it to all companies. The aim of this essay is to provide some suggestions on the development of an accounting standard for R&D by the RASB. In this essay, first, principal problems concerned with accounting for R&D by the RASB would be identified. Three major problems would be discussed. After that, accounting concepts that can be utilized by the RASB to solve the problems being proposed will be explained. Then, we will raise some recommendations to the RASB by applying these concepts.
2. Three Major Problems
2.1 Defining R&D Activities
To account and report R&D costs, firstly, it is required to recognise the boundaries of R&D activities and further to recognise the elements of costs arising from those activities. The precondition to recognise whether an activity belongs to R&D is to define 'research' and 'development' respectively. Secondly, the accounting standard will exemplify what R&D activities are really like. Thirdly, the standard will specify which activities are excluded from R&D.
2.2 Measuring R&D Activities
Due to the special fact that R&D activities may bring future economic benefits, part of its expenditure to acquire or generate may be accounted as intangible assets. Therefore, it is necessary to set up criteria to recognise them as either intangible assets or expense in financial accounting.
Firstly, the elements of costs associated with R&D activities should be recognised. The elements of costs include the expense on materials, equipment and facilities, salaries paid to personnel, the costs of intangibles that are purchased from others for use in R&D activities, contract services and indirect costs. Then the expenditure that are generated from these elements will be categorized respectively into the headings of intangible assets and expense.
2.2.1 Recognised as intangible assets
First of all, a definition of intangible assets should be given. Secondly, the criteria against which to examine whether such expenditure belongs to intangible asset should be set up. Thirdly, the useful life of intangible assets should also be considered. To deal with the intangible assets with finite useful life, the amortisation period, amortisation method and residual value should be stated clearly. To deal with the intangible assets with indefinite useful life, specific treatment should be given.
2.2.2 Recognised as expense
There are two parts of expense. First, when expenditure does not meet the criteria for recognition as intangible assets, it is recognised as expense when it is incurred. The second category is the costs incurred from the intangible assets. It should be stated clearly in the standard which are the costs of internally generated intangible assets and which are not.
Disclosure is the information which is finally reflected in financial statements. It needs a standard format. The specific requirements about what should be disclosed and what should not be reflected in the financial statements should be stated clearly. There should also be a standard for disclosing the additional information about R&D activities. Appropriate disclosure can help financial users to understand the financial information better. However, the unnecessary disclosure may mislead users and cause some problems relating to confidentiality.
3. Dealing with the Problems Applying Accounting Concepts
There are eleven basic accounting concepts underpin the preparation of any kinds of accounts, among which four are major, named going concern, consistency, prudence and matching. In the following parts, different concepts which can be applied to deal with the three problems will be examined.
Going concern is the premise of any accounts. Also, it is a significant concept. That companies are going concern indicates they are in a stable financial position. If an entity is considered as not a going concern, it would probably be difficult for the entity to find long-term finance. Thus, the existence of long-term loans or invests in financial statements would be meaningless. In the field of R&D, going concern would be an encouragement for researchers. In return, R&D can push the companies go further.
To deal with the problem of defining R&D activities, the concept of consistency may be the principal one. It is important for companies to define R&D activities consistently from the companies' foundation to the companies' extermination. Besides, different companies are also required to utilizing the concept of consistency when defining R&D activities. Meeting the conditions of consistency makes both longitudinal and horizontal comparisons easier. Further, the same scope of R&D activities would bring convenience to account for R&D activities in terms of clear and definite division of R&D activities.
The fundamental accounting policies relating to the measuring and disclosure of R&D expenditure are going to be discussed in the next several paragraphs, which will contain the following concepts: prudence, matching, accounting period and realization together with the concept of consistency, whose importance has already been stressed above.
Prudence means conservation is significant when valuing a business. In addition, a cautious view is taken for future problems and costs of business, i.e. to account these costs as soon as there is a reasonable chance that such costs will be incurred in the future. Allow for the fact that R&D expenditure constitutes a large proportion in the high and new industries, besides, products from these industries are upgraded frequently, and the period during which such products bringing benefits is relatively short, it is necessary for those companies in these industries to involve the prudence concept into their accounting standards.
While we are on the subject of period and benefit, the concept of matching with the consideration of the accounting period is another issue to be regarded. Matching suggests that accounting transaction and relative events should be identified, recorded and clearly reported in financial statements when they happen within a given accounting period (Benedict and Elliot, 2008: 331). Normally, a successful innovation of a project or a product, the company will be granted a patent right, after that, it begins to enjoy the benefits from this in the following years. Therefore, the expenditure of development or innovation should be regarded as the book value of the company's intangible assets and to be shared out equally in the accounting periods represents the basic connotation of the matching concept.
4. Recommendations to the RASB:
As was mentioned above, the concepts of how to solve the three principle problems being explained can help propose the following recommendations on R&D standard in Ruritania.
4.1 Defining R&D Activities
Defining a clear scope of R&D activities properly is the key to the account measurement and financial information disclosure. However, it may be difficult in practice to recognise the R&D activities in a whole, but we can define 'research' and 'development' respectively. The research activities are making planned and creative efforts to obtain new scientific or technical knowledge. According to Dukes, Dckman and Elliott, this knowledge will help to develop a new product or serviceâ€¦or a new process or techniqueâ€¦or lead to a vital upgrade to a current product or process (Dukes, Dckman and Elliott, 1980). The development activities here mean using the research results to produce or improve new products or services before the commercial manufacture or usage. 'It includes the conceptual formulation, design, and testing of product alternatives, construction of prototypes, and operation of pilot plants' (Dukes, Dckman and Elliott, 1980). Hence, the cost from these research and development activities can be treated as R&D cost. However, any accounting cost which is under the contracts or can be reimbursed is beyond the R&D costs.
4.2 Measuring R&D Activities
4.2.1Recognised as Intangible Assets
'An intangible asset is an identifiable non-monetary asset without physical substance' (IAS 38). The expected economic benefit of the asset will flow into company and its cost can be recognized reliably.
The expenditure of an intangible asset's research stage shall be included in the current profits and losses; it can be recognized as expense when it incurred. The expenditure of an intangible's development stage should be accounted depending on the relevant criteria.
The useful life of an intangible asset is generally finite and the useful life can not exceed twenty years. Meantime, the finite useful years are the amortization period of the assets. Intangible assets should be amortized averagely over this period. If the economic life of an intangible asset can not be recognized, the useful life of it is identified.
4.2.2Recognised as Expense
Expenditure on an intangible item shall be recognised as an expense when it is incurred, except that it can fulfil the criteria for recognition as intangible assets.
Concurrently, costs incurred from the intangible assets shall be recognised as expense. This kind of costs could be:
(1) Expenditures on research should be recognised as expense. Here the research phase can be divided into two parts: basic research phase and applied research phase. The expenditure incurred in basic phase shall be recognised as expense while the expenditures incurred in applied and development phase shall be capitalised in definite conditions.
(2) Expenditures on development should be recognised as expense only if its future revenue cannot be confirmed when it is incurred.
Considering the accruals and prudence concept, if R&D projects succeed in the future and bring in satisfied returns, the expenditure recognition as expense will result in overestimating profit. According to Lev (1999), the accuracy of financial information could be distorted by expensing for different situation of investment in R&D companies. Besides, as the Ruritania is a rapidly developing country with an active share market, we consider that the capitalization of development cost to some extent could improve the investment in R&D market.
The class of intangible assets shall be disclosed by distinguishing internal generated intangible assets and other intangible assets, and the information of impaired intangible assets shall also be included in the report. Meanwhile, the useful life of asset shall be disclosed and the amortization rates used in the finite also shall be represented.
The activities which are important to the future prospects shall be disclosed in detail.
An entity shall disclose the total expenditure of R&D which is recognised as an expense.
Additional information such as intangible assets which cannot be defined as assets but controlled by the entity could also be disclosed in the report. The accounting policy shall be stated regarding to the R&D expenditure.
In considering matching concept, the recommendations for disclosure meet the requirement of stating the useful information about R&D companies appropriately. It also reflects the going concern concept by providing the additional information of long term development. However, the recommendations which have been proposed in current situation are not consummate. Hopefully, it can help RSAB with the process of developing the accounting standard for R&D industry to some extent.
According to the identification and explanation above, it can be concluded that the major problems of to be addressed by an accounting standard are how to define R&D activities, measure R&D activities and what to disclose. To deal with such problems, several accounting concepts such as going concern, prudence and matching are chosen to be analysed. Based on the structure of identified problems and the analysis of accounting concepts, recommendations are proposed to form an accounting standard concerned with R&D for RASB. However, there is no perfect standard which can be applied to any situation and this standard is not an exception. Limitations certainly exist within it. Also, this standard is not unchangeable; it will develop with the changing status of country.