Generally Accepted Accounting Principles (GAAP) are just what their name implies: a generally accepted set of accounting principles, procedures, and standards that public companies in the U.S. must follow when preparing financial statements.
This set of standards is issued and maintained by the Financial Accounting Standards Board (FASB). It comprises methods for recording and reporting accounting information that are already commonly used and gives them uniformity. The objective of GAAP is to establish clarity and consistency in the reporting of financial data, so it can be clearly understood by anyone.
The international equivalent to GAAP is the International Financial Reporting Standards (IFRS). This set of standards has been adopted by over 120 countries, including the members of the European Union.
It is also used throughout Asia and in South America but has yet to make any serious inroads in U.S. reporting. While GAAP allows for much more detailed reporting of financial information, IFRS may be a better logical representation of the economics of most business transactions.
It is not likely to be fully embraced here in the U.S., although at some point IFRS methods may be used to supplement those from the GAAP system.
Differences between GAAP and IFRS
The primary difference between GAAP and IFRS is that GAAP is more rules-based, whereas IFRS is decidedly more principles-based. Guidelines under IFRS call for much less overall detail than is required by GAAP.
This results in IFRS reporting leaving much more room for interpretation, and it sometimes calls for lengthy supporting descriptions on financial statements to clarify entries that have been made. However, IFRS is more intuitive than GAAP reporting, and it often represents financial transactions better than GAAP reporting can.
The biggest single area of variance between the two reporting systems lies in how they handle the reporting of inventory. IFRS does not allow the usage of last-in, first-out (LIFO) accounting methods, whereas GAAP does. Both reporting systems permit first-in, first-out (FIFO) accounting methods, as well as the weighted average method of accounting.
GAAP does not permit inventory reversals, while IFRS does allow for them, albeit only under specific circumstances.
GAAP as it relates to R&D accounting
The rules set forth in GAAP require that most R&D costs be expensed in the present financial period, although companies are allowed to capitalize certain R&D software costs.
According to FASB definitions, research is considered to be planned investigation for the purpose of acquiring knowledge about new or existing products or processes, while development is defined as the translation of research discoveries into some kind of plan or design.
Whenever a company spends any funds on R&D activities, it must record those costs under the current financial period. Costs that are typically incurred in this manner are for equipment, facilities, and materials, and these must all have no other purpose in the company aside from research and development.
There are situations that allow a company to treat some R&D expenses as non-current assets, and in these situations, the costs can be capitalized and expensed over a set period of years. When costs are associated with assets that contribute to some kind of alternate future, costs can be depreciated over the anticipated lifetime of the asset.
Capitalized costs relating to some intangible assets like trademarks or logos can also be amortized. Projects which develop software products are considered by the FASB to have three clear stages: feasibility studies, actual production, and sales and distribution. The only one of these three stages that the FASB allows companies to capitalize costs on is the production phase.
In such cases, companies are allowed to amortize capitalized costs using one of two approaches: 1) straight-line charge-off spread out over the useful life of an item, or 2) the ratio of current to future generated revenue brought in by the product. Any remaining unamortized costs can be written off if the net potential value of the product has been impaired or interrupted in some manner.
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R&D accounting under GAAP and under IFRS
It often happens that accounting reporting requirements for R&D costs can be much more complex under IFRS than when GAAP is used.
Using GAAP, research and development costs are expensed right as they are incurred, although there are some specific requirements in areas such as cloud-computing costs, website development, motion picture films, and software development.
Using IFRS, R&D costs are still expensed, just like in GAAP. However, IFRS requires companies to capitalize some development expenditures (for instance, internal costs), when certain conditions have been met.
Intangible assets that have been developed internally are usually capitalized and then amortized under IFRS, whereas they would simply be expensed under GAAP. This causes a couple of sticking points under IFRS.
It requires that development activities be clearly differentiated from research activities, and it necessitates an analysis of whether and at what point the criteria have been met for capitalizing any development expenditures. This means the logical starting point for any company using IFRS would be to sort out which of its activities should be considered research, and which should be considered development.
Unfortunately, GAAP nor IFRS provide any strong clarification of what the difference is between these two categories of activity, so it is generally the responsibility of the individual company to set up its own group of processes and controls which separate the two. During the development phase of a project, expenditures can be capitalized when all the following criteria have been met.
- It is technically possible to complete the project, so the product will have future usage
- The asset will produce future economic benefits
- The expenditures on the asset are clearly defined
- All resources necessary for the completion of the project are available
- The company has the ability and the intent to complete the product and sell it
The above constitutes the best guideline for determining when a company can begin to capitalize development costs on any project currently underway. The single most important factor would be identifying when technical feasibility has been reached, and that is when development costs can begin to be capitalized.
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Save money on your R&D expenditures with help from Tri-Merit
At Tri-Merit, our specialty tax professionals are well-versed in all aspects of the research and development tax credit, a tax credit that allows businesses engaged in R&D activities to save money on expenses incurred as a result of those activities. However, in order to take advantage of the tax credit, businesses need to actually qualify for it.
This is easier said than done, as in-depth audits have to be performed on your R&D activities, and these audits need to be able to hold up to even the most stringent IRS scrutiny. Tri-Merit can help you make sure that your research and development activities are fully and accurately documented, and we can ensure that you receive the highest possible savings come tax time.
R&D can be an expensive, time-consuming, and tricky process. We want to make sure that you are having to spend as little money as possible on creating and improving the products and processes of the future.
BE MORE CONFIDENT IN WHO YOU TRUST TO ADVISE YOUR CLIENTS.
We understand what it’s like for CPAs to question whether they have selected the right specialty tax partner. The right partner will have proven expertise and serve to enhance the relationship between client and CPA. This is why Tri-Merit serves as an extension of the CPA’s advisory team to reinforce the CPA’s role as a trusted advisor, while helping taxpayers increase cash flow through specialty tax incentives. Schedule a discovery call at 800.624.1076 to give your clients the best possible experience with a partner you can trust.
R&D tax credit | Cost segregation | 179D | 45L | Employee Retention Credit