Research and Development Costs
Companies invest heavily in research and development (R&D) to create new products, processes, and technologies. Under U.S. GAAP, the default treatment is straightforward — most R&D costs are expensed as incurred (ASC 730). The BAR exam expects you to know which costs qualify as R&D, which costs are excluded, and how to compute the total R&D expense reported on the income statement. Special rules also apply to R&D performed under contract for others and to in-process R&D acquired in a business combination.
This topic maps to Area II, Group E of the 2026 CPA Exam Blueprints for Business Analysis and Reporting (BAR). The blueprint expects candidates to:
- Identify research and development costs and classify the costs as an expense in the financial statements.
- Calculate the research and development costs to be reported as an expense in the financial statements.
ASC 730 at a Glance
ASC 730, Research and Development, establishes the core principle: all R&D costs shall be charged to expense when incurred unless another GAAP standard provides specific capitalization guidance (e.g., ASC 985-20 for software to be sold or ASC 350-40 for internal-use software).
| Principle | Rule |
|---|---|
| General rule | Expense R&D costs as incurred |
| Balance sheet impact | No R&D asset except for (1) tangible assets with alternative future use, (2) acquired in-process R&D, and (3) capitalized software costs under separate standards |
| Income statement | Total R&D expense must be disclosed either on the face of the income statement or in the notes |
| Scope exclusions | Extractive industries (e.g., oil & gas exploration), software development (covered by ASC 985-20 and ASC 350-40) |
Research vs. Development — Definitions
Understanding the distinction between research and development is important for exam questions, even though both categories receive the same accounting treatment (expense as incurred).
| Phase | Definition (ASC 730-10-20) |
|---|---|
| Research | Planned search or critical investigation aimed at the discovery of new knowledge with the hope that such knowledge will be useful in developing a new product, service, process, or technique — or in bringing about a significant improvement to an existing one |
| Development | Translation of research findings or other knowledge into a plan or design for a new product or process, or for a significant improvement to an existing product or process, whether intended for sale or use |
The exam rarely tests whether a cost is "research" versus "development." What matters is whether the cost falls within or outside the scope of ASC 730. Both research and development costs are expensed — the distinction is definitional, not accounting.
Costs That ARE R&D
ASC 730-10-25 identifies the following categories of costs that must be included in R&D expense:
1. Materials, Equipment, and Facilities
| Situation | Treatment |
|---|---|
| Materials and supplies consumed in R&D | Expense as incurred |
| Equipment or facilities acquired for R&D with no alternative future use | Expense as incurred (the full cost) |
| Equipment or facilities acquired for R&D with alternative future use | Capitalize and depreciate over useful life; depreciation allocated to R&D is R&D expense |
Equipment purchased solely for a single R&D project with no alternative future use must be expensed immediately — even if the equipment has a multi-year physical life. This is a heavily tested point.
2. Personnel
- Salaries, wages, and benefits of personnel engaged in R&D activities.
- Includes time spent on design, testing, and experimentation.
3. Contracted Services
- Costs of services performed by others (third-party contractors, universities, research institutes) on behalf of the reporting entity for its own R&D.
- Expensed as incurred by the entity that contracts the work.
4. Indirect Costs
- A reasonable allocation of indirect costs (overhead) that are clearly related to R&D activities.
- General and administrative costs that are not clearly related to R&D are excluded.
5. Intangibles Purchased from Others
- Cost of intangibles (e.g., patents, licenses) purchased from others for use in R&D activities.
- If the intangible has no alternative future use, expense immediately.
- If it has an alternative future use, capitalize and amortize.
Summary of the "Alternative Future Use" Rule
The alternative future use test is the single most-tested concept in ASC 730. If the asset can be used in other R&D projects or in non-R&D operations, it has alternative future use and should be capitalized.
Costs That Are NOT R&D
Not every cost associated with a new or improved product qualifies as R&D. ASC 730 specifically excludes the following:
| Activity | Why It Is NOT R&D |
|---|---|
| Routine or periodic quality control testing during commercial production | Quality control serves ongoing operations, not discovery of new knowledge |
| Engineering follow-through in an early phase of commercial production | Represents production start-up, not experimentation |
| Troubleshooting during commercial production breakdowns | Maintenance/operations activity |
| Routine design of tools, jigs, molds, and dies | Part of the manufacturing process |
| Adaptation of an existing capability to a particular customer's requirements as part of a continuing commercial activity | Customization, not new product development |
| Legal work on patent applications and litigation | Legal expense, not R&D |
| Seasonal or other periodic design changes to existing products | Routine product updates |
| Routine ongoing efforts to refine, enrich, or improve the qualities of an existing product | Sustaining engineering, not R&D |
| Market research and testing | Selling/marketing activity |
Engineering follow-through and adaptation of existing products are frequent exam distractors. Read the facts carefully — if the work involves a known process being applied to production or a specific customer request, it is not R&D.
R&D Performed for Others (Contract R&D)
When an entity performs R&D under contract for another party, the accounting depends on the nature of the arrangement:
| Scenario | Accounting by the Performing Entity |
|---|---|
| R&D under contract for others (entity has no rights to the results) | Costs are accounted for as a contract to perform services — recognized as an expense matched with contract revenue; not reported as R&D expense |
| Entity-funded R&D (entity retains all rights) | Expense as R&D under ASC 730 in the normal manner |
| R&D arrangement with funding parties (ASC 730-20) | If the entity is obligated to repay the funds regardless of R&D outcome, the arrangement is essentially a borrowing — record a liability, not R&D expense. If the entity has no obligation to repay, expense costs as R&D |
The key question for contract R&D: Who bears the risk? If the entity performing the R&D is obligated to repay the funds regardless of the project's outcome, the arrangement is a liability (financing), not an expense. If the funding party bears the risk of failure, the performing entity records R&D expense.
Acquired In-Process R&D (IPR&D)
When R&D activities are acquired as part of a business combination (ASC 805) or as an individual asset acquisition, special rules apply:
Business Combination (ASC 805)
- In-process R&D acquired in a business combination is recognized as a separate intangible asset at fair value on the acquisition date — even if the project has no alternative future use.
- The asset is classified as an indefinite-lived intangible and is not amortized until the project is completed or abandoned.
- Upon completion, the asset is reclassified as a finite-lived intangible and amortized over its useful life.
- Upon abandonment, the remaining carrying amount is written off as an expense.
- While classified as indefinite-lived, the asset is tested for impairment at least annually under ASC 350.
Asset Acquisition (Not a Business Combination)
- R&D assets acquired outside of a business combination that have no alternative future use are expensed immediately.
- If they have an alternative future use, they are capitalized and depreciated/amortized.
Acquisition Type Treatment of IPR&D Business combination Capitalize at fair value → indefinite-lived intangible → amortize upon completion or write off upon abandonment Asset acquisition — no alternative future use Expense immediately Asset acquisition — alternative future use exists Capitalize and amortize warningAcquired IPR&D in a business combination is always capitalized at fair value regardless of whether it has alternative future use. This is a departure from the general ASC 730 rule and a common exam trap.
Comprehensive Example 1 — Bear Co. R&D Expense Calculation
Bear Co. incurs the following costs during Year 1 related to the development of a new product:
| Cost Item | Amount | R&D? |
|---|---|---|
| Salaries of R&D lab personnel | $400,000 | Yes |
| Materials consumed in R&D experiments | $120,000 | Yes |
| Equipment purchased solely for the project (no alternative future use) | $250,000 | Yes |
| Equipment purchased for R&D that has alternative future use (5-year life, no residual value; used for R&D the full year) | $300,000 | Depreciation only |
| Fees paid to an outside testing laboratory | $85,000 | Yes |
| Overhead reasonably allocable to R&D | $60,000 | Yes |
| Quality control testing during regular production | $45,000 | No |
| Legal fees for patent application | $30,000 | No |
| Step 1 — Calculate depreciation on the equipment with alternative future use: |
Step 2 — Compute total R&D expense:
| Component | Amount |
|---|---|
| R&D personnel salaries | $400,000 |
| Materials consumed | $120,000 |
| Equipment with no alternative future use | $250,000 |
| Depreciation on equipment with alternative future use | $60,000 |
| Outside testing laboratory | $85,000 |
| Allocable overhead | $60,000 |
| Total R&D Expense | $975,000 |
| Step 3 — Record the journal entries: |
Equipment with no alternative future use is expensed at its full cost in the period acquired. Equipment with alternative future use is capitalized and only the depreciation portion is included in R&D expense. This single distinction can swing your answer by hundreds of thousands of dollars.
Comprehensive Example 2 — Gies Co. Multiple R&D Projects
Gies Co. has two active R&D projects during Year 2. It also performs contract R&D for a client.
| Cost Item | Project Alpha | Project Beta | Contract R&D |
|---|---|---|---|
| Personnel costs | $200,000 | $150,000 | $100,000 |
| Materials consumed | $50,000 | $70,000 | $40,000 |
| Depreciation on shared R&D equipment (allocated) | $30,000 | $20,000 | $10,000 |
| Equipment purchased with no alternative future use | $80,000 | $0 | $0 |
| Allocated overhead | $15,000 | $10,000 | $5,000 |
| Contract R&D terms: Gies Co. performs the work for a client who owns the results. Gies Co. has no obligation to repay if the project fails. The contract price is $200,000. | |||
| Gies Co.'s R&D expense (own projects only): | |||
| Component | Project Alpha | Project Beta | Total |
| ----------- | -------------- | ------------- | ------- |
| Personnel | $200,000 | $150,000 | $350,000 |
| Materials | $50,000 | $70,000 | $120,000 |
| Depreciation (shared equipment) | $30,000 | $20,000 | $50,000 |
| Equipment — no alternative future use | $80,000 | $0 | $80,000 |
| Overhead | $15,000 | $10,000 | $25,000 |
| Total | $375,000 | $250,000 | $625,000 |
| The contract R&D costs ($155,000) are not reported as R&D expense — they are reported as cost of contract services matched against the $200,000 of revenue. |
Comprehensive Example 3 — MAS Inc. Acquires In-Process R&D
MAS Inc. acquires 100% of a biotech company in a business combination for $8,000,000. The fair values of the identifiable net assets at the acquisition date are:
| Item | Fair Value |
|---|---|
| Tangible net assets | $4,500,000 |
| Customer relationships (finite-lived intangible) | $800,000 |
| In-process R&D (drug in Phase II clinical trials) | $1,200,000 |
| Total identifiable net assets | $6,500,000 |
| Step 1 — Calculate goodwill: |
Step 2 — Record the acquisition:
The IPR&D of $1,200,000 is carried as an indefinite-lived intangible asset. It is not amortized and is tested for impairment annually until the project is completed or abandoned. If the project is completed and the drug receives regulatory approval, MAS Inc. reclassifies the asset and begins amortization over its estimated useful life (assume 10 years):
If the project is abandoned, the entire carrying amount is written off:
Financial Statement Presentation and Disclosure
| Item | Presentation |
|---|---|
| R&D expense | Disclosed on the face of the income statement or in the notes; must show total R&D costs charged to expense for each period presented |
| Equipment with alternative future use | Reported as a tangible asset on the balance sheet; depreciation allocated to R&D included in R&D expense |
| Acquired IPR&D | Reported as a separate intangible asset on the balance sheet until completed or abandoned |
| Contract R&D costs | Reported as cost of services, not as R&D expense |
Quick-Reference Summary
| Question | Answer |
|---|---|
| General rule for R&D costs? | Expense as incurred |
| Equipment with no alternative future use? | Expense the full cost immediately |
| Equipment with alternative future use? | Capitalize; include depreciation in R&D expense |
| Contracted R&D for others (no repayment obligation)? | Cost of contract services, not R&D expense |
| R&D funding arrangement — obligated to repay? | Record a liability (financing) |
| IPR&D in a business combination? | Capitalize at fair value as indefinite-lived intangible |
| IPR&D in an asset acquisition — no alternative use? | Expense immediately |
| Quality control testing during production? | Not R&D |
| Engineering follow-through? | Not R&D |
| Legal fees for patents? | Not R&D |
Key takeaway: Under ASC 730, virtually all R&D costs are expensed as incurred. The main exceptions are (1) tangible assets with alternative future use (capitalize and depreciate) and (2) in-process R&D acquired in a business combination (capitalize at fair value as an indefinite-lived intangible). On the exam, always apply the alternative-future-use test to each cost item and remember that contract R&D performed for others is reported as cost of services — not R&D expense.