 Hello and welcome to the session in which we'll discuss research and development costs also known as R&D. What is the big idea behind the research and development costs? Those are costs incurred by a company to come up with a new product such as a drug, technology, or maybe a process, a formula, some sort of a composition. Research and development costs really is not an intangible asset by itself. It could lead to an intangible asset. What does that mean? It means when a company incurred those research and development costs. It could be many worth millions or billions of dollars. They must expense them as they are incurring them, as they are incurred. Now the question is why? So this is basically what R&D is. R&D is expense. Why? Well, the reason is simple in a sense that they don't fit the definition of an asset. In other words, we cannot treat them as an intangible asset because an intangible asset is something that's gonna provide probable future benefit for the company. Well, when you are researching a product, you don't know the value, the future value of R&D. Many companies, they spend billions of dollars, billions in B, and come up empty handed. Therefore, you are not allowed to capitalize, to treat those research and development as an asset until you reach a certain stage. For example, I'm pretty sure right now, many pharmaceutical companies are spending a lot of money to find a cure and medication for COVID-19. Well, as they incur this cost, they cannot capitalize it. They cannot treat it as an asset. They all have to expense it and it's gonna hit their income statement. But let's talk about research and development and make sure we understand what research is and what development is because on the CPA exam, you might have a question just to differentiate between what's research and what's development. Research is considered directed work aimed at discovering a new knowledge that's useful and finding a new product or process slash technique, significant improvement of an existing product. So this is what a research is. Simply put, an example will be searching, finding a new drug, searching for a new drug. Development on the other side is the translation of the research. So you did the research, now you want to translate it. Maybe you want to translate into a design for this new process or a new product or significant improvement. An example will be construction a prototype software. You are researching a prototype software, a search engine. Now you have a prototype. This is the development stage. R&D are incurred before the start of the commercial production. What do we mean by this? Commercial production means you are ready to sell the product to the customers. Well, what does that mean? It means you have a final saleable product. Well, you're no longer in the R&D phase. You're no longer in the R&D phase. What costs are usually associated with R&D? Well, salaries and wages paid for those employees, material, supplies, any payroll costs related to this. If you purchase any intangibles, notice you are buying an asset for that R&D project and you do that a lot. For example, you'll buy the ideas, the techniques, the patent of another company to integrate that into your research. That's expense. Any contract services, if you contracted a third party and many pharmaceutical companies, I know this because my wife work for a pharmaceutical company is they bring, they buy the research and development from an outside party, like as a contract, that's also expense. Any indirect cost, that's still an expense. We have to be aware that if you purchase an asset that could have alternative future used, that's not expense. What does that mean? It means let's assume to keep it simple, you bought a copier and you're using this copier and this R&D project. But guess what? Once this project is done, you're gonna move the copier to another project that's used for an alternative use. Well, you will not expense the copier as R&D. What's gonna happen is the copier will be its own asset. Now, the best way to illustrate this is to actually look at an example to see what is considered R&D and what is not considered R&D, what's considered actually an asset. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, foreheadlectures.com. I don't replace your accounting course, I don't replace your CPA review course, I'm a supplemental material, like a vitamin pill to your resources. I can help you understand the material better by providing you with alternative lectures, resources, multiple choice, true, false, exercises. Your risk is to try me one month. Give it a try, if you like it, you keep it. If not, you cancel, that's your risk. But your return is actually improving your performance on the CPA exam, understanding the material better. If not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. This is a list of all my accounting courses with various resources, true, false, multiple choice. My CPA supplemental modules are aligned with your Becker, Roger, Gleam and Wiley. So you can go back and forth between my material and your CPA review course for better understanding. If you have not connected with me only then, please do so, take a look at my LinkedIn recommendation and like this recording, share it with other, connect with me on Instagram, Facebook, Twitter and Reddit. The best way to illustrate this concept is to actually work an example. And let's take a look at this example. Let's assume in 20X5, Tesla modified its XV20 model to be fully driverless. Tesla made the following expenditure. They have research to develop technology, 2 million, development of a prototype, half a million, cost of engineering, 170, purchase of equipment. They purchase a specialized equipment, 3 million, testing the prototype, 75,000, legal fees for patent application, 4,500, legal fees for successful defense of the patent against Apple, it looks like Apple, they said, well, we have a similar patent, it cost them 20,000. The equipment purchase for this project will be used in another project. So this piece of equipment, it will be used in another project. Depreciation per year, 1 million, it means we're gonna depreciate this asset over three periods, one, three years. The accountant at Tesla treated all the above cost as patent, intangible assets. So what they did at Tesla, they took all of those and they showed all of those are considered patent and asset. Management claimed that the cost of the new system represent a significant improvement of the existing system. Well, if it's a significant improvement, it's research and development. So if they put everything as patent, we have to fix this problem. So let's see, research to develop, is this R&D? Yes, what does that mean? This means we have to take it out of the asset, development of a prototype. Yes, this is R&D cost, cost of engineering, R&D cost. Purchase of the equipment, not really, why not? Because they told us that this equipment will be used in another project. So it's not solely for this project, it has an alternative use. Testing the prototype, R&D. Legal fees for patent application, no. Patent application is considered an asset and it's gonna be considered a patent, an asset. Therefore, this is correct, we don't have to do anything with this. Legal fees for successful defense of the patent, that's also we learned when we talked about patent, that's an asset because the defense was successful, you added to the patent. What does that mean? That means you have to back out, out of patent, all these costs that are considered R&D. And let me go ahead and highlight them. Those costs are the two million, the 500,000, the 170 and the 75,000. So those gonna add up to 2,745,000. So I'm gonna credit the patent to remove them, to back them out from the patent and increase research and development costs. Tesla will not like this because now 2.7 million hit their income statement. I also need to back out the equipment because the equipment was treated as a patent. So I'm gonna have to reduce the patent and increase the equipment. So it's still an asset. And what else I have to do? I'm gonna have to account for one million of research and development expense for this asset because that's the depreciation that's considered part of R&D and credit accumulated depreciation. So once this project done, we still have two million to depreciate for an alternative use. But for now, we're only going to expense a million of R&D, three million as research and development costs. Well, the best way to illustrate this concept and to learn it more is to work additional multiple choice questions on my website farhatlectures.com. Again, I'm gonna remind you, don't shortchange yourself, whether you are an accounting student or a CPA candidate. Invest in yourself, invest in your career. A CPA exam is worth it. Your accounting career is worth it. Give me a try. I can help you improve your performance. Good luck, study hard, and of course, stay safe.