Treatment of Research and Development Cost Case Solution
In the case of White Pharmaceutical if the sole rights of obtaining the jointly developed drug will be considered as acquired asset other than goodwill. And these rights can reliably measure in cost which may consist of contract charge. This cost is allowed to be capitalised if providing hint for probable economic benefit although these should be tested or impairment annually or when there is indication of impairment (IAS 36).
IAS 36 provides guidance for the impairment of the non-current asset either in the form of rights. According to IAS 36 as an asset is said to impair when carrying amount of the asset exceed its recoverable amount. Whereas recoverable amount is the higher of fair value and value in use. The value in use is computed through getting the present value of all future benefits that an asset can deliver.
However, no other intangible assets should be recognised in the research phase and all research costs should be charged to expense. The assets will enter in the development phase when the future economic benefit demonstrated either by sale or use and cost incurred after that point will be capitalised.
According to US GAAP
There is a difference in an asset acquired and internally generated.If an intangible asset is acquired it should be capitalised if alternative future benefit expected and amortisation/impairment charged into expense.
In the case of rights acquired if these rights can reliably estimate the future economic benefit. Then they can capitalise it in which some amount was expensed out in internally generated case. Although in US- GAAP impairment of intangible non-current asset is recorded when recoverable amount is lower than carrying value but here recoverable amount is considered on a nun discounted basis which will make a lesser amount of impact of impairment in contrast to IFRS. Currently,White Pharmaceutical has expensed out all the costs incurred on research and development. Hence the income statement will need to be reinstated here.
Accessing the payment made by White Pharmaceutical
White Pharmaceutical offered a partnership to Neuro central in the development of neurological drug as they had enough money to make strategic alliance through which Neurological get a lot of progress on developing a trans dermal patch. White Pharmaceutical has paid five million upfront payments. Which is nonrefundable for an increase in research efforts. Although the further amount is paid to them for the research and development phase.
IAS 38 will consider the case as asset acquired is separately acquired or internally generated, in which the future economic benefit is probable and cost can be reliably measured. But amount paid initially by White Pharmaceutical did not impact benefits. This initial cost of five million paid will be expanded out as it was meeting criteria of the research phase.
Although when in phase 1 of development, no complication arose in preliminary testing phase, there creates a hint that this asset can generate future economic benefit so it needs to be capitalised after wards. The development phase was then started assuming different other covenants are already satisfied in this jointly developed product i.e. the prevailing law of the country like if law approves the case only after noting safety and effectiveness result then amount accrued till 2004 will be expanded out.
In normal circumstances, there will no change in the financial year of 2000 as amount needs to expense out as per IAS 38 also. When the amount incurred of preliminary testing proved the positive result in the 1st phase, it means that development phase was started and the amount that was paid later need to be capitalised, comprises of ten million efficiencies and a side effect on 300 person and final payment of fifty-five million on completion of phase three. Amount spent will book as non-current intangible asset accordingly and IAS 36 will also be considered which provided guidance for the impairment when carrying amount of the asset exceed its recoverable amount whereas recoverable amount is the higher of fair value and value in use of an asset. The value in use is computed through getting the present value of all future benefits that an asset can deliver.
Hence White Pharmaceutical need to reinstate financial statement from 2003 and afterwards if IAS 38 applies.
2 Capitalization of Research and development
Managerial decision or explicit rules
If the amount is considered on the managerial decision the result will be different from the explicit rules. In addition, it will be impossible for the user to understate company’s condition in the industry if every corporation uses their own methodology for capitalization rather than following the standard.
Management tries to justify their action legitimate in order to earn the incentive. So they will capitalise the cost that should be expensed out. Hence, providing the wrong view of the corporation due to an over statement of financial assets. Management can then also use this capitalization as a cookie jar to use as an expense for declining tax effect during unfavorable tax rate.
Furthermore, management can also avoid tax amount, through expensing out the amount that needs to be capitalised. As in the case of White Pharmaceutical the capitalization effect also taken into expense may be to earn tax benefits……………..
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