File - Marcus William Hilbert

Jared Rucks
Sonam Sherpa
YiHong You
Andrew Michaelis
Marc Hilbert
University of Idaho - Master of Accountancy Program
October 30, 2012
Leslie F. Seidman
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, Connecticut 06856-5116
Dear Ms. Seidman:
As a group of Master of Accountancy students, we have been studying the differences
between FASB and IASB in the treatment of research and development costs. We
understand that the SEC has slowed down the convergence process from U.S. GAAP
to IFRS. However, we would like to make a recommendation on how research and
development costs should be accounted for.
We propose that FAS No. 2, Accounting for Research and Development Costs, should
converge with IAS 38. FAS No. 2, does not address the needs for today's markets.
Critics feel it is too structured. IAS 38 requires more professional judgment, but it
provides emerging markets a better way to account for research and development
costs. However, people do criticize IAS 38 because of the amount of professional
judgment needed. It has been shown that following IAS 38 and amortizing research
and development costs, is a better predictor of future benefits. We understand that
there are costs involved in converging with IFRS, but we feel, in the area of research
and development costs, IFRS has a superior regulation.
In 1974 FASB issued SFAS No. 2, which required companies to expense R&D costs as
they were incurred. Post SFAS No. 2, studies were conducted to grasp the effects this
new rule had on businesses around the United States. These studies showed the kind
of business that were capitalizing R&D costs were the small “high-technology” firms. By
requiring the expense of all R&D costs as they were incurred, SFAS No. 2 had a great
effect on these smaller firms’ net income. In 1985 SAFS No. 2 was adjusted, creating
FAS No. 86. This new statement still required R&D costs to be charged to an expense,
however allowed the option for capitalization of these assets if certain recognition
criteria were met. This eased the effect SFAS No. 2 had on companies that were not
expensing R&D pre-SFAS 2. Although FAS 86 allows for R&D costs to be capitalized as
an asset to be an option, the recognition criteria are often difficult to meet. Another issue
with FAS No. 86 is the disallowance of the revaluation of intangible assets. This also
challenges the accuracy of a company’s future economic benefits. IAS 38 allows the
capitalization of these assets, as well as the revaluation of intangible assets. We believe
this gives companies the ability to more accurately predict and show their true value.
Capitalization and amortization of research and development costs have been shown to
better match research and development benefits, relative to expensing (Nissim, 2000).
In a study by Doron Nissim and Jacob Thomas (2000), from Columbia Business School,
they were able to show that for every $1 of research and development cost, there was
$1.3 of future benefits. However, this study included many different industries, where
heavy research industries provided a much larger gain and where lighter research
industries provided a much smaller gain or loss. Under current U.S. GAAP the
industries that have large future benefits from research and development costs are not
able to disclose that information to financial statement users. IAS 38, however, allows
more transparency because that information is disclosed on the balance sheet as well
as in the financial statement footnotes.
Since heavy research industries are not able to match their research and development
costs to future profits this causes swings from year to year with expenses one year and
with profits the next. When a company has a product on the market, its sales are being
used to cover the cost of a new product, not the original cost to develop the product
being sold on the market. This is contrary to the matching principle established by U.S.
U.S. GAAP standards for the treatment of research and development costs compared
with IFRS are more conservative, consistent, and allow for comparability between
companies. U.S. GAAP standards are industry specific. Except for some relatively
minor exceptions such as development costs related to computer software developed
for internal use, all research and development costs are expensed as incurred (ASC
985). Thus, all companies following U.S. GAAP standards ends up providing the same
information in the same manner. U.S. GAAP standards also prevent earnings
management and allow decision makers to easily determine the amount spent on
research and development in each period.
Although, U.S. GAAP standards have some advantages, this principle is overly
conservative for heavy research companies. The standard is based on the idea that the
future success is highly uncertain, so it is hard to determine whether to capitalize the
research and development costs or not. Hence, U.S. GAAP standards require
industries such as technology, pharmaceutical, and biotech companies to expense all
their research and development costs regardless of their future benefits. These costs
could generate items of significant value which needs to be reported on their balance
IFRS standards, on the other hand, are broader and allow every industry to capitalize
development costs if it can demonstrate the technical and economical feasibility of the
assets for sale or use (ISA 38.57). Therefore, IFRS standards address the problems
associated with U.S. GAAP standards by permitting every industry to recognize
valuable assets created from research and development costs on their balance sheet.
However, there are some criticisms against IFRS standards. First, since only
development costs are capitalized, more professional judgment has to be made to
distinguish development costs from research costs. As a result, the comparability of
financial statements will be reduced because different companies have different ways to
classify costs. Second, according to the study by Stephen Kerr and associates (2009),
“management could keep a product in development even though it knows the product
may never make it to market in order to keep the development costs capitalized”.
Therefore, IFRS could lead to earning manipulation. Third, investors who analyze U.S.
GAAP figures will have to find information hidden inside the notes and adjust IFRS
figures. Although these are real concerns, IFRS informs the users of the financial
statements how they are applying IAS 38, which results in a clearer picture of the
accounting of the costs.
Adopting IFRS standards concerning capitalization of development costs will save time
and cost for FASB. The broader and more versatile IFRS standard will allow for
application to many industries and possible future changes. The current GAAP
standard has already begun to see problems associated with such a specific and
narrow rule for the capitalization of development costs. As discussed earlier, the
development of internal use software is capitalized contrary to the original standard.
This occurred because of the growing technology advancements that were unforeseen
at the time the original standard was created. FASB was forced to make amendments
to ASC section 985, creating topic 605. Adopting IAS 38 is an improvement over U.S.
GAAP because IFRS does not need to spend time adjusting or creating further
standards to provide guidance for proper accounting. IAS 38’s versatility is one of its
strengths, making it more efficient for FASB; this will eliminate the need for further
In summary, neither regulation is perfect for the ever changing world market. However,
we feel that IAS 38 is a superior regulation. It is able to adapt to the ever changing
markets. Amortization and capitalization of development costs are able to show that
there are future benefits from the costs incurred. Nissim showed that companies that
engage in research and development will have future benefits from their research. We
acknowledge that FASB took the conservative approach. There is more professional
judgment involved with IAS 38, which could result in more earnings management. But
most important, the users of financial statements need to know the potential of the
future benefits provided by research and development. IAS 38 makes this information
available, unlike current U.S. GAAP. It is our hope that FASB will put this topic on their
agenda and pursue this change further.
FASB Codification,
Kerr, Stephen G., Gillett, John, Sandoz, Nathan ve Wilcox, William E. (2009), “International
Financial Reporting Standards: Impact on professional Financial Statement Users”.
Commercial Lending Review (September-October 2009): 6-7
KPMG (2009), “IFRS for Technology Companies: Closing the GAAP”,
IFRS: Initial Recognition: Research and Development Costs,
Nissim, Doron and Thomas, Jacob. (2000). R&D Costs and Accounting Profits. Columbia
Business School.
Accounting %20Profits.pdf