Research phase and development phase under IAS 38
Entity K is working on a project to create a database containing images and articles from newspapers around the world, which it intends to sell to customers over the internet. K has identified the following stages in its project:
(a) Research stage – gaining the technical knowledge necessary to transfer images to customers and assessing whether the project is feasible from a technological point of view;
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(b) Development stage – performing market analysis to identify potential demand and customer requirements; developing the ability to exploit the image capture technology including configuration of the required database software and acquiring the required data to populate the database, designing the customer interface and testing a prototype of the system; and
(c) Production stage – before and after the commercial launch of the service, debugging the system and improving functionality to service higher user volumes; updating and managing the database to ensure its currency. The activities in the research stage included under (a) meet the definition of research under IAS 38 and would be accounted for as part of the research phase of the project, as an expense.
The activities in the development stage included under (b) meet the definition of development under IAS 38. However, whilst K has started to plan the commercial exploitation of its image and data capture technology, it will not be immediately apparent that the project is economically viable. Until this point is reached, for example when the entity has established there is demand for the database and it is likely that a working prototype of the system will be available, the development activities cannot be distinguished from the research activities taking place at the same time. Accordingly, the initial development activities are accounted for as if they were incurred in the research phase. Only once it becomes possible to demonstrate the existence of an intangible asset that will generate future income streams, can project expenditure be accounted for under IAS 38 as part of the development phase.
There may be a period after the commercial launch of the service that would still be accounted for as part of the development phase. For example, activities to improve functionality to deal with higher actual customer volumes could constitute development. This does not necessarily mean that K can capitalise all this expenditure because it needs to pass the double hurdle of: the presumption in IAS 38.20 that ‘there are no additions to such an asset or replacements of part of it"; and the six criteria in IAS 38.57 for recognition of development costs as an asset (see above).
Activity to ensure that the database is up-to-date is a routine process that does not involve major innovations or new technologies. Therefore, these activities in the production stage do not meet the definition of ‘research’ or ‘development’ and the related costs are recognised as an expense.