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R&D costs: IFRS® Accounting Standards vs. US GAAP

Accounting for research and development activities under IFRS Accounting Standards can be significantly more complex than that under US GAAP.

Handbook: IFRS® compared to US GAAP
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From the IFRS Institute – March 14, 2025

Authors: Ingo Zielhoff and Kurt Wojtanek 

Companies often incur costs to develop products and services that they intend to sell or for internal processes and systems that they intend to use. The accounting for these research and development (R&D) costs under IFRS Accounting Standards can be significantly more complex than that under US GAAP.

Under IFRS Accounting Standards (IAS 381), research costs are expensed. However, broad-based guidance in IAS 38 requires companies to capitalize development expenditures, including internal costs, when certain criteria are met. Based on these criteria, internally developed intangible assets (e.g. software, new chemical formulas, or automotive component prototypes) are generally capitalized and amortized. This accounting requirement gives rise to two complexities in applying IFRS Accounting Standards:

  • distinguishing development activities from research activities; and
  • analyzing whether and when the criteria for capitalizing development expenditures are met.

The International Accounting Standards Board (IASB) is currently in the early stages of researching whether the requirements of IAS 38 remain relevant and continue to fairly reflect current business models, or whether its requirements should be improved.

Under US GAAP, the accounting is much simpler: R&D costs in the scope of ASC 7302 are expensed as incurred. US GAAP also has specific requirements for motion picture films, website development, cloud computing costs, and software development costs. The FASB and IASB have each also issued guidance on the accounting for cloud computing arrangements and differences exist on the treatment of implementation costs3. Further, the FASB has issued a proposed ASU4 on software development costs for internal use software to update the guidance for agile development methods and clarify the point at which capitalization may begin. To learn more about the differences between IFRS Accounting Standards and US GAAP, see KPMG’s publication, IFRS compared to US GAAP.

Distinguishing development from research

The starting point for companies applying IFRS Accounting Standards is to differentiate between costs that are related to ‘research’ activities versus those related to ‘development’ activities. While the definition of what constitutes ‘research’ versus ‘development’ is very similar between IFRS Accounting Standards and US GAAP, neither provides a bright line on separating the two. Instead, a company needs to develop processes and controls that allow it to make that distinction based on the nature of different activities.

R&DResearchDevelopment

Definition

Costs related to original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding.Costs incurred in applying 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.

Examples

  • Activities to obtain new knowledge on self-driving technology.
  • Search activities for alternatives to metal components used in a company’s current manufacturing process.
  • Search activities for a new smart phone operating system that replaces an existing one.
  • Design and construction activities related to the development of a new self-driving prototype.
  • Design and construction of a new tool required for the manufacturing of a new product.
  • Testing activities on a new smart phone operating system that will replace the current one.

Analyzing when to start capitalizing development costs

Expenditures incurred in the development phase of a project are capitalized from the time the company is able to demonstrate it has met all of the following criteria:

  • the technical feasibility of completing the intangible asset so that it will be available for use or sale;
  • its intention to complete the intangible asset and use or sell it;
  • its ability to use or sell the intangible asset;
  • how the intangible asset will generate probable future economic benefits;
  • the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
  • its ability to reliably measure the expenditure attributable to the intangible asset during its development.

A key factor in the above list is technical feasibility. There is no definition or further guidance to help determine when a project crosses that threshold. Instead, a company need to evaluate technical feasibility in relation to each specific project. Projects related to new product development are generally more difficult to substantiate than projects in which the company has more experience.

Industry considerations – technical feasibility

The process of establishing technical feasibility for products or services available for sale will vary by industry and differences in the development cycle or regulatory environment should be carefully evaluated.

In the pharmaceutical industry, companies spend significant amounts on R&D activities to develop therapeutics. The ability to commercialize therapeutic products is heavily affected by both scientific risk and regulatory risk. In establishing technical feasibility for therapeutics, companies may consider results of clinical trials, the potential need for additional trials, and the applicable regulatory authority’s approval history for similar therapeutics for similar illnesses in similar markets. Relevant considerations regarding the prospect of regulatory approval include whether:

  • the approval is for a secondary indication;
  • the approval is for a therapeutic approved by other regulatory authorities; and
  • the therapeutic is a generic or biosimilar for an already approved therapeutic by the same authority.

In the software industry, the development of a product is not typically subject to regulatory approval and is more dependent on the company’s ability to complete the product. In establishing technical feasibility, key considerations may include whether the software includes novel, unique or unproven functions and whether the company has sufficiently addressed any risks related to those functions.

In the manufacturing industry, companies routinely develop lighter, more durable, and less expensive versions of their products. Technical feasibility in this case is often easier to demonstrate and is established earlier in the process, before the company can demonstrate its intention to complete and its ability to sell the asset.

What about acquired R&D projects?

R&D based intangible assets (in-process R&D, or IPR&D) may be acquired rather than developed internally. As a general principle under IFRS Accounting Standards, the acquired IPR&D is capitalized, regardless of whether the transaction is a business combination. IPR&D is inherently not yet available for use and therefore subject to annual impairment testing. Any subsequent expenditure on the IPR&D is capitalized only if it meets the IAS 38 criteria for capitalizing development costs. 

In contrast, under US GAAP, only IPR&D acquired in a business combination is capitalized and any subsequent expenditure is expensed as incurred. The cost of any IPR&D acquired outside the context of a business combination (e.g. in an asset acquisition) is expensed under US GAAP, unless the IPR&D has an alternative future use. 

A required business combination screen (or concentration) test under US GAAP leads to much less IPR&D being capitalized under US GAAP than under IFRS Accounting Standards5, because this screen test, while similar, is optional under IFRS Accounting Standards. Less IPR&D is capitalized under US GAAP, as the screen test may preclude a transaction from being a business combination, if substantially all the fair value of the acquired assets is concentrated in a single asset or group of similar assets.

Summary of Treatment of Acquired IPR&D
IPR&DUS GAAPIFRS Accounting Standards

Initial recognition - business combination

CapitalizeCapitalize

Initial recognition - asset acquisition

Expense, unless alternative future use6 existsCapitalize

Subsequent expenditure

ExpenseCapitalize only if IAS 38 criteria are met

The takeaway

Significant IFRS Accounting Standards to US GAAP differences currently exist with regard to capitalizing costs associated with internally developed intangibles and acquired IPR&D. These differences are relevant during new product development, cross-border acquisitions and divestitures. Under IFRS Accounting Standards, the determination as to when all IAS 38 criteria have been met may require significant judgment and considerations will vary across industries. Further, acquirees and first-time adopters initially applying IFRS Accounting Standards may find it challenging and time consuming to establish the necessary processes and controls to support key accounting conclusions and track capitalizable costs.

The FASB and IASB continue to include intangibles related topics on their research agenda, therefore dual preparers should continue to monitor for IFRS Accounting Standards to US GAAP differences in this area.

Footnotes

  1. IAS 38, Intangible Assets
  2. ASC 730, Research and Development
  3. Customer accounting for software-as-a-service arrangements (kpmg.com)
  4. KPMG Defining Issues on Proposed Software Costs ASU 
  5. Other differences exist between IFRS Accounting Standards and US GAAP related to business combinations but were not the focus of this article on R&D projects.
  6. Refer to Question 2.3.80 and Example 2.3.30 in the KPMG Research and Development Handbook for the determination of whether an alternative future use exists

 

KPMG US IFRS® Institute

Delivering KPMG guidance, publications and insights on the application of IFRS® Accounting and Sustainability Standards in the United States. Sharing our expertise to inform your decision-making in an evolving global financial reporting environment.

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Meet our team

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Ingo Zielhoff
Partner, Accounting Advisory Services, KPMG US
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Image of Kurt D Wojtanek
Kurt D Wojtanek
Director, Advisory, Accounting Advisory Services, KPMG US
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