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ACCT245- Intermediate Accounting 2

Spring 2019

Case Study Project – 20 marks


1. You are required to submit a group project report on the below case study.
2. You, as a group, need to make a brief class presentation.
3. You are required to follow the following instructions:
a. Group size will be 4-5 students.
b. Project written report to be submitted as a written document.
c. The group presentation should be limited to 10 minutes

Chapter 12
CA12-4 - end of chapter homework material

(Accounting for Research and Development Costs)

Cuevas Co. is in the process of developing a revolutionary new product. A new division of the
company was formed to develop, manufacture, and market this new product. As of year-end
(December 31, 2015), the new product has not been manufactured for resale (economic viability
has not been achieved). However, a prototype unit was built and is in operation.

Throughout 2015, the new division incurred certain costs. These costs include design and
engineering studies, prototype manufacturing costs, administrative expenses (including salaries of
administrative personnel), and market research costs. In addition, approximately €900,000 in
equipment (with an estimated useful life of 10 years) was purchased for use in developing and
manufacturing the new product. Approximately €315,000 of this equipment was built specifically
for the design development of the new product. The remaining €585,000 of equipment was used
to manufacture the pre-production prototype and will be used to manufacture the new product once
it is in commercial production.
(a) How are “research” and “development” defined in IFRS? (3 marks)

(b) Briefly indicate the practical and conceptual reasons for the conclusion reached by the IASB
on accounting and reporting practices for research and development costs. (7 marks)

(c) In accordance with IFRS, how should the various costs of Cuevas described above be recorded
on the financial statements for the year ended December 31, 2015? (8 marks)

(d) Discuss the importance of economic viability as it relates to research and development cost
accounting. 2 (marks)

You can access the IFRS authoritative literature at the IASB website (


(a) Research, as defined in IFRS, is “original and planned investigation undertaken with the
prospect of

gaining new scientific or technical knowledge and understanding.”

Development, as defined in IFRS, is “application of research findings or other knowledge to a plan

or design for the production of new or substantially improved materials, devices, products, systems
or services before the start of commercial production or use.”

(b) The current accounting and reporting practices for research and development costs (incurred
before achieving economic viability) were promulgated by the IASB in order to reduce the number
of alternatives that previously existed and to provide useful financial information about research
and development costs. The IASB considered four alternative methods of accounting: (1) charge
all costs to expense when incurred, (2) capitalize all costs when incurred, (3) selective
capitalization, and (4) accumulate all costs in a special category until the existence of future
benefits can be determined. The IASB concluded that all research and development costs should
be charged to expense as incurred. Accounting for the costs of research and development activities
conducted for others under a contractual arrangement is a part of accounting for contracts in
general and is addressed in other literature .

In reaching this decision, the IASB considered the three pervasive principles of expense recog-
nition: (1) associating cause and effect, (2) systematic and rational allocation, and (3) immediate
recognition. The IASB found little or no evidence of a direct causal relationship between current
research and development expenditures and subsequent future benefits. The IASB also stated that
the high degree of uncertainty surrounding future benefits, if any, of individual research and
development projects make it doubtful that there is any useful purpose to be served by capitalizing
the costs and allocating them over future periods. In view of the above, the IASB concluded that
the first two principles of expense recognition do not apply, but rather that the “immediate
recognition” principle of expense recognition should apply.

The high degree of uncertainty about whether research and development expenditures will provide
any future benefits, the lack of objectivity in setting criteria, and the lack of usefulness of the resul-
ting information led the IASB to reject the alternatives of capitalization, selective capitalization,
and accumulation of costs in a special category.

(c) The following costs attributable only to research and development should be expensed as
incurred: Design and engineering studies.

 Prototype manufacturing costs.

 Administrative costs related solely to research and development.
 The cost of equipment produced solely for development of the product ($315,000).

The remaining $585,000 of equipment should be capitalized and shown on the statement of finan-
cial position at cost, less accumulated depreciation. The depreciation expense resulting from the
current year is a part of research and development expense for the year. The market research direct
costs and related administrative expenses are not research and development costs. These costs are
treated as period costs and are shown as expense items in the current income statement.

(d) Economic viability indicates that a project is far enough along in the process such that the
economic benefits of the R&D project will flow to the company. Development costs incurred from
that point forward meet the recognition criteria and should be recorded as an intangible asset.