IAS 38 Research and Development Costs

IAS 38 Research — Core Rule

Under IAS 38 Research and Development Costs, all research expenditure must be expensed as incurred, while development expenditure is capitalised as an intangible asset only when six specific recognition criteria are simultaneously met.

How IAS 38 Research Works

The standard draws a hard line between two phases, and the accounting treatment follows the phase — not the nature of the underlying activity:

• Research phase — immediate expensing (IAS 38.54): Expenditure on original, planned investigation undertaken to gain new scientific knowledge is recognised as an expense in profit or loss when incurred. There is no option to capitalise research costs, even if management believes future economic benefits are probable.

• Development phase — conditional capitalisation (IAS 38.57): An internally generated intangible asset arising from development is recognised if, and only if, the entity can demonstrate all six criteria: (1) technical feasibility of completing the asset; (2) intention to complete and use/sell it; (3) ability to use or sell the asset; (4) existence of a market or internal usefulness; (5) availability of adequate technical, financial, and other resources; and (6) ability to reliably measure the expenditure attributable to the asset during its development.

• Measurement at recognition (IAS 38.65–66): The capitalised development asset is initially measured at cost — directly attributable expenditure including materials, employee costs, borrowing costs (where IAS 23 applies), and overheads that are directly traceable to the asset creation. General administration, selling costs, and inefficiencies are excluded.

• Post-recognition measurement (IAS 38.72–74): The entity may choose the cost model (cost less accumulated amortisation and impairment) or the revaluation model (fair value less subsequent amortisation and impairment), though the revaluation model is only available where an active market exists — an exceptionally rare circumstance for intangible assets.

• Amortisation (IAS 38.97): Amortisation begins when the asset is available for use, over its useful life. If useful life is indefinite, no amortisation is charged but an annual impairment test under IAS 36 is mandatory. Most development assets have finite lives, so systematic amortisation is the norm.

• Disclosure (IAS 38.118–128): Entities must disclose the aggregate amount of research and development expenditure recognised as an expense during the period, along with carrying amounts, useful lives, amortisation methods, and any impairment losses for each class of intangible asset.

IAS 38 Research — Practical Example

Scenario: A pharmaceutical company incurs the following costs during the year: laboratory research into a new compound — €400,000; development of a prototype drug (all six IAS 38.57 criteria met from 1 July) — €600,000 over 12 months, of which €300,000 relates to H2 of the year; subsequent amortisation on a 10-year straight-line basis begins 1 January next year.

Year-end journal entries

1. Expensing research costs

2. Capitalising qualifying development costs (H2 only, €300,000)

3. Development costs incurred before criteria were met (H1, €300,000) — expensed, not reinstated

Year 2 amortisation (€300,000 ÷ 10 years)

IAS 38 Research — Common Pitfalls

• Retroactive capitalisation is prohibited (IAS 38.71): Once expenditure has been recognised as an expense, it cannot be reinstated as an intangible asset in a later period — even if the six development criteria are subsequently met. The date the criteria are first satisfied determines the capitalisation start point.

• Conflating research and development activities: In practice, projects often blend both phases. Entities must rigorously segregate costs by phase; where phase cannot be reliably determined, IAS 38.52 requires the cost to be treated as research and expensed. Auditors scrutinise phase-allocation documentation closely.

• Ignoring the impairment trigger during development (IAS 36.10): An intangible asset not yet available for use must be tested for impairment annually — regardless of indicators — and again whenever an indicator exists. Many preparers incorrectly wait until the asset is in use before applying IAS 36.

IAS 38 Research — Key Paragraphs

• IAS 38.54 — mandatory expensing of all research phase expenditure
• IAS 38.57 — the six cumulative criteria for development cost capitalisation
• IAS 38.71 — prohibition on retrospective reinstatement of previously expensed costs
• IAS 38.97 — amortisation commencement and useful life assessment
• IAS 38.118 — disclosure requirement for total R&D expenditure recognised in profit or loss