CA Garima Mittal

CA Garima MittalIntroduction

Pharmaceutical markets are extremely complex. Consumer demand is often indirect for prescription drugs medicated by doctors. New drugs must undergo costly and time consuming process before it could be sold in the market. Further, brainstorming & analysis need to be done about what to work on and how intensively to invest in research and development. It is not necessary that all research and development will be successful. Hence, research and development cost not only depends upon the nature of drug being developed but also upon its likelihood of failure.

Meaning of Research & Development (‘R&D’)

Research is original and planned investigation, undertaken with the prospects of gaining new scientific or technical knowledge and understanding. Example of research activities are the activities aims at obtaining knowledge, search for alternatives for materials, devices, products, processes, systems or services etc.

Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved material, devices, products, processes, systems or services, before the start of commercial production or use. Examples of development activities are design, construction and testing of pre production or pre use prototypes and models; design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.

R&D is indeed an important means of achieving future growth and maintaining a relevant product in the market.

Types of R&D

  • Basic Research: Generally aims to understand the subject matter and build on the body of knowledge relating to it.
  • Applied Research: Generally aims to determine methods to address a specific customer/ industry need or requirement.
  • Development: Research findings are utilized for the production of specific products.

Accounting Aspects

Research and development in pharmaceutical industry primarily includes in house research and development. The cost of in-house development activities are recognized as an internally generated intangible asset from the date on which all the criteria for the asset’s recognition are meet.

There is no definitive starting point for the capitalization of internal development cost. Management must use its judgement, based on the facts and circumstances of each project.

As per IAS 38.57, development costs are capitalized as an intangible asset if all of the following criteria are met:

  • The technical feasibility of completing the asset so that it will be available for use or sale.
  • The intention to complete the asset and use or sell it
  • The ability to use or sell the asset
  • The asset will generate probable future economic benefits and demonstrate the existence of a market or the usefulness of the asset if it is to be used internally
  • The availability of adequate technical, financial and other resources to complete the development and to use or sell it.
  • The ability to measure reliably the expenditure attributable to the intangible asset.

However, filling of submission to the regulatory authority for final product is the strong indication that entity has met all of required criteria.

As per IAS 38.54, expenditure on the research phase of an internal project shall be recognized as an expense when it is incurred.

Now, what if entity can’t distinguish research phase from the development phase of an internal project, then in such a scenario, the entity treats the expenditure on that project as if it were incurred in the research phase only.

As per US GAAP [FAS 2R.12], research and development costs should be expensed when incurred. Research and development costs are defined in FAS 2R.8 and examples of such costs are presented in FAS 2R9 and R10.

Please note that probability of success and past history do not impact the requirement to expense research and development costs as incurred. R&D costs incurred prior to regulatory approvals are generally expensed under US GAAP.

External cost to acquire a licence, product or right paid upon or after regulatory approval should be capitalized as intangibles pursuant to FAS 142. As per FAS 142R.11, the useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity. Further, accounting to FAS 142R14, the remaining useful life of intangible asset should be reviewed each reporting period to determine whether events or circumstances warrant a revision to the remaining period of amortization.

As far as UK treatment of R&D is concerned, expenditure on R&D can fall into category of intangible asset and the same is accounted using the rules from FRS 10 “Goodwill and Intangibles”. Even though R&D can be an intangible asset in the UK, accounting for R&D is governed by its own accounting standard- Statements of Standard Accounting Practice (‘SSAP’) 13, Accounting for Research and Development.


Though this article focus on research and development cost, there are many accounting issues to look upon in pharma sector. Some of them are contract manufacturing, timing of recognition and provision for anticipated returns, turnover, trade and cash discount and volume rebates, etc.

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