Week 9 – Lectorial 1 Exercise - IAS 38 Research and Development

Question 1

(i) Explain the accounting treatment prescribed by IAS 38 ‘Intangible assets’ in respect
of research and development (R & D) expenditure and the conditions which must be
met if any such expenditure is to be capitalised.

(ii) Airlite plc designs and manufactures ventilation systems for shops and offices. In
20X4 a confirmed order was received for the design and manufacture of a
specialised ventilation unit for a new electricity power station on the south coast of
England. To fund the project, Airlite plc obtained a loan from its bankers of
£1,000,000.

During its financial year ended 31 December 20X4 the expenditure incurred by Airlite
plc on the project was as follows:

28 Feb 20X4: Paid £100,000 for salaries and wages of the technicians,
engineers and consultants

20 Mar 20X4: Incurred £60,000 for the cost of developing the ventilation unit.

18 Jun 20X4: Paid an additional £40,000 for revising the features of the
ventilation unit.

8 Sep 20X4: The first trial model was produced and tested to ensure its
compatibility with the power station’s specifications at a cost of
£20,000.

27 Oct 20X4: The model had to be further enhanced to ensure its

marketability, and the cost incurred was £30,000.

With reference to IAS 38 ‘Intangible assets’ and your explanations in (i), identify and
explain the accounting treatment for the various costs incurred by Airlite plc during 20X4 in
respect of the specialised ventilation unit.
Question 2

Pharm plc is a company operating in the pharmaceutical industry. During the financial year
ended 31 March 20X5, the company focused on various projects to develop innovative new
products. One of its projects was to develop an improved typhoid vaccine. This project
started two years ago and development expenditure of £750,000 had been capitalised at
31 March 20X4. During the year ended 31 March 20X5, the company spent a further
£850,000 to complete this project and applied to the UK Patent Office for this improved
vaccine. The company paid £25,000 to obtain the patent. The improved vaccine is one of
the successful projects of the company. The market research indicates that there is a
strong demand for this new product. Based on the company’s current forecasts, Pharm plc
expects to generate revenue of £8,500,000 per year from this product.

Another research project being conducted by the company is to develop new medication for
dealing with high blood pressure that does not have the side-effects of medication that is
currently available. During the year ended 31 March 20X5, Pharm plc spent £860,000 on
the early stages of developing the new medication. The company’s management team
anticipates that it will take another three years to complete the project; the company is
currently trying to secure the necessary funding for the remaining period of the project.

Required:
Explain and show how these two projects should be reported in the financial statements of
Pharm plc for the year ended 31 March 20X5.