International Finance and Accounting Handbook

(avery) #1

development costs can be capitalized. Such is the case, for example, in Canada and
the United Kingdom, and under IAS 38, “Intangible Assets.” The theory is that the
development costs eventually will turn the “researched idea” into action and gener-
ate revenue. Therefore, these are the only costs that should be capitalized. Countries
that advocate this approach generally stipulate that the product should have a high
likelihood of success before development costs may be capitalized. In Brazil, Italy,
and Japan, the constraints on capitalization of R&D are less restrictive than in the
other countries. IAS 38 requires that:



  • The product or process is clearly defined and the costs attributable to the prod-
    uct or process can be separately identified and measured reliably.

  • The technical feasibility of the product or process canbe demonstrated.

  • The enterprise intends to produce, and market or use, the product or process.

  • The market exists for the product or process or, if it is to be used internally
    rather than sold, its usefulness to the enterprise can be demonstrated.

  • Adequate resources exist, or their availability can be demonstrated, to complete
    the project, and market or use the product or process.


The key considerations from an IAS perspective revolve around technical feasi-
bility and the enterprise’s intention to produce and market/use the product or process.
To illustrate, if IAS 38 required that technical feasibility has been(as opposed to can
be) demonstrated before permitting capitalization, then it would be clear that most
development activities (e.g., costs of constructing and operating a pilot plant) would
not satisfy the criterion because the activity have not been completed and technical
feasibility would remain unproven. Demonstrating technical feasibility for a new
product or process would appear to necessitate that all R&D aspects of a product or
process have been completed because, until their completion, feasibility would not
have actually been demonstrated. On the other hand, it can be argued that the “can”
in IAS 38 leaves room for management to take the position that it will be able to
demonstrate technical feasibility in the future.
Another criterion that must be met under IAS 38 before development costs can be
capitalized is that the enterprise must intend to produce and market the product or
process. In cases in which the enterprise is still evaluating alternative products or
processes, this test will arguably not be satisfied, and certain development costs will
not qualify for capitalization. However, once the particular product or process has
been selected to take to market, and assuming that the other tests have been satisfied,
the enterprise may no longer be engaged in an R&D activity. Furthermore, until these
criteria are made clear, debate will be inevitable as to whether an identifiable asset
exists.


(b) Fixed Assets. Fixed assets consist of land, building, machinery, and equipment.
These assets are used by an enterprise in its business for a number of years, and they
generally require a significant expenditure at the time of acquisition. The two critical
issues raised in accounting for fixed assets are: (1) In what periods should these ex-
penditures be charged to the income statement for accounting purposes? (2) At what
amount, if any, should the assets be carried on the company’s balance sheet?
Enterprises in all countries are required to capitalize and to depreciate fixed assets.
The reasoning is that this large expenditure will benefit the enterprise in future years;


12 • 12 SUMMARY OF ACCOUNTING PRINCIPLE DIFFERENCES
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