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Flashcards in R&D and Risk Uncertainties Deck (19):
1

Which of the following is the proper treatment of the cost of equipment used in research and development activities that will have alternative future uses?

  1. Expensed in the year in which the research and development project started.
  2. Capitalized and depreciated over the term of the research and development project.
  3. Capitalized and depreciated over its estimated useful life.
  4. Either capitalized or expensed, but not both, depending on the term of the research and development project

Capitalized and depreciated over its estimated useful life.

Equipment that is used in research and development activities and has alternative future uses should be depreciated over its estimated useful life. During the time that the equipment is used for R&D activities the depreciation will be recorded as R&D expense.

2

West, Inc. made the following expenditures relating to Product Y:

  • Legal costs to file a patent on Product Y: $10,000. Production of the finished product would not have been undertaken without the patent.
  • Special equipment to be used solely for development of Product Y: $60,000. The equipment has no other use and has an estimated useful life of 4 years.
  • Labor and material costs incurred in producing a prototype model: $200,000.
  • Cost of testing the prototype: $80,000.

What is the total R & D cost that will be expensed when incurred?

  1. $280,000
  2. $295,000
  3. $340,000
  4. $350,000

$340,000

The first cost listed is capitalized to patents because it is an amount paid to an external party.

The last three costs listed are all classified as research and development.

  • The special equipment has no other use and is expensed immediately. Although the equipment has a 4-year life, it has no other use beyond this project and thus qualifies for immediate expensing.
  • The labor, materials, and testing are all routine research and development costs.

Thus, the total cost to be expensed immediately is $340,000 ($60,000 + $200,000 + $80,000).

3

Which of the following is a research and development cost?

  1. Development or improvement of techniques and processes
  2. Offshore oil exploration that is the primary activity of a company
  3. Research and development performed under contract for others
  4. Market research related to a major product for the company

Development or improvement of techniques and processes

R & D is the pursuit of new knowledge and the translation of that knowledge to new products and processes. Improvement in techniques and processes is also "new" in that sense and is included in R & D.

4

On January 1, 2005, Jambon purchased equipment for use in developing a new product. Jambon uses the straight-line depreciation method. The equipment could provide benefits over a 10-year period.

However, the new product development is expected to take 5 years, and the equipment can be used only for this project.

Jambon's 2005 expense equals

  1. The total cost of the equipment.
  2. One-fifth of the cost of the equipment.
  3. One-tenth of the cost of the equipment.
  4. Zero.

The total cost of the equipment.

The equipment is being used solely in research and development. Even though the equipment has a 5-year useful life, the only use of the machine is in this particular research project.

Therefore, it qualifies as research and development and is expensed immediately. If it had usefulness apart from this project, then it would be depreciated over its useful life.

5

n 2005, Ball Labs incurred the following costs:

  • Direct costs of doing contract research and development work for the government to be reimbursed by governmental unit $400,000

Research and development costs not included above were:

  • Depreciation $300,000
  • Salaries $700,000
  • Indirect costs appropriately allocated $200,000
  • Materials $180,000

What was Ball's total research and development expense in 2005?

  1. $1,080,000
  2. $1,380,000
  3. $1,580,000
  4. $1,780,000

$1,380,000

The contract work performed for the government is not research and development expense to Ball but rather is normal contracting cost that will be applied against contract revenue in computing contract profit.

Research and development for Ball includes efforts aimed at discovering and translating new knowledge toward new products and services that Ball will produce and market. All four costs in the question are included in research and development.

The sum of $1,380,000 is the firm's research and development expense for 2005 ($300,000 + $700,000 + $200,000 + $180,000).

6

Cody Corp. incurred the following costs during 2006:

  • Design of tools, jigs, molds, and dies involving new technology $125,000
  • Modification of the formulation of a process $160,000
  • Troubleshooting in connection with breakdowns during commercial production $100,000
  • Adaption of an existing capability to a particular customer's need as part of a continuing commercial activity $110,000

In its 2006 income statement, Cody should report research and development expense of

  1. $125,000.
  2. $160,000.
  3. $235,000.
  4. $285,000

$285,000.

Only the first two costs are research and development costs. R & D involves the search for new knowledge and translation of that knowledge toward new products and processes and improvements in existing products and processes.

The first two items are listed in ASC 730 as being included in R & D.

The last two are listed as specifically being excluded from R & D because they are routine activities or do not involve essentially new products and processes. The total R & D expense is therefore $285,000 ($125,000 + $160,000).

7

During 2005, Kent Co. incurred $204,000 of research and development costs in its laboratory to develop a patent that was granted on July 1, 2005. Legal fees and other costs associated with registration of the patent totaled $41,000. The estimated economic life of the patent is 10 years.

What amount should Kent capitalize for the patent on July 1, 2005?

  1. $245,000
  2. $204,000
  3. $41,000
  4. $0

$41,000

Only the legal fees and other registration costs are capitalized to the patent account. These costs are paid to outside parties. The research and development costs are expensed under ASC 730. All research and development is expensed as incurred.

8

Under U.S. GAAP, how should NSB, Inc. report significant research and development costs incurred?

  1. Expense all costs in the year incurred.
  2. Capitalize the costs and amortize over a five-year period.
  3. Capitalize the costs and amortize over a 40-year period.
  4. Expense all costs two years before and five years after the year incurred.

Expense all costs in the year incurred.

Under U.S. GAAP, all research and development costs are expensed as incurred.

9

Which of the following is an example of activities that would typically be excluded in research and development costs?

  1. Design, construction, and testing of preproduction prototypes and models
  2. Laboratory research aimed at discovery of new knowledge
  3. Quality control during commercial production, including routine testing of products
  4. Testing in search for, or evaluation of, product or process alternatives

Quality control during commercial production, including routine testing of products

ASC 730 clearly defines R & D expenditures. Routine activities involving existing production, including quality control activities, are not considered a search for new knowledge (research) or translation of that knowledge to new products and services (development).

10

Brand Co. incurred the following research and development project costs at the beginning of the current year:

  • Equipment purchased for current and future projects $100,000
  • Equipment purchased for current projects only $200,000
  • Research and development salaries for current project $400,000

Equipment has a five-year life and is depreciated using the straight-line method. What amount should Brand record as depreciation for research and development projects at December 31?

  1. $0
  2. $20,000
  3. $60,000
  4. $140,000

$20,000

Under U.S. GAAP, all research and development costs are expensed as incurred. Therefore, the cost of equipment for current projects and the salaries would be expensed in the current year. The equipment that can be used in future years would be depreciated over its useful life. Depreciation expense reclassified as research and development would be $100,000 / 5 years = $20,000.

11

Wizard Co. purchased two machines for $250,000 each on January 2, 2005.

The machines were put into use immediately. Machine A has a useful life of 5 years and can only be used in one research project. Machine B will be used for 2 years on a research and development project and then used by the production division for an additional 8 years. Wizard uses the straight-line method of depreciation.

What amount should Wizard include in 2005 research and development expense?

  1. $75,000
  2. $275,000
  3. $375,000
  4. $500,000

$275,000

The cost of facilities, equipment, materials, etc. acquired for research and development purposes is expensed when incurred unless the acquired item has expected future alternative uses either in other research and development undertakings or in ongoing operations, in which case the cost is capitalized. The cost of research and development-related assets capitalized is amortized as research and development expense over the useful life of the asset.

Since Machine A can be used only in one research project, its cost should be expensed when the machine is acquired. Since Machine B will be used for an expected 8 years by the production division after it is used for 2 years for research and development, it should be capitalized and amortized over its expected (total) life of 10 years. 
Therefore, Wizard's 2005 research and development expense will be:

  • Machine A (cost) $250,000
  • Machine B ($250,000/10 years) (amortization) $25,000
  • Total R & D Expense (2005) $275,000

12

During the current year ended December 31, Metal, Inc. incurred the following costs:

  • Laboratory research aimed at discovery of new knowledge $75,000
  • Design of tools, jigs, molds, and dies involving new technology $22,000
  • Quality control during commercial production, including routine testing $35,000
  • Equipment acquired two years ago, having an estimated useful life of five years with no salvage value, used in various R&D projects $150,000
  • Research and development services performed by Stone Co. for Metal, Inc. $23,000
  • Research and development services performed by Metal, Inc. for Clay Co. $32,000

What amount of research and development expenses should Metal report in its current-year income statement?

  1. $120,000
  2. $150,000
  3. $187,000
  4. $217,000

$150,000

Research costs are associated with the discovery of new knowledge or the development of new products, services, processes or techniques. Development costs are the translation of the research into a plan or design. The costs included in R&D are $75,000 + 22,000 and the depreciation associated with the equipment used in R&D ($150,000 / 5 years = $30,000) and the R&D services paid to a third party $23,000 = $150,000. The receipt of payment from a third party is not netted against the R&D costs.

13

Under what conditions is disclosure about risks and uncertainty pertaining to concentrations required?

  1. If the firm has any of the concentrations for which disclosures are required by GAAP
  2. If events affecting the firm negatively have already occurred, with respect to a concentration
  3. If the firm is vulnerable to a severe impact in the near term because of a concentration, and it is at least reasonably possible that the impact will occur
  4. If the Board of Directors has taken a direct action serving to reduce risk and uncertainty within a given concentration

If the firm is vulnerable to a severe impact in the near term because of a concentration, and it is at least reasonably possible that the impact will occur

Disclosures are required when the event is reasonably possible. The event is not required to be probable.

14

Which of the following is not a source of risk and uncertainty for which disclosures are required by GAAP?

  1. Nature of a firm's operations
  2. Effect of changes in government regulations
  3. Use of estimates in financial statements
  4. Vulnerability to significant concentrations

Effect of changes in government regulations

This is not one of the four sources noted in the applicable standard. It is specifically noted as a source not included in the accounting standard.

15

Which of the following is not an aspect of a firm's operations necessitating disclosure of risks and uncertainties?

  1. Principal markets
  2. Products and services
  3. Pension plan
  4. Geographical location

Pension plan

This is an internal policy matter and is not listed as a specific attribute for disclosure in the standard.

16

Miller Co. incurred the following computer software costs for the development and sale of software programs during the current year:

  • Planning costs $50,000
  • Design of the software $150,000
  • Substantial testing of the project's initial stages $75,000
  • Production and packaging costs for the first month's sales $500,000
  • Costs of producing product masters after technology feasibility was established $200,000

The project was not under any contractual arrangement when these expenditures were incurred. What amount should Miller report as research and development expense for the current year?

  1. $200,000
  2. $275,000
  3. $500,000
  4. $975,000

$275,000

Costs incurred in the development of software expected to be sold, leased, or licensed are expensed as research and development until technological feasibility of the software has been established

Costs incurred after technological feasibility has been established are capitalized and subsequently amortized. Technological feasibility exists for accounting purposes only after a detailed program design is completed or a working version of the software is completed.

Thus, costs of planning, designing, and testing (in initial stages) software programs occur before technological feasibility has been established and would be reported as research and development expense. For Miller, those costs are:

  • Planning costs $50,000
  • Design of software $150,000
  • Substantial testing $75,000
  • & development expense $275,000

Miller would capitalize the cost of producing masters and production and packaging cost for software sales.

17

Which of the following is an indication that a cloud computing arrangement includes a software license?

  • I.The customer has contractual right to take possession of the software at any time during the hosting period without significant penalty.
  • II.The cloud computing arrangement has an indefinite life because the contract is renewable indefinitely.
  • III.It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

I and III ONLY.

Both option I. and III. are the criteria for determining if the cloud computing arrangement contain a software license.

18

Yellow Co. spent $12,000,000 during the current year developing its new software package. Of this amount, $4,000,000 was spent before it was at the application development stage and the package was only to be used internally. The package was completed during the year and is expected to have a 4-year useful life.

Yellow has a policy of taking a full-year's amortization in the first year. After the development stage, $50,000 was spent on training employees to use the program.

What amount should Yellow report as an expense for the current year?

  1. $1,600,000
  2. $2,000,000
  3. $6,012,500
  4. $6,050,000

$6,050,000

There are three expenses to be recognized: 

  • (1) software development costs incurred before the application development stage was reached, $4,000,000; 
  • (2) amortization of capitalized software development costs incurred after the application development stage was reached, $8,000,000/4 = $2,000,000; 
  • (3) $50,000 training costs.

The sum of these is $6,050,000.

Training costs are expensed as incurred. The application development stage is the point after which there is sufficient evidence of a product that software development costs are capitalized and amortized. Such costs will benefit future periods.

19

Standard Co. spent $10,000,000 on its new software package that is to be used only for internal use. The amount spent is for costs after the application development stage. The economic life of the product is expected to be three years. The equipment on which the package is to be used is being depreciated over five years.

What amount of expense should Standard report on its income statement for the first full year?

  1. $0
  2. $2,000,000
  3. $3,333,333
  4. $10,000,000

$3,333,333

The cost of developing software for internal purposes is expensed up to the "application development stage" at which point the effort appears to be leading to a useable application. After that point, costs are capitalized. With a three-year useful life and $10 million capitalized cost, the amortization expense is one-third, or $3.33 million.

The useful life of the product is used rather than the useful life of the equipment because new software can be developed after three years for use on that equipment.