Research and development projects make an important contribution to the future of your business. They provide you with a source of new products, as well as improvements to existing products that can improve their performance in the market.
Like any other project, research and development (R&D) incurs expenditure that should be included in your business accounts. However, the treatment of the expenditure varies if the items have an alternative future use.
For example, if you buy project management software for an R&D project but also use it for other types of project, the cost must be recorded in a different way, as we’ll explain later.
There are also accounting differences if you work with another organisation where one party carries out R&D-related work for the other or provides funding for R&D.
And, if you are carrying out research under the government’s Research and Development Expenditure Credit (RDEC) scheme, other accounting considerations may apply to your business.
This article will explain those different aspects of R&D accounting in more detail. However, you may find it useful to take professional advice to ensure that you are claiming the correct level of expenditure for your specific R&D project.
The basis of R&D accounting is that all relevant expenditure should be treated as incurred. You should include most of them in your income statement and show them as operating expenses. The exception is software development costs, as there is the option for these to be capitalised as an Intangible asset.
These are the main categories of R&D expenditure, with an indication of their accounting treatment if they have an alternative future use. Any items that have alternative future use are treated as capital expenditure and their costs can be depreciated over time.
Treat the purchase costs as incurred expenses. If they have an alternative future use, treat them as capital expenditure.
Treat a relevant proportion of your overheads as incurred expenses.
Treat a relevant proportion of your indirect and energy costs as incurred expenses.
Treat intangible assets such as licenses, copyright or franchising rights that you purchase as incurred expenses. If they have an alternative future use, treat them as capital expenditure.
Treat the purchase cost as an incurred expense. If the software has an alternative future use or is used for other types of project, treat it as capital expenditure.
Treat the development costs as incurred expenses or intangible assets, provided the software is only used in the R&D project.
Treat the wages and benefits of staff, supervisors, managers and support staff working exclusively on R&D projects as incurred expenses. If the staff have other roles, only include part of their costs, based on the proportion of their time spent on R&D.
If you hire staff from an agency specifically for the R&D project, treat their costs as incurred expenses.
Treat the invoiced costs of any external services provided for the R&D project as incurred expenses.
If your business carries out research for, or with, a third party, a number of accounting rules apply to the transactions between the two parties. For example, you might handle research for a sponsor in return for a fee or a share of future royalties.
These are some of the rules that apply if you carry out research with, or for, a third party.
If you lend funds to another business to carry out research and repayment of the funds is dependent on financial gain from the project, treat the funds as incurred expenses.
If you make a non-refundable advance to a third party to carry out research, treat the advance as an incurred expense when the results are delivered.
If a sponsor lends you funds to carry out research and there is an obligation to repay the funds, regardless of the results, treat the funds, as well as the relevant R&D costs, as incurred expenses.
If the other party in a merger or acquisition recognises your R&D programme as goodwill, your R&D expenses can be treated as capital.
The government’s Research and Development Expenditure Credit (RDEC) scheme is aimed at small businesses and start-ups that are not liable to corporation tax. The scheme provides a credit in the form of a cash payment or reduction of other tax liabilities.
The scheme is limited to certain categories of R&D in the fields of science and technology, and these are detailed in an HMRC publication ‘Research and development tax relief’.
If your R&D project qualifies for the scheme, you can claim the same types of expenses that we outlined in the section ‘R&D accounting for company projects’. There are a number of differences:
If you hire R&D staff from an external agency, you can only claim relief on 65 percent of the fees paid to the agency.
If you subcontract research to a third party you can only claim 65 percent of the fees paid to the other party.
If you collaborate with another qualifying company on a research project, each company can claim tax relief under the scheme. However, if you collaborate with a university, only you can claim under the scheme.
If you carry out research for a larger company as a contractor, you can claim your costs under the scheme.
This is a brief outline of the requirements for accounting for research and development. If you would like to discuss the accounting needs for your R&D project, our team of experienced small business accountants will be glad to help.