1. Revise lecture 12 1

2. IAS 38 Definitions: Research can be defined as original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding 2

3. IAS 38 Definitions: Development can be defined as the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. 3

4. IAS 38 Accounting treatment of research All research expenditure should be written off to the income statement as it is incurred. This is compliance with the prudence concept. Research expenditure does not directly lead to future benefits and therefore it is not possible to follow the matching concept. Any capital expenditure on research equipment should be capitalised and depreciated as normal. 4

5. IAS 38 Accounting treatment of development Development expenditure must be capitalised as an intangible asset provided that certain criteria are met: 1.Separate project 2.Expenditure identifiable and reliably measured 3.Commercially viable 4.Technically feasible 5.Overall profitable 6.Resources available to complete 5

6. IAS 38 (Disclosure) The financial statements should disclose the following for capitalised development costs: 1.The amortisation method used and the expected period of amortisation 2.A reconciliation of the carrying amounts at the beginning and end of the period, showing new expenditure incurred, amortisation and amounts written off because a project no longer qualifies for capitalisation 3.Amortisation during the year 6

7. Research and development Question: An entity has incurred the following expenditure during the current year: A) Rs100,000 spent on the initial design work of a new product. It is anticipated that this design will be taken forward over the next two year period to be developed and tested with a view to production in three years time. 7

8. Research and development Question: B) Rs500,000 spent on the testing of a new production system which has been designed internally and which will be in operation during the following accounting year. This new system should reduce the cost of production by 20% How should each of these costs be treated in the financial statements of the entity? 8

9. Research and development Answer: a) These are research costs as they are only in the early design stage and therefore should be written off as part of profit and loss for the period. 9

10. Research and development Answer: b) These would appear to be development stage costs as the new production system is due to be in place fairly soon and will produce economic benefits in the shape of reduced costs. Therefore these should be capitalised as development costs. 10

11. Research and development Question: This year, Angro Ltd has developed a new material from which the next generation of wetsuits will be made. This special material will ensure that swimmers are kept warmer than ever. The cost incurred meet the capitalisation criteria and by the 31 December 2005 year end Rs250,000 has been capitalised. 11

12. Research and development Question: The wetsuits are expected to generate revenue for 5 years from the date that commercial production commences on 1 st January 2006. What amount is charged to the income statement in the year ended 31 december 2006? 12

13. Research and development Answer: Amortisation will be charged for each of the 5 years that revenue is generated. As there is no reliable pattern of this revenue, amortisation will be charged on the straight- line basis. Therefore the amortisation charge for each of the years ended 31 December 2006 will be: Rs250,000 / 5 years =Rs 50,000 13

14. Research and development Question: Pyramids International Ltd is developing a new product, the blue star. This is expected to be sold over a 3 years period starting in 2006. the forecast data is as follow: 14

15. Research and development 2005 2006 2007 2008 Net revenue from activities 400 500 450 400 Net revenue from blue star - 450 600 400 Development costs (900) - - - Show how the development costs should be treated if: 1.The costs do not qualify for capitalisation 2.The cost do qualify for capitalisation 15

16. Solution 16

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18. Solution 18

19. Amortisation of development expenditure Question: Xerox plc has deferred development expenditure of RS600,000 relating to the development of new miracle brand X. It is expected that the demand for the product will stay at a high level for the next three years. Annual sales of 400,000, 300,000 and 200,000 units respectively are expected over this period. Brand X sells for Rs10. How should the development expenditure be amortised? 19

20. Solution There are two possibilities for writing off the development expenditure: 20

21. Solution 21

22. Solution 22