As long as discrete information is reviewed by the Chief Operating Decision Maker (CODM) a R&D function can be an operating segment. Typically, an entity’s research and development (R&D) function is a vertically integrated operation (see Operating segments – Vertically integrated operation), in which the R&D activities serve as an integral component of the entity’s business. The definition of operating segment envisages that part of an entity that earns revenue and incurs expenses relating to transactions with other components of the same entity may still qualify as an operating segment even if all of its revenue and expenses derive from intra-group transactions. Can a R&D function be an operating segment?
Where entities allocate entity-wide R&D costs into the business activities for which the R&D is specifically being performed, the R&D function will be a separate operating segment as long as the CODM separately reviews discrete R&D activity and data. It will not be separate segment if the CODM does not review discrete financial data for the criteria.
What is Research and Development (R&D)?
R&D is a process by which a company obtains new knowledge and uses it to improve existing products and introduce new ones to its operations. R&D is a systematic investigation with the objective of introducing innovations to the company’s current product offerings. It achieves this by adding improvements to the current goods and services or introducing a new product offering. Can a R&D function be an operating segment?
Basic research is concerned with the acquisition of new knowledge. It is a systematic study that intends to gain a deeper understanding of the fundamental elements of a concept or phenomenon. Basic research is an initial stage of the R&D process. However, it does not provide the possible applications of concepts or phenomenon in production. Also, basic research is the most time-consuming part of R&D. Can a R&D function be an operating segment?
On the other hand, applied research is a systematic study of application knowledge in developing products or operations. Relative to basic research, applied research is more complex in nature. Thus, it requires higher spending than basic research. Can a R&D function be an operating segment?
Accounting for R&D
The general problem with R&D accounting is that future benefits from research and development are uncertain and R&D expenditures cannot be capitalized. Accounting standards require companies to expense all research and development expenditures as incurred. However, in case of an M&A transaction, the R&D expenses of the target company may be capitalized because the acquirer can recognize the fair value of the R&D assets. The R&D costs are included in the company’s operating expenses (part of profit or loss) and are usually reflected in its income statement.