Key Points
- Research spend is always expensed in the period incurred; no capitalisation is permitted.
- Development costs are capitalised only when all six IAS 38.57 criteria are satisfied simultaneously.
- Misclassifying research as development inflates intangible assets and overstates operating profit in the current period.
- Entities in pharma, software, and engineering sectors typically spend 8%–15% of revenue on combined R&D, making the split a material judgment.
What are Research vs Development Costs?
The boundary between research and development sits on a single judgment: the date technical feasibility is demonstrated. Push that date earlier and you capitalise more spend, which lifts reported profit in the current year and increases total assets. Push it later and current-year profit drops while the balance sheet stays leaner.
IAS 38.56 acknowledges that separating the two phases is difficult when a project combines both. If the entity cannot distinguish research from development, IAS 38.53 requires the entire spend to be treated as research (and therefore expensed). Auditors encounter this rule most often in software companies where agile sprints blur phase boundaries. Under ISA 540.13(a), the auditor evaluates whether management's method for identifying the transition point is appropriate.
Side-by-side comparison
| Dimension | Research costs | Development costs |
|---|---|---|
| Accounting treatment | Expensed as incurred (IAS 38.54) | Capitalised when all six IAS 38.57 criteria are met |
| Typical activities | Original investigation, laboratory studies, searching for alternatives, evaluating formulations | Prototyping, pilot production, designing tools and jigs, testing pre-production samples |
| Recognition test | None; expense is automatic regardless of intent | Six cumulative criteria: technical feasibility, intention to complete, ability to use or sell, probable future economic benefit, availability of resources, ability to measure cost reliably |
| Reversal to asset | Prohibited; once expensed, research costs cannot be reclassified even if the project succeeds (IAS 38.71) | Not applicable; capitalisation starts when criteria are first met |
| Phase boundary | Ends when the project can demonstrate technical feasibility | Begins at the point technical feasibility is demonstrated |
| Common documentation gap | Failure to maintain a project log that separates research-phase spend from development-phase spend | Failure to document the date all six criteria were first satisfied |
Decision rule: If the project cannot yet demonstrate technical feasibility, expense the cost. If all six IAS 38.57 criteria are satisfied and the entity can document when that threshold was crossed, capitalise from that date forward.
Worked example: Novák Pharma s.r.o.
Client: Czech pharmaceutical company, FY2025, revenue EUR 22M, IFRS reporter. Novák is developing a generic formulation of an off-patent cardiovascular drug. Total project spend in FY2025 is EUR 1.4M.
Step 1 — Identify the project phases
From January to August 2025, the team conducted bioequivalence studies, tested alternative excipient blends, and evaluated three different release profiles. In September 2025, Novák received positive results from its pivotal bioequivalence trial, confirming that the formulation meets EU regulatory thresholds.
Step 2 — Test the six IAS 38.57 criteria at the transition date (1 September 2025)
(a) Technical feasibility: positive bioequivalence results demonstrate the formulation works. (b) Intention to complete: board minutes from 5 September 2025 confirm approval to proceed to regulatory submission. (c) Ability to use or sell: the product targets an existing off-patent market with established distribution channels. (d) Probable future economic benefit: management's forecast projects annual sales of EUR 3.8M from 2027. (e) Adequate resources: Novák has a committed bank facility of EUR 2M and an in-house regulatory team. (f) Ability to measure cost reliably: the project uses a dedicated cost centre with time-sheet allocation.
Step 3 — Split the FY2025 spend
January to August (research phase): EUR 980,000 expensed to profit or loss. September to December (development phase): EUR 420,000 capitalised as an internally generated intangible asset.
Step 4 — Subsequent measurement
The capitalised EUR 420,000 is not amortised yet because the asset is not available for use (regulatory approval is expected in Q3 2026). IAS 38.97 requires annual impairment testing for intangible assets not yet available for use.
Conclusion: of the EUR 1.4M total R&D spend, EUR 980,000 is expensed and EUR 420,000 is capitalised. If the auditor accepted management's assertion that the transition occurred in June (rather than September), an additional EUR 280,000 would have been capitalised, overstating both the intangible asset and operating profit by that amount.
Why it matters in practice
- Entities frequently use the project's board approval date as the capitalisation trigger without verifying that all six IAS 38.57 criteria were satisfied at that date. A board resolution signals intention (criterion b) but does not demonstrate technical feasibility (criterion a) or the ability to measure cost reliably (criterion f).
- When a project fails after development costs have been capitalised, teams sometimes continue carrying the asset rather than impairing it to zero. IAS 38.111 requires the entity to assess at each reporting date whether there is any indication that the intangible asset is impaired. A failed regulatory submission or abandoned product line is an impairment indicator that demands immediate write-down under IAS 36.
Related terms
Frequently asked questions
Can development costs be capitalised under Dutch GAAP (RJ)?
RJ 210.223 permits but does not require capitalisation of development costs that meet criteria similar to IAS 38.57. Under Dutch GAAP, entities have an accounting policy choice. If the entity elects to capitalise, it must maintain a legal reserve equal to the capitalised amount under BW2 Article 365.2, restricting distributable profits by the same figure.
What happens if a capitalised development project is abandoned?
The entity writes the remaining carrying amount down to zero through profit or loss as an impairment charge. IAS 38.111 and IAS 36.12(b) require recognition of the loss in the period the abandonment decision is made. The amount cannot be reinstated later if circumstances change, because a fully abandoned project has no recoverable amount to support a reversal.
How do I audit the transition date from research to development?
Obtain the entity's internal project documentation (stage-gate reports, trial results, feasibility studies) and map the six IAS 38.57 criteria against dated evidence. ISA 540.18 requires the auditor to evaluate whether management's assumptions (including the claimed transition date) are reasonable. If the entity cannot produce dated evidence for each criterion, IAS 38.53 requires all spend to be expensed.