Expense recognition - General standards

The Financial Accounting Standards Board (FASB) offers some guidance as to how intangible assets should be accounted for in financial statements. (For more detail see Appendix)

In general, intangibles that are developed internally are not recognised and intangibles that are purchased from third parties are recognised.  However intangible assets developed in-house can be recognised using a well developed accounting scheme. As with all assets, the intangible asset also has to contribute to generate future benefit. Until this can be proved, expense recognition is postponed. Therefore, every cost related to an R+D project has to be collected on a special ledger called “unfinished investments”.

In the event that the research is completed, product development made and commercialisation started, the costs gathered under the unfinished investments account can be activated. Activation means cost recognition, from which moment expenses can be depreciated.

Depreciation is a term used in accounting, economics and finance with reference to the fact that assets with finite lives lose value over time.

In accounting, depreciation is a term used to describe any method of attributing the historical or purchase cost of an asset across its useful life, roughly corresponding to normal wear and tear. It is of most use when dealing with assets of a short, fixed service life, and which lose value over that life.

The use of depreciation affects the financial statements and the taxes of companies and individuals. The recording of depreciation will cause an expense to be recognised; thereby lowering stated profits on the income statement, while the net value of the asset (the portion of the historical cost of the asset that remains to provide future value to the company) will decline on the balance sheet. Depreciation reported for accounting and tax purposes may differ substantially.

Depreciation and its related concept, amortization (generally, the depreciation of intangible assets), are non-cash expenses. Neither depreciation nor amortization will directly affect the cash flow of a company, as both are accounting representations of expenses attributable to a given period. Depreciation recognised for tax purposes will, however, affect the cash flow of the company, as tax depreciation will reduce taxable profits.  There is generally no requirement that treatment of depreciation for tax and accounting purposes be identical. Where depreciation is shown on accounting statements, the figure usually does not relate to depreciation for tax purposes.

Thus costs of in-house R+D activity can be depreciated when they start to generate profit. Activation is the baseline for costs related to a R+D project to be recognised and depreciated. Until activation is not possible, costs incurred are accounted on a special ledger called “unfinished investments”.

Intangible assets are typically expensed according to their respective life expectancy and are characterised as having either an identifiable or indefinite useful life. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever is shorter. Examples of intangible assets with identifiable useful lives include copyrights and patents. Intangible assets with indefinite useful lives are reassessed each year for impairment. If an impairment has occurred, then a loss must be recognised. An impairment loss is determined by subtracting the asset's fair value from the asset's book value. This impairment loss may only be reversed under certain circumstances.

Trademarks and goodwill are examples of intangible assets with indefinite useful lives, thus amortization of them is forbidden.