Research and development costs – IFRS vs IFRS for SME’s


Research and development costs are commonly referred to as R&D.

For businesses to be up to date or even ahead of market trends, they have to conduct investigative activities to improve existing products, services and procedures. These activities are R&D activities. In consumer goods companies these activities may lead to the improvement of product lines or even the development of new products, services and procedures. Companies that have the biggest budgets for R&D are the pharmaceutical and software/ technology companies.

In the past all the above companies were big companies that had to apply IFRS.

IFRS prescribe the treatment of R&D in IAS 38, Intangible assets, as part of the internally generated intangible assets.

IAS 38 par 8 defines research as: ”original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding,” and development 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.”

Based on the above definitions, development is thus the application of the research findings. In the development stage, the knowledge obtained and the planning done during the research phase are applied.

IAS 38 prescribe the recognition of research expenditure as an expense (par 54) and par 57 prescribe the recognition of development costs as:

An intangible asset arising from development (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following:

  1. the technical feasibility of completing the intangible asset so that it will be available for use or sale.
  2. its intention to complete the intangible asset and use or sell it.
  3. its ability to use or sell the intangible asset.
  4. how the intangible asset will generate probable future economic benefits. [Refer: paragraph 17] Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
  5. the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
  6. its ability to measure reliably the expenditure attributable to the intangible asset during its development.”

This means that development costs can only be recognised as an intangible asset if all of the above criteria are met.

In summary IFRS prescribes the recognition of research expenditure only as an expense and that of development expenditure either as an expense, if all of the above criteria are not met, or as an intangible asset if all of the above criteria are met.

In contrast to the above, IFRS for SME’s has just a short sentence in S18.14 (Intangible Assets other than Goodwill) where the treatment of R&D is prescribed:

“An entity shall recognise expenditure incurred internally on an intangible item, including all expenditure for both research and development activities, as an expense when it is incurred unless it forms part of the cost of another asset that meets the recognition criteria in this Standard.”

This boils down to the requirement that all R&D to be expensed for companies that apply IFRS for SME’s. Both research as well as development expenditure will be expensed if IFRS for SME’s are applied.

For internally generated intangible assets, such as brands, logos, recipes etc. both the research and development costs will be expensed even if it meets the definition of an asset which, according to par 2.37 of IFRS for SME’s is as follows:

“An entity shall recognise an asset in the statement of financial position when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably.”

In the case of IFRS the development expenditure may however be capitalised if it met the requirements of IFRS mentioned above.

Presently, specifically software/technology companies can be smaller companies with generation Y or millennials as the entrepreneurs. If these companies are not public companies, they will have to apply IFRS for SME’s and not IFRS. That can have a significant impact on the financial statements as illustrated in the following example:

Suppose we have two identical software development companies A and B. Company A is an entrepreneurial company run by young people from generation Y and millennials and prepare financial statements according to IFRS for SME’s. Company B is a corporate entity that prepares its statements according to IFRS. If both of the companies incurred the same development expenditure that meets the requirements of IAS 38 mentioned above, company B will reflect an asset in its statement of financial position, where company A will not be disclosing the same asset, but an expense in the statement of profit or loss and other comprehensive income.

If both company A and B apply for finance, it may be easier for company B to get finance, since the assets on its financial statements will be higher than that of company A (assuming that amortization on the asset is recognised over the useful life of the asset) The profits of company A will also be lower than that of company B in the first year after incurring the expenses. In the following years the profit of company A will be higher that of company B, since company B has to recognise amortization over the useful life of the asset.

This scenario illustrate the significance of the effects of applying IFRS or IFRS for SME’s, and perhaps the following question should receive attention:

Are the accounting regulators really contributing to Entrepreneurship in South Africa by having differences like this in IFRS and IFRS for SME’s?