We have already discussed the two main considerations a management needs to take into account when thinking about recognizing an internally generated asset. First one relates to identifying the asset itself and strictly speaking this shouldn’t be a difficulty. However, the second consideration is far trickier and with this post we’ll start opening the issue of why this is considered more difficult.

To begin with the assessment, the management needs to classify the generation of the asset into two phases – research and development phase. With this post we’ll go into more detail with the first one – research phase. As this distinction is trivial for identifying and measuring the cost, those two terms need to be clearly understandable and hopefully we’ll be able to bring more sense into this dilemma.

Generally speaking expenses incurred during a research phase shall not be recognized as an asset, but instead are recognized as an expense when they are incurred. Since in this stage the company is unable to demonstrate that an intangible asset exists (refer to the first consideration) and any future benefits are improbable or rough estimations, recognizing an asset from those expenses is not correct.

When we say ‘research’, what is usually meant under this is any activity that relates to obtaining new knowledge, search and evaluation of applications and information, choosing proper materials, machinery, devices, systems, etc. Basically a research phase is meant for planning and any preliminary information obtaining concerning the generation process itself. Nothing is fixed and all options are still open. The company and the management are visioning still the asset and hence obtaining an understanding of anything that is needed and useful for generating the asset.

As you see, since the phase itself relates to basically visualizing the asset and even deciding whether to generate it in the first place, recognizing those expenses as assets is not correct.

To summarize, all expenses a company does for researching (e.g. obtaining information, making selections etc) are expensed when they incur and no assets are recognized. Moreover, if the company is unable to distinguish the research phase from development phase all expenditure on that project are treated as they had incurred in research phase only meaning that they are expensed and not recognized as assets on the balance sheet.