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 must be recognised 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 requires development-phase expenditure to be recognised as an intangible asset if, and only if, 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.
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.
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.
An intangible investment — R&D, brand-build, customer-acquisition with measurable payback, software development — that has been moved from operating expense to balance-sheet asset and amortised over its useful life under management accounting. Statutory accounting rarely permits the same treatment for internally-generated intangibles: IAS 38 imposes six conservatism criteria that are difficult to meet in practice; ASC 730 forces immediate expensing under US GAAP.
In-process research and development (IPR&D) is a project acquired part-way through — bought as a standalone asset or picked up in a business combination — where the underlying work is incomplete at the acquisition date. Its treatment differs sharply from the same activity performed in-house, and the difference is a common source of confusion.
Internal-use software is software a business acquires or develops for its own operations rather than to sell or licence. Under US GAAP, ASC 350-40 sets a stage-based model.
An intangible asset created within the business (R&D output, brand, customer relationships, organisational know-how) rather than acquired through a transaction. IAS 38 conservatism rules make these difficult to capitalise on statutory books — six development-cost capitalisation criteria must all be met.
The opening IFRS statement of financial position is the balance sheet a first-time adopter prepares at its date of transition under IFRS 1, First-time Adoption of International Financial Reporting Standards. It is the starting point of the entity's IFRS record, and four things happen in preparing it.
Website development costs are the amounts a business incurs building and launching its own web site. Under IFRS, SIC-32 (“Intangible Assets — Web Site Costs”) applies IAS 38 to the activity by splitting a project into stages: planning, application and infrastructure development, graphical design, content development, and the operating stage that follows launch.
Further Reading
Round Ready — preparing for a Series A or B
How founders evidence research and development investment before an institutional round.
Read more →What is R&D tax credit and how do UK startups claim it?
UK companies claim R&D tax relief on qualifying R&D spend through their corporation tax return. Under the merged scheme the expenditure credit is 20% and taxable, so the net benefit depends on the company's tax position.
Read more →Related FAQ
What is the difference between tangible and intangible assets?
Tangible assets have physical form: land, buildings, machinery, vehicles and stock. Intangible assets have none: they are identifiable non-monetary assets such as patents, trade marks, software and customer contracts.
Read full answer →How should companies capitalise AI investments under IAS 38?
Under IAS 38, AI development costs can be capitalised once technical feasibility, intent to complete, probable future benefits, and reliable cost measurement are demonstrated — research phase costs must be expensed.
Read full answer →What are the ASC 350 rules for software capitalisation?
ASC 350-40 requires capitalisation of internal-use software development costs during the application development stage, while preliminary project and post-implementation costs must be expensed.
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