Advising clients on how to minimize research and development costs, not to mention understanding the ins and outs of the research and development tax credit, can be a daunting task.
A research and development (R&D) operation can determine how successful a company can be in the long run, but the reality of R&D expenses affecting the bottom line can also be a scary proposition if the company is not prepared for it.
Understanding Research and Development Accounting Principles
Prior to 1975, research and development activities were classified as intangible assets, as future benefits were expected to occur as a result of the efforts.
However, due to the unpredictable outcomes of research and development efforts, the Financial Accounting Standards Board (FASB) ruled that companies must expense all R&D costs as incurred.
This is justified because the number of costs applicable to the future cannot be measured with any true precision and doubt exists as to whether research and development efforts will actually bring future benefit to the business.
Even if benefits are expected, they cannot truly be measured. These are key things to understand when dealing with research and development costs and expenditures.
Recommended Read How Businesses Can Save on Research and Product Development
Will Research and Development Be Beneficial to the Company?
Before investing in research and development operations, a business must decide whether or not R&D efforts will actually be beneficial to its success.
There are several factors to take into consideration when making the decision. It is important that CPAs are knowledgeable about these factors, so they can help their clients make the best decision for their future.
The first factor to consider is proprietariness.
If research and development operations can be protected by way of patents and non-disclosure agreements, then this provides a significant advantage to the company, as the product or service that is being developed becomes their sole property.
This can provide a vital head start in a competitive industry and can easily justify the steep costs associated with development expenditures. If the focus of a research and development project is not patentable, then the risk can be much greater.
Risk is the second major factor to consider when developing new products or processes.
R&D does not guarantee success, and, when a company has numerous competitors, the risk may be far greater than the potential reward.
The third important factor to consider is timing.
Sometimes the timing isn’t ideal for a particular endeavor. R&D is most effective when a company is trying to capitalize on a slow- or moderately-paced market growth rate. An overly competitive and fast-paced industry makes it much more difficult to gain an advantage.
Understanding the Research and Development Process
In order to make improvements to your clients’ R&D operations and minimize expenses, you need to have a thorough understanding of the actual research and development process. R&D is an extensive process that can take a lot of manpower, a lot of time, and a lot of money.
Ideation
Any research and development project has to start with an idea, whether that idea was created within the business itself or is an existing idea that is being updated or expanded upon.
This often takes the form of a group of industry experts engaging in a collective effort to determine ways to fix problems or improve processes for their target market.
Oftentimes, these ideas start out very broad and generic and have to be narrowed down by assessing potential obstructions, complications, and future benefits for the business. If an idea seems outside the realm of possibility, then it will probably be scrapped.
Google, famously known for rewarding project teams for failed ideas within its semi-secret testing lab (formerly known as Google X), is generally considered an exception to this rule.
Most companies do not have the same resources that are afforded to the Google research and development staff.
Applied Research
Once the researchers have narrowed their focus to a handful of ideas, applied research is conducted to determine industry compatibility and market readiness.
This phase of research is where ideas show whether they actually have true potential or need to be taken back to the drawing board. Ideas that pass are then brought into the development phase to be turned into a marketable asset.
Development
The development phase is where the nitty-gritty of the process actually begins. Here, researchers will work hand-in-hand with developers to determine how an idea can be turned into a tangible product.
The development phase is where prototypes are brought to life to showcase the capabilities of the product or service. Topics such as mass production and manufacturing materials are important to consider during this phase.
Launch
Research and development is not necessarily a linear process. So, while listed last, the launch phase should be underway by the time real development has begun.
Once the product is ready to be made available to the masses, the company will want to have already been marketing it and gotten the public excited for its launch. The launch phase is also where other important information is determined, such as pricing and distribution methods.
Recommended Read What Are the Steps Involved in the Product Development Process?
How to Save on Research and Development Costs
Streamline R&D Processes
One of the best ways to save on costs is to look for ways to streamline the aforementioned research and development process. First and foremost, it is important at the outset for a company to determine what its objectives are and what problems it is trying to solve.
Having a focused goal to start with will prevent an excessive amount of time spent trying to decide what the purpose of the R&D team is.
Speaking of which, establishing a dedicated research and development team (or two separate research and development teams) keeps employees focused on a sole effort, as opposed to dividing employee attention amongst multiple efforts.
This will result in more productivity and will eliminate complications and obstructions.
In addition, depending on the situation of your client, it may be in their best interest to outsource their research and development efforts.
Universities and research organizations that are dedicated to a specific industry can handle processes that might be outside the scope of a business with a limited budget.
Utilize the R&D Tax Credit
The inner workings of the R&D tax credit are a tricky business, which is why many businesses fail to utilize it to its fullest potential.
The R&D tax credit has the ability to save companies thousands of dollars on research and development expenses, as long as they apply for the credit and their efforts are actually deemed as qualified activities.
The IRS uses a four-part test to determine if a business’s activities qualify as research and development efforts. The efforts must be a qualified business component, be technological in nature, eliminate uncertainty, and include the process of experimentation.
Learn more about what activities qualify as R&D efforts
To qualify for the maximum R&D credit, and do so in a way that will be sustainable in the event of an audit, companies must conduct a thorough study of their R&D activities.
If the claim is approved, then the credit is usually applied against income tax liabilities and under certain situations through payroll tax liabilities.
Partner with Tri-Merit!
Our specialty tax professionals here at Tri-Merit offer unparalleled support for CPAs who need assistance saving their clients money on research and development costs.
We offer training and continuing professional education (CPE) for CPAs, because, as a firm with experience dealing with the R&D tax credit, we know how difficult it can be for a business to receive the largest possible tax return.
Tri-Merit will reinforce your role as a trusted advisor, bring in technical experts to help you make decisions, and we always put you and your clients before anything else.