Generally Accepted Accounting Principles (GAAP) are standards, principles, and procedures for accounting issued and maintained by the Financial Accounting Standards Board (FASB).
GAAP methods standardize accounting recording and reporting across companies, establishing uniform methods for treating specific items and topics. When preparing financial statements, public companies operating in the US must follow these standards.
Internationally, many companies in over 140 countries use the International Financial Reporting Standards (IFRS) instead of US GAAP.
In the US, IFRS has yet to make serious inroads. Although they share some similarities, GAAP allows for more detailed reporting of financial information, while IFRS may better represent the economics of many business transactions.
Differences Between GAAP and IFRS
The primary difference between GAAP and IFRS is that GAAP is more rules-based, whereas IFRS is more principles-based. IFRS calls for much less overall detail than GAAP requires.
IFRS is more intuitive than GAAP reporting, and it often represents financial transactions better than GAAP reporting can. However, IFRS reporting leaves much more room for interpretation, leading to lengthy supporting and clarifying descriptions of financial transactions.
The most significant variances between the two reporting systems surround handling assets and inventory. Further, 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 and the weighted average method of accounting.
GAAP does not permit inventory reversals, while IFRS does allow for them, albeit only under specific circumstances.
GAAP and R&D Accounting
GAAP rules specify that research and development costs are expensed as incurred. However, cloud-computing costs, website or software development, and motion picture films can be capitalized.
According to the FASB, research is a planned investigation to acquire knowledge about new or existing products or processes. Alternatively, development is defined as translating research discoveries into specific plans or designs.
Investment in R&D activities must be recorded as costs in the current financial period. These costs typically include expenses for equipment, facilities, and materials with no other purpose in the company aside from R&D.
In some cases, a company may treat R&D expenses as non-current assets, capitalizing the cost and expensing it over a set period of years. Costs associated with assets that contribute to the company’s future value can be depreciated over the anticipated lifetime of the investment.
Capitalized costs relating to other intangible assets like trademarks or logos can also be amortized. The FASB considers software development to have three clear stages: feasibility studies, actual production, and sales and distribution. The production phase is the only one of these three stages in which the FASB allows capitalization of costs.
Capitalized intangible assets are then amortized using one of two approaches: 1) straight-line over the useful life of an item, or 2) the ratio of current to future revenue brought in by the product. Companies can write off any remaining unamortized costs if the product’s net potential value has been impaired or disrupted.
R&D Accounting Under GAAP and IFRS
Under IFRS, accounting reporting requirements for R&D costs can be much more complex than with GAAP.
As with GAAP, R&D costs are generally expensed under IFRS. However, under certain conditions, IFRS requires capitalization of development expenditures, especially internally developed intangible assets.
Unfortunately, neither GAAP or IFRS provides any real clarification regarding the difference between research and development. It’s on the individual company to define processes and controls to separate the two.
During the development phase, capitalized expenditures must meet the all of the following criteria:
- The project is technically feasible, and the product will have future usage
- The asset will produce future economic benefits
- Expenditures can be allocated to the defined asset
- All resources necessary for the completion of the project are available
- The company has the ability and the intent to complete and sell the product
Save Money on Your R&D Expenditures With Help from Tri-Merit
Tax laws are constantly changing, and rules surrounding R&D are no different. Although it conflicts with GAAP, part of the Tax Cuts and Jobs Act requires capitalization of R&D costs to be depreciated over 5 or 15 years. This short-term expense reduction can impact your quarterly tax bills in 2022.
At Tri-Merit, our specialty tax professionals are well-versed in all aspects of the research and development tax credit. Businesses engaged in R&D activities can often save money on taxes due to qualifying activities.
Schedule a discovery call today to see how Tri-Merit can help you through the process of assessing and documenting your clients’ research and development activities.
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R&D tax credit | Cost segregation | 179D | 45L | Employee Retention Credit