More and more often in the "commercial annual accounts" it is chosen to capitalize research and development costs. There are conditions attached to the activation and depreciation. On this page you can read what these conditions are, and what the advantages and disadvantages are of the choice to capitalize or not.
When can I capitalize development costs?
Innovative companies put a lot of money into developing a new product (or service), also known as an intangible fixed asset (hereafter "product"). A lot of time goes into developing a new product. In addition, costs are often incurred to purchase materials for prototypes and the like. The new product often represents great value to the company. But when is it possible to reflect this value in the balance sheet? In other words; when can development costs be capitalized?
What is the difference between research and development costs?
First, the distinction between research costs and development costs is important. Research costs are defined as the costs of fundamental research to acquire knowledge and insights. When these costs are incurred, it is generally not yet clear whether the costs incurred will lead to future benefits. Development costs are incurred in the next phase. When the development costs are incurred, there is often already a belief that the product should be made and that there is a market for it. The Guidelines for Annual Reporting (RJ) provide some examples of research and development costs:
Research includes:
- activities aimed at acquiring new knowledge;
- The search for, evaluation and final selection of, and application of, research findings or other knowledge;
- Finding alternatives for materials, devices, products, processes, systems or services;
- The formulation, design, evaluation and final selection of possible alternatives for new or improved materials, devices, products, processes, systems and services.
Examples of development costs are:
- The design, construction and testing of prototypes and models, prior to production and use;
- designing tools, molds and dies related to the new technology;
- The design, construction and commissioning of a pilot plant that is not yet suitable for commercial production;
- The design, construction and testing of a chosen alternative for new or improved materials, devices, products, processes, systems or services.
Is it mandatory to capitalize development costs?
For medium and large companies, capitalization of development costs is mandatory, if all conditions to proceed to capitalization can be met. Small companies have the choice of whether or not to capitalize development costs, unless the internal development of intangible assets is part of the main activity of the legal entity. These legal entities must capitalize the intangible asset if the capitalization criteria are met.
Which research and development costs can I capitalize?
The costs of research cannot be capitalized and should therefore be accounted for directly in the income statement. However, the costs of development can be capitalized. These include, for example, the following costs:
- hours of own personnel (at cost);
- hours of hired staff;
- materials used during the development phase;
We advise you to already take into account the subsidies you have received (for example WBSO or specific subsidies for a certain project).
What are the conditions for capitalizing development costs?
Development costs can only be capitalized if a number of conditions are met. These conditions are:
- The company developing the product must have determined that it is technically possible to complete the development;
- There must be an intention to also complete the development of the product and start selling it;
- The company must have the ability to use or sell the product;
- It must be able to be made plausible that there is a market for the product;
- The company must have people and resources to complete development;
- The expenditure of development costs incurred should be reliably determinable.
Development costs should only be capitalized when these criteria are met. It is therefore important that the development costs (if you would like to capitalize them) are properly recorded in a separate subadministration or by means of cost centers.
It is also necessary to distinguish between various developments. To do this, you need to be able to break down the development costs to the "smallest cash flow generating unit". This roughly equates to at what level you can still generate revenue from the development. For example, if you are developing a completely new product, this is easy to determine. Then the product is the smallest cash flow generating unit. But if you are developing a component that will be incorporated into several of the company's products, it is already more difficult. It is important to think about this question in advance so that the company's administration can be set up accordingly.
Is it possible to retroactively capitalize development costs over previous years?
No, it is not allowed to capitalize costs that were charged to the result in a previous reporting period. We are happy to explain this to you using an example:
- In year 1, you incurred 100,000 euros in research costs;
- In year 2 you conclude from the research that there is a market for the product and that you start the development. However, it is not yet clear whether you are capable of completing the development and it is not yet clear whether profits can be made with the product. In the second year you incur 200,000 euros in development costs;
- In year 3 you set up a project administration, you have done a market research and it appears that the product can be technically completed. Calculations show that you can make a nice profit with the product. You complete development and have developed an initial prototype that you have placed with a customer to identify and fix teething problems. The project records show that you incurred 500,000 euros in year 3.
The costs you incurred in the first year fall under the heading of research costs and are therefore not capitalizable. The costs from the second year are development costs, but you have not yet been able to meet all the requirements for capitalization in that year. In year 3, it appears that the product is likely to be profitable and the other requirements for capitalization are also met. You can now capitalize only the costs of the third year (500,000 euros).
Can I take research and development costs incurred directly as expenses for tax purposes?
Yes, you may. There is a difference between the treatment of development costs in the "commercial financial statements" and the tax return. In the tax return, it is important that you follow a consistent line of conduct, and that in the first year in which you start the development, you make a well-considered choice (together with your advisor) as to whether you charge the development costs directly to the result for tax purposes or, as in the commercial annual accounts, capitalize them and start writing them off over the expected life of the product.
Capitalized development costs in relation to the innovation box
Capitalizing development costs does not automatically grant you access to the Innovation Box benefits. However, it is realistic to assume that if you are engaged in development, you are already receiving WBSO subsidies or have even registered patents. In that case, you already have the so-called “ticket” to the Innovation Box. By recognizing the development costs on the balance sheet (capitalizing them), you may be able to more easily demonstrate the innovative nature of your business in discussions with the Tax Authority regarding the application of the Innovation Box facility.
What can we do for you?
There are advantages and disadvantages to capitalizing development costs. An important disadvantage is that banks correct the capitalized development costs when applying for financing (and thus actually charge them to the result). It also involves more administrative burden. The advantage for innovative companies is that by capitalizing and amortizing development costs, certainly during the years in which the company is (almost exclusively) engaged in development, but also thereafter, the balance sheet and profit and loss account present a much more realistic picture of the company than if the development costs had been charged directly to the result. We can advise and assist you in considering whether to capitalize and amortize development costs. In addition, we can guide you in setting up proper records that meet the criteria for capitalizing development costs.
We like to work on your entrepreneurial dreams. What are your ambitions?
Every successful client relationship begins with a personal introduction. A conversation about your ambition and how we can help you achieve it. Leave your details below and we will contact you soon.