Development Costs (IAS 38)

Definition

Development costs are the expenditure incurred applying research findings to a plan or design for a new or substantially improved product, service, process or system before it enters commercial production or use. Under IAS 38 (IFRS — the default framework for UK groups reporting under adopted IFRS), the standard divides the work into two phases and treats them differently. Expenditure in the research phase is written off as incurred under IAS 38.54, because at that stage an entity cannot demonstrate that an asset exists. Expenditure in the development phase may be carried forward as an intangible asset once six conditions are demonstrated together under IAS 38.57: technical feasibility, intention to complete, ability to use or sell, probable future economic benefits, adequate technical and financial resources, and reliable measurement of the cost attributable to the asset. Where the two phases cannot be separated, the standard treats the whole project as research. Worked example: a software business spends £900,000 in a year, of which £250,000 explores whether an approach is viable and £650,000 builds an approved, funded, technically feasible module scheduled for release. The first tranche is research expenditure; the second is the population against which the six conditions are tested. Jurisdiction contrast: US GAAP expenses research and development as incurred under ASC 730, with narrower routes for software in ASC 350-40 and ASC 985-20, and FRS 102 s.18 makes development-cost capitalisation an accounting-policy choice rather than a requirement. The judgement management makes is where in the project the development phase began, and whether records created at the time support that date.

Taking a defensible position

The position

IAS 38.54 requires research-phase expenditure to be written off as incurred. IAS 38.57 permits development-phase expenditure to be carried forward as an intangible asset only where all six conditions are demonstrated together: technical feasibility, intention to complete, ability to use or sell, probable future economic benefits, adequate resources, and reliable measurement of cost. Where the phases cannot be distinguished, the standard treats the whole project as research.

A defensible posture

Where the six conditions can genuinely be demonstrated, capitalisation is the position the standard contemplates rather than an aggressive one. A management team that dates the development phase from a specific evidenced decision — an approved specification, a funded plan, a working prototype — and applies that date consistently across projects is in a position it can hold. The weaker version capitalises from the start and reasons backwards at the year end.

Evidence to hold

Technical feasibility evidence — a working prototype, pilot results or a signed technical specification, dated at the point the development phase is said to begin.
A board or steering-group minute approving the project, its budget, and its intended route to use or sale.
Project cost records that attribute internal time and third-party spend to a named project rather than to a department.
A commercial case supporting probable future economic benefits — a market assessment, a sales pipeline, or a costed internal-use case.
Evidence of adequate technical, financial and other resources to complete the project, such as a funding plan or resourcing schedule.

The challenge you may face

An auditor or diligence reviewer will press on the date the development phase began and on how expenditure before that date was separated. Expect a test of whether the six conditions were demonstrable at the time rather than reconstructed afterwards, whether costs trace to a project rather than an allocation from a departmental total, and whether the same policy was applied to projects that were later abandoned.

Complementary Terms

Concepts that frequently appear alongside Development Costs (IAS 38) in practice.

IAS 38 (Intangible Assets)

The International Accounting Standard governing the recognition, measurement, and disclosure of intangible assets. IAS 38 requires that an intangible asset be identifiable, controlled by the entity, and expected to generate future economic benefits.

Research & Development (R&D)

Systematic investigation and experimentation aimed at creating new products, services, or processes, or significantly improving existing ones. R&D expenditure is one of the largest categories of intangible asset investment and is a key driver of innovation capital and future competitiveness.

Capitalisation of Intangibles

The accounting practice of recording an intangible expenditure as an asset on the balance sheet rather than expensing it immediately through the income statement. Under IAS 38, development costs may be capitalised when specific recognition criteria are met, whereas research costs must always be expensed.

ASC 730

The US GAAP standard requiring immediate expensing of research and development costs as incurred. ASC 730 is the structural source of the gap between statutory and capitalisation-reclassified EBITDA for US-headquartered companies: virtually no R&D is permitted on the balance sheet, regardless of stage, evidence quality, or commercial proximity.

FRS 102 Section 18 (Intangible Assets other than Goodwill)

The section of the UK and Republic of Ireland financial reporting standard that governs the recognition, measurement, and disclosure of intangible assets other than goodwill for entities not applying IFRS. Section 18 requires intangible assets to be measured at cost less accumulated amortisation and impairment losses, with all intangible assets presumed to have a finite useful life.