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The research and development activities have become normal part of operations for many organizations. In the cut through competition, it has become really important for the organizations to continually endeavor to explore new products and services. It is the innovation which gives a competitive edge to the organizations, thus, putting efforts in research and development are worthy (ACCA, 2016). From the accounting view point, the research and development poses challenges in front of the accountants. Certain part of the expenses incurred on the research and development are to be expenses in the profit and loss account while certain is capitalized.
In this context, a report on the research and development activities being undertaken by Bio-sustainable Feeds (BSF) Ltd has been presented here. This report is mainly focused on the accounting treatment of the research and development expenditure incurred by Bio-sustainable Feeds (BSF) Ltd. Further, the report also covers a discussion on the valuation of patent and accounting treatment of government grant. Apart from this all, the management’s assertion made in the prospectus has also been analyzed in this report.
Bio-sustainable Feeds (BSF) Ltd is an Australian company and engaged in the research on sustainable aqua-culture feeds. The company is currently undertaking a research that is focused on finding out the bacteria based fish feed. The research on bacteria based fish feed has been implemented to overcome the problems of earlier research which was to explore plant based feeds. Further, the plant based feed research was undertaken to overcome the problems of fish based feed. However, the plant based feed research not only failed in resolving the problems of fish based feed, but it also added few more new problems.
Due to the use of plant based feed, the fish dying rate increased from 1/20th to 1/3rd resulting in loss to the fish producers. Further, good quality human food was required to produce plant based feed, which caused problems for poor people. The food which could have been used by the poor people was now being used in the production of the fish feed. The environmentalists alleged that diversion of the good quality food, which can be used for human consumption; to the production of fish feed is not justifiable. In the opinion of the environmentalists this research will cause imbalance in the society by promoting the rich to become richer and demoting the poor to become poorer. Therefore, it could be inferred that the impact of the plant based research on the society has been adverse.
The company has been carrying on the research activities to find out the sustainable aqua-culture feeds. The sustainable aqua-culture feed means the feed that meets the required specifications in terms of quality and also fulfills the environmental and social needs. Earlier, the company carried out research to explore fish based feed, which could not sustain due to lower conversion rate. The fish based feed had a conversion rate of 1kg high value fish from the consumption of 10 kg fish based feed. Thus, the problem with the fish based feed was of low conversion rate. In order to resolve this problem, the company switched from exploring the fish based feed to plant based feed.
In the pant based feed, the use of high quality human food such as canola, corn, soya-bean, and sunflower was to be made. The main focus of the plant based feed research was to increase the conversion rate so that the production of the fishes could be increased. However, this research also failed in achieving increment in the conversion rate. The conversion rate of plant based feed was 1Kg high value fish from consumption of 30Kg good quality plant based feed. Further, the use of plant based feed also increased the dying rate of the fishes from 1/20th to 1/3rd. Apart from that the plant based feed research also failed to meet the environmental and social needs as claimed by the environmentalists.
As the competition is getting tough day by day therefore the firms are required to maintain uniqueness in their products and services so that more customers could be attracted. In order to explore the new products and services, the firms need to undertake research and development activities (Harris & Trainor, 2009). Thus, the primary aim for undertaking research and development activities is to survive from the competition and maintain a sustainable growth. In the present era, it has been observed that the firms incur huge amount of expenses on the research and development activities. The research and development activities have become integral part of the operations of the firms in the present days (Harris & Trainor, 2009).
The expense on the research and development is one time while the benefits accrue over the number of years, for example, once the patent is developed for the new product or process, the firm will reap the benefits of this patent over the number of years. Thus, from accounting view point, there arises a need to segregate the expense on the research and development in revenue and capital nature. The revenue nature expense on research is charged to the profit and loss account as and when incurred, whereas, the capital nature expense is recognized in the balance sheet as an intangible asset (Weygandt, Kimmel, & Kieso, 2009). In this regard, identification as to what part of expense should be charged to the profit and loss account considering it as the revenues nature and what part should be capitalized is crucial.
The Australian Accounting Standard 1011, “Accounting for Research and Development Cost” contains provisions that guide in identifying the revenue and capital nature of the expenses incurred on the research (AASB 1011, 1987). As per the provisions of this AASB, the entire research operations are divided in two phase such as research phase and development phase. Preliminary activities are performed in the research phase, while, substantial activities needed to get the intangible developed are carried out in the development phase. The research phase activities are too basic and preliminary that on completion of the research phase, the outcome of the research could not be predicted with precision (AASB 1011, 1987).
The development activities are taken up after completion of the research phase to work on the initial findings (AASB 1011, 1987). The accounting standard states that the activities of the development are significant. As the development phase progresses, the outcome of the research becomes easier to predict with precision. As soon as the development phase activities are completed to the extent that the outcome of the research could be measured reliably, the expense becomes eligible for capitalization in the books. Thus, in order to capitalize the expense of the development phase, the outcome of the research should be visible and clearly predictable (AASB 1011, 1987).
Thus, overall it could be inferred that the expenses incurred on the research when the activities are in research phase, should be charged to the profit and loss account in the year in which these are incurred. Further, when the outcome of the research is clear and it is probable that the firms will receive the benefits of the research over the number of years, the expense incurred should be capitalized by recognizing intangible asset in the books. The capitalized expense is then amortized to the profit and loss account proportionate to the accrual of benefits on yearly basis (AASB 1011, 1987).
The patent is recognized as an intangible asset in the books of accounts of the organization. As per the accounting standard, the patent purchased from other person is recognized at the amount paid to the seller. Thus, the valuation and measurement of the purchased patent is simple. However, the patent generated internally poses problems in front of the management in valuation and measurement. The costs accumulated under the development phase qualifies for capitalization, therefore, initially, the patent is valued and recognized in the books of accounts at the development cost (AASB 138, 2015).
However, the revaluation model prescribed in the accounting standard 138 permits revaluation of the intangible asset in the later accounting periods. As per this model, the entities may revalue the intangible assets at the fair market value (AASB 138, 2015). However, there should be in existence an active market so as to enable reliable measurement of the fair value of the intangible asset. The measurement of the fair value of the intangible asset is a subjective matter. The fair value of an asset implies the amount that can be received by the buyer on selling the asset to the seller in an open market. Alternatively, the fair value could also be ascertained by discounting the future cash benefits that will accrue to the entity from the use of intangible asset (AASB 138, 2015).
As per the principles of accounting and finance, the fair of the patent can be determined by discounting the expected cash benefits accruing to the entity. Applying this method to the current case of Bio-sustainable Feeds (BSF) Ltd, the fair value of patent has been determined as under:
Case-1: When Sold in 2 Years
Cash Flows ($M)
Present Value ($M)
Case-2: When Used for 10 Years
There are two cases, in the first case, the company is expected to the sell the patent in second year, while, in the second case, the company intends to use the patent for 10 years. In the first case, the fair value of the patent is worked out to be $785.32 million, while, in the second case, the fair value of the patent is worked out to be $1,342.02 million. The fair value that is to be used for recognition of the patent in the financial statements of Bio-sustainable Feeds (BSF) Ltd will depend on the dominant intention of the company. If the company intends to use the patent, the fair value will be used as arrived in the second case, on the other hand, if the company intends to sell it in two years, the fair value as arrived in the first case will be used.
Journal Entries for the R&D Transactions From 2013 to 2016
Debit (AUD$ M)
Credit (AUD$ M)
Research and Development Expense
(Research expense on plant based fish feed paid)
Profit and Loss Account
(Research expense on plant based fish feed charged to profit and loss account)
(Grant received from CSIRO)
(Grant credited to profit and loss account to the extent of expenditure on research)
(Research expense on bacteria based fish feed paid)
(Research expense on bacteria based fish feed charged to profit and loss account)
In relation to the research, BSF Ltd has received a grant of $500 million from CSIRO which is a government agency. Accounting standard 120 prescribes the accounting treatment of the government grant in the books of the receiver (AASB 120, 2009). According to the provisions contained in this standard, the government grant if received for the intangible assets that has been developed can be deducted from the carrying amount of the respective asset. However, if the government grant has been received but the intangible asset has not been developed yet, the entity may chose to credit to the profit and loss account to the extent the expense on research has been was debited to the profit and loss account (AASB 120, 2009).
In the current case of Bio-sustainable Feeds (BSF) Ltd, it can be observed that the company received grant in the year 2013. The expense on the research and development activities incurred by the company in the year 2013 amounted to $360 million. However, the company utilized $340 million from the grant receipts; therefore, $340 million has been credited to the profit and loss account in the year 2013. In the year 2014 and 2015, the company did not incur any expense on the research and development operations. In the year 2016, the company undertook a new research called bacteria based feed research and incurred a sum of $160 million on the research and development activities in relation to this research.
The amount remained in the grant account also stands at $160 million in the year 2016. Therefore, the whole remaining amount in the grant account has been credited to the profit and loss account in the year 2016.
The prospectus of Bio-sustainable Feeds (BSF) Ltd contains a statement that company holds exclusive control over the bacteria based feeds technology. In this regard, it is the responsibility of the accountant to determine the fairness of this statement made in the prospectus before affixing his signatures (Gaeremynck & Vermoesen, 2009). The prospectus is a highly sensitive document as the public at large makes investment in the company based on the evaluation of the prospectus. Thus, the accountant should satisfy himself to the fullest that the assertions or statements made in the prospectus are genuine and true (Gaeremynck & Vermoesen, 2009).
BSF Ltd is currently undertaking a research to explore the bacteria based feed. It is projected that this research will require a sum of $360 million in all to explore the technology that will be used for producing the bacteria based feed. The research is in initial years, which is evident from the fact that the company is yet to undertake the development phase activities on this research. The company has incurred a sum of $160 million on this research till now and it is expected that another $200 million will be required to be sent in the upcoming years.
Thus, it could be observed that the substantial part of the research is yet to complete in respect of bacteria based research being undertaken by BSF Ltd. As per the provisions of AASB 138, the entity can not recognize intangible asset in the books unless it is ensured that the future economic benefits will flow to it from the use of such asset (AASB 138, 2015). Further, it is provided that the completion of the substantial part of the development phase activities is considered as an indication that the entity will receive the economic benefits from the intangible asset being developed. Thus, unless the substantial part of the development phase activities is complete, the entity can not recognize intangible asset in the books (AASB 138, 2015).
In the case of BSF Ltd, the company has completed only the research phase activities in relation to the bacteria based research, while, the development phase is still to be initiated. Therefore, the company can not recognize patent in the books of accounts. The whole expenditure of $160 million is to be charged to the profit and loss account in the current year. Thus, the assertion made in the prospectus by the management of BSF Ltd is not tenable.
AASB 1011. 1987. Accounting for Research and Development Costs. Retrieved September 17, 2016, from https://www.aasb.gov.au/admin/file/content102/c3/AASB1011_5-87.pdf
AASB 120. (2009). Accounting for Government Grants and Disclosure of Government Assistance. Retrieved September 17, 2016, from https://www.aasb.gov.au/admin/file/content105/c9/AASB120_07-04_COMPjul08_01-09.pdf
AASB 138. (2015). Intangible assets. Retrieved September 27, 2016, from https://www.aasb.gov.au/admin/file/content105/c9/AASB138_08-15_COMPoct15_01-18.pdf
ACCA. (2016). Research and Development. Retrieved September 27, 2016, from https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f7/technical-articles/rd.html
Gaeremynck, A. & Vermoesen, R. (2009). Guidelines to the Auditor in Prospectus and Other Related Engagements. Maklu.
Harris, R. & Trainor, M. (2009). Why Do Some Firms Undertake R&D Whereas Others Do Not? Retrieved September 16, 2016, from https://www.spatialeconomics.ac.uk/textonly/serc/publications/download/sercdp0020.pdf
Weygandt, J.J., Kimmel, P.D., and Kieso, D.E. (2009). Financial Accounting. John Wiley & Sons.
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