Research and development costs are the costs of planned investigation aimed at discovering new knowledge, and of applying that knowledge to design new or significantly improved products, services or processes. They include salaries of scientists and engineers, materials used in experiments, the cost of prototypes and testing, depreciation of laboratory equipment used for research, and contract research paid to outside firms.
The accounting for this spending is one of the clearest differences between US standards and international standards. Under US GAAP, almost all such spending is charged to expense when incurred. Under IFRS, research is expensed but development costs must be capitalized as an intangible asset once certain conditions are met.
Treatment under US GAAP
ASC 730, which carries forward FASB Statement No. 2 from 1974, requires these costs to be expensed as incurred. The reasoning is that the future benefits of most research are too uncertain to measure reliably. Costs are reported on the income statement, usually as a separate line within operating expenses, and total research and development spending must be disclosed. Some items are treated differently:
- Equipment and facilities that have alternative future uses are capitalized and depreciated; only the depreciation during research work counts as a research and development cost.
- Costs of developing software to be sold are expensed until technological feasibility is established and capitalized afterward, under separate software guidance.
- In-process research and development acquired in a business combination is recognized as an intangible asset at fair value, alongside goodwill, even though the same spending done internally would be expensed.
- Legal costs of registering a patent are capitalized, but the research behind the invention is not.
Treatment under IFRS
IAS 38 splits a project into a research phase and a development phase. Research costs are expensed. Development costs must be capitalized once a company can show all of the following: technical feasibility, the intention and ability to complete and use or sell the asset, how it will generate probable future economic benefits, adequate resources to finish it, and the ability to measure the costs reliably. Capitalized development is then amortized over its useful life and tested for impairment. This means IFRS reporters, such as European car makers, often show sizable capitalized development assets that a US competitor would not.
Worked example
A medical device company spends $4 million in a year: $1.5 million on early research into a new sensor and $2.5 million on developing a prototype. Technical feasibility and the other IAS 38 criteria are met on 1 July, after which $1.2 million of development costs are incurred.
Under US GAAP, all $4 million is expensed. Under IFRS, $2.8 million is expensed and $1.2 million is capitalized as an intangible asset. If the product launches the next year with an expected life of five years, that $1.2 million is amortized at $240,000 a year. The IFRS company reports $1.2 million higher profit in the development year and lower profit in later years through amortization of intangible assets.
US tax treatment
Tax rules have changed several times. Under Section 174 of the Internal Revenue Code as amended by the 2017 Tax Cuts and Jobs Act, research and experimental costs paid in tax years beginning after 2021 had to be capitalized and amortized over five years for domestic research and 15 years for foreign research. Legislation enacted in July 2025 restored immediate deduction of domestic research costs for tax years beginning after 2024, while foreign research remains subject to 15-year amortization. Separately, the research tax credit under Section 41 rewards qualifying increases in research spending. Because book and tax treatment differ, research spending often creates deferred tax assets. Taxpayers should check current Internal Revenue Service guidance.
Analysis
Because research and development is expensed under US GAAP, research-heavy companies can look less profitable and less asset-rich than their economic value suggests. Analysts often compare research intensity, research and development spending as a percentage of sales, across peers, and some capitalize it in their own models to estimate returns on invested capital.