Accounting For Research and Development Cost

Monograph on Accounting for Research and Development
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MONOGRAPH ON ACCOUNTING FOR RESEARCH & DEVELOPMENT COSTS
PREFACE
The advent of WTO related issues have once again surfaced on a strong platform, after
1st January, 2005, when the new patent, IPR regime will come into full effect. The
main theme of “ Competency Building under Global Competition under WTO
scenario”, opens the key issues relating to Accounting of Research and
Development Costs. The Institute of Cost and Works Accountants Of India, had
come out with a major treatise on “ Management and Accounting for Research and
Development – The Indian Praxis” by Prof. S.K.Chakraborty in collaboration with
Mr. Bipul K.Bhaumik, in the year 1984. The macro and micro level issues on
Research and Development Costs were deliberated in detail in the publication. The
current brief update on Accounting for Research and Development Costs, takes off
from the earlier views and opens the area, that has to evolve in Accounting for
Research and Development Costs. The Chapter on “Product and Project Costing
and Monitoring of R & D Costs” is thorough analysis of R&D Costs replete with
practical examples and the author as well as the Committee felt that it will be most
appropriate to include it as part of this monograph. The Accounting Standard –8 –
Accounting for Research and Development is also included as a reference, as the
accounting treatment is a key issue on the treatment of Research and Development
Costs. We hope that this brief monograph, evolves standard practices in future, that
can be helpful to the management accounting fraternity and various users.

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We thank Mr.S.Srinivasan, Cost Accountant, Chennai, who alongwith
Mr.S.Ganapathisubramanian, Cost Accountant, Chennai, helped in producing this
well thought out monograph.
We also acknowledge the help rendered by S/Sri.A.S.Durgaprasad, A.N.Raman,

J.S.Anand, K.S.Subramanian and R.Narayanan, as part of the Technical Committee, for
providing valuable technical support for the publications.
We are also grateful to Dr.H.R.Subramanya, President, ICWAI, who germinated the

idea of bringing out special publications on topical issues and which will form the plank
on which the future guidance notes and cost accounting standards will emanate.
M.Gopalakrishnan
Chairman- Technical Committtee.
Diamond Jubilee Celebrations.

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INDEX
Sl.No Topics
1 Research & Development Scenario in India
2 Private Sector Initiative
3 Need for Fresh Approach
4 Types of R & D Activity
5 Evolution of Accounting Standards
6 Provisions in the Cost Accounting Records Rules
7 Provisions in the Cost Audit (Report) Rules, 2001
8 Practices in some Leading Companies
9 Earlier Research by ICWAI
10 Issues to be included in the Suggested Guidelines
11 Product and Project Costing and Monitoring of R & D
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1. Research & Development scenario in India
Research & Development activity in India is carried out through three major
channels.
a) Departments of the Central Government and the various research
laboratories functioning under their jurisdiction
b) Research in various higher centers of learning, viz., IITs and Universities
c) Private sector Industrial undertakings
The following are some of the major organisations falling under category (a)
1. Department of Science and Technology
2. Department of Space
3. Department of Atomic Energy
4. Council of Scientific and Industrial Research (CSIR)
5. Defence Research and Development Organisation (DRDO)
6. Research Design and Standardisation Organisation, Railways (RDSO)
7. Indian Council of Agricultural Research (ICAR)
8. Indian council of Medical Research (ICMR)

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There are several other institutions functioning under state and central governments.
The CSIR alone has nearly 40 R&D institutions working in diverse areas, employing
over 10000 scientists. The income arising out of patent rights is a significant
component of CSIR's current turnover of about $80 million.
There are more than 150 universities and institutes of technology undertaking research,
which are funded by the University Grants Commission, State and Central governments
and Private sector industries.
There are hundreds of R&D centers run by private sector companies and registered
with the Department of Science and technology.
Products and technologies developed by the government research laboratories are
taken up for commercial exploitation by the National Research Development
Corporation (NRDC).
2. Private sector initiative - A historical perspective
R&D activity in the private sector in the past was driven primarily by tax planning
considerations. A number of industries had foreign technical collaboration and the
technical know-how was imported for which a royalty or lump sum fee was paid. Fiscal
incentives (Eg., Sec.35 of the Income tax act) gave an impetus to R&D effort, and
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prompted many companies to setup R&D centers. The registration with the Department
of Science and Technology was a pre-requisite for getting the tax benefits.
However no substantial progress was made by private sector for nearly four decades.
3. Need for fresh approach:
The following developments during the last 20 years have forced a paradigm shift in the
approach of private sector industry to R&D activity.
1. Rapid technological advancement, especially in the information technology,
electronics, bio-technology and pharmaceutical sectors.
2. Number of multi national companies setting up shop in India with huge
investment and infrastructure exclusively for R&D
3. Multi national pharma companies outsourcing R&D activity in India
4. Globalisation of Trade resulting in cut throat competition and the advent of the
WTO regime
5. Changes in patent laws/trade related intellectual property rights (TRIPS)
- the number of patent filings by Indian companies through the Patent
Co-operation Treaty (PCT) route available with the World Intellectual
property organisation (WIPO) is increasing year after year.
All the above developments have collectively led to a shift in emphasis from pure
accounting and tax planning considerations to strategic planning and survival in a
globally competitive market.

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There is therefore an urgent need to evolve a fresh standard for collection of costs and
accounting thereof, which will help the management in
a) Strategic planning,
b) Pricing of intellectual property rights (fixing of royalty rates etc.)
c) Deciding on the amount of funds to be invested in R&D
d) Meeting of requirements of tax laws/other statutory regulatory bodies.
4. Types of R&D activity
The following are some of the areas towards which R&D effort is directed
a. Improvements in existing products
b. Design and development of new products
c. Development of new processes
d. Adaptation of imported technology to suit Indian conditions
e. Import substitution of material/ components
f. Conservation of energy
g. Market research for existing and new products
5. Evolution of accounting standards
Treatment of costs of R&D in financial statements is a controversial accounting area.
International accounting standards have been introduced to improve quality, degree of

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comparability, credibility and usefulness of the financial statements through out the
world. International accounting Standard 9 (IAS 9) lists the elements of costs, which
may be included under the head R&D expenditure and charged as an expense of the
period in which they are incurred. It also spells out the criteria for treating a portion of
the R&D costs as deferred costs. The Institute of chartered accountants of India has
also issued AS-8 for Accounting for R&D in 1985. However this standard stands
withdrawn after AS-26 (covering intangible assets) becomes effective in respect of the
concerned companies. The Indian standard is more or less in line with the IAS 9. AS-8
gives the definition of the terms "Research" and "development" as follows
(i) Research is original and planned investigation undertaken with the hope
of gaining new scientific or technical knowledge and understanding;
(ii) Development is the translation of research findings or other knowledge
into a plan or design for the production of new or substantially improved
materials, devices, products, processes, systems or services prior to the
commencement of commercial production.
The Indian standard also spells out the criteria for deferral of development costs.
Copies of these two standards are attached.
6. Provisions in the Cost Accounting Record Rules:
A typical clause in the Cost Accounting Record Rules prescribed under section 209(1)
(d) relating to the research and development expenses reads as follows:

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(1) The proper records showing the details of expenses, if any, incurred by the
company for the research and development work on the products covered under
these rules, according to the nature of development of products i.e. existing or
new products and processes, development of process of manufacture - existing
and new, design and development of new plant facilities and market research for
the existing and new products, shall be maintained separately. The records shall
also indicate the payments made to outside parties for the research and
development work. The basis of charging such amount including lump sum
payment and its treatment shall be indicated in the cost records.
(2) The basis of charging these expenses to the cost of production under reference
and to other products shall be indicated in the cost records. Where the utility of
research and development work extends to over more than one financial year,
such expenses shall be charged to the cost of products under reference and to
all other products on equitable and reasonable basis and applied consistently
indicating the criteria on the basis of which it has been decided to extend the
utility period of these expenses to more than one financial year.
(3) The expenses incurred by the research and development department for
providing technical know-how to outsiders shall be recorded separately and
excluded from the cost of products under reference. The amount recovered for
providing technical know-how to outsiders shall also be indicated separately and
excluded from the income arising from the sale of products under reference.
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7. Provisions in the Cost Audit (Report) Rules, 2001.
The above rules call for information on research and development expenses in Para 13
of the annexure to the cost audit report. The details are to be given separately for
process development and improvement, existing product development and new product
development and also the amount capitalised/ deferred out of the total amount spent.
8. Practices in some leading companies:
The practices followed by some leading companies are given below;
1. Ashok Leyland Ltd -
Expenditure on design and production of prototypes is charged to revenue as
incurred
2. TATA Motors Ltd. -
Product development costs incurred on new vehicle platforms, variants on
existing platforms and new vehicle aggregates are recognised as intangible
assets (included under fixed assets) and amortised over a period of thirty-six
months from the commencement of commercial production.

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Product development costs relating to minor product enhancement, facelifts
and upgrades are charged off to the Profit and Loss Account as and when
incurred.
3. Tamilnadu Newsprint and Papers Ltd.
Research and development expenditure of revenue nature are
charged off to Profit and Loss Account every year.
4. Chemplast Sanmar Limited
Revenue expenditure on research and development is charged as an
expense for the period in which it is incurred.
9. Earlier research by the ICWAI
The Institute of Cost and Works Accountants of India has published a treatise
on Management and accounting for R&D - the Indian Praxis in 1984. Chapter
VI of this treaties deals with the product and project costing and monitoring of
R&D costs. The learned authors have elaborately dealt with the subject with
a number of illustrations, which are still current and hence the same chapter
is reproduced.
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10. Issues to be included in the Proposed guidelines
In these guidelines the terms Research & Development will have the following
meanings:
(i) Research is original and planned investigation undertaken with the
hope of gaining new scientific or technical knowledge and
understanding;
(ii) Development is the translation of research findings or other
knowledge into a plan or design for the production of new or
substantially improved materials, devices, products, processes,
systems or services prior to the commencement of commercial
production.
Research & Development Activities - These activities can be defined as any systematic
and creative work undertaken in order to increase the stock of knowledge and the use
of this knowledge to devise new applications. R&D activities include any one or more of
the categories of research such as basic research, applied research and experimental
development.
Basic Research - Basic Research may be defined as any experimental or theoretical
work undertaken primarily to acquire new knowledge of the underlying foundations of
phenomena and observable facts, without any particular or specific application or use in
view.
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Applied Research - Applied Research may be defined as any original investigation
undertaken in order to acquire new knowledge. It is, however, directed primarily
towards a specific aim or objective.
Experimental Development - Experimental development may be defined as any
systematic work, drawing or existing knowledge gained from research and / or practical
experience that is directed to produce new materials, products and devices, and/or to
improve substantially those already produced or installed.
Research and development costs shall include:
1. Salaries and wages and other related costs (cost to the company) of
personnel in research and development
2. Cost of material and services consumed in R&D activity
3. Depreciation of building, equipment and facilities, to the extent they are used
for R&D
4. Overhead costs related to research and development activities,
apportioned/allocated based on Cost Accounting Standard - 3
5. Payment to outside bodies (Research laboratories / universities etc.) for R&D
projects related to the enterprise
6. Other costs related to R&D such as amortisation of patents and licences

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7. Expenditure incurred for obtaining patents for new products / processes.
The total expenditure on R&D, collected under the above heads shall be allocated /
apportioned to the specific products / processes under development on an appropriate
basis.
The amount of the research and development costs described above should be
charged as an expense of the period in which they are incurred except to the extent that
development costs are deferred in accordance with the following paragraph.
Development costs of a project may be deferred to future periods if all the following
criteria are satisfied:
(a) The product or process is clearly defined and the costs attributable to the
product or process can be separately identified;
(b) The technical feasibility of the product or process has been demonstrated;
(c) The management of the enterprises has indicated its intention to produce
and market, or use, the product or process;
(d) There is a clear indication of a future market for the product or process or, if it
is to be used internally rather than sold, its usefulness to the enterprises can
be demonstrated; and
(e) Adequate resources exist, or are reasonably expected to be available, to
complete the project and market the product or process.
The deferral of development costs of a project under the above criteria should be limited
to the amount that, taken together with further development costs, related production
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costs, and selling and administrative costs directly incurred in marketing the product,
can reasonably be expected to be recovered from related future revenues.
If an accounting policy of deferral of development costs is adopted, it should be applied
to all development projects that meet the above criteria.
If development costs of a project are deferred, they should be allocated on a systematic
basis to future accounting period by reference either to the sale of use of the product or
process or to the time period over which the product or process is expected to be sold
or used.
The deferred development costs of a project should be reviewed at the end of each
accounting period. When the criteria, which previously justified the deferral of the costs,
no longer apply, the unamortised balance should be charged as an expense
immediately. When the criteria for deferral continue to be met but the amount of
deferred development costs (and other relevant costs as set out in paragraph18) that
can reasonably be expected to be recovered from related future revenues is exceeded
by the unamortised balance of such costs, the excess should be charged as an
expense immediately.
Development costs once written off should not be reinstated even through the
uncertainties which had led to their being written off on longer exist.
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PRODUCT AND PROJECT COSTING AND MONITORING OF R&D COSTS
(Extract from “ Management and Accounting for Research and Development – The Indian Praxis”
by Prof. S.K.Chakraborty in collaboration with Mr. Bipul K.Bhaumik, and ICWAI Publication.)
I Product and Project Costing of R&D Costs
While the question of project wise cost finding and control of Research & Development
expenditure is relatively straightforward, that of product costing is not so simple. How do R&D costs find
their way into product costs and prices? Or do they get debited straight to the profit and loss account? If
they are treated as overhead costs, do they form a part of corporate or manufacturing or administrative
overheads? Is any distinction drawn between Research costs and Development costs? It is to these
issues that the present section addresses itself.
A Practical Illustration:
(A) In a public sector chemicals firm two distinct stages of R&D work are involved, viz., the laboratory
experiments and trials, and the pilot plant operations. While each pilot plant is a large capital expenditure
by itself, and is subjected to independent evaluation at the time of selection, and costing during operation,
the system in use for the laboratory phase of R&D is something like that shown in the following Table.
ANNUAL LABORATORY R&D COSTS

Year
(Rs. In lacs)
1. Salaries and wages 5.53
2. Laboratory chemicals 2.00
3. Maintenance (lab. bldg. and equip.) 0.93
4. Insurance 0.25
5. Depreciation 1.70
6. Interest (on proportionate term loan at weighted interest rate) 1.15
7. Common Services 5.31
_____
TOTAL 16.87
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Table
Now, 50 per cent of Rs. 16.87 lacs is assumed to be for 'Research', and is allocated to various
manufacturing plants in proportion to the gross profits from each. The remaining 50 per cent considered
as 'Development', is distributed amongst the plants in proportion to the estimated cost of production in
each plant.
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In other words, the above methodology illustrates the following important management
accounting principles:
(a) 'Research' costs are treated differently from 'Development' costs.
(b) 'Research' costs apparently do not form a part of product costing, and, therefore, not of product
pricing either. These costs are charged straightway against gross profits. (At least that is the
logical implication of allocating 'Research' costs in proportion to gross profits).
(c) 'Development' costs form a part of product cost-probably because they are much more visibly
correlated with current operations. But these costs enter into product cost, apparently, via
administrative overheads.
(d) Gross profits are derived after paying for Development costs.
(e) It is reasonable, therefore, to infer that while Research costs do not enter into product prices,
Development costs do.
It is not clear, however, as to why laboratory costs are split into Research and Development as
50:50, and not on any other basis. Except as a general thumb rule there seems to be no stronger
argument for this procedure.
(B) In an intermediate-cum-capital goods firm the practice is to include R&D expenditure within
corporate overheads. Records are available for total project times (man hour-wise) under separate
business centres. Total R&D costs are apportioned to these business centres in proportion to these
project times. But what happens after this apportionment is done? Does the apportioned cost get added
to the manufacturing or administrative overhead of the business centre? If it does get included in either, it
then forms a part of the cost of current production in the centre. However, closing inventory valuation will
differ, if the basis of valuation is only manufacturing cost, while R&D costs are included in either
manufacturing or administrative overheads. Since the firm claims that R&D costs enter into product cost,
it is clear that they are not charged off directly to the centre's profit and loss account.
(C) A large engineering concern has for one of its Divisions a 'Design and Development Department'
D&D. There are several products in this manufacturing division. Each product has a number of models
within its range. All D&D costs, project wise, are accumulated for each product separately. The total D&D
costs for each product (say covering three D&D projects over the year) are then split amongst the various
models of that product in proportion to the shop costs of the respective models. Shop costs comprise:
- direct materials
- direct labour
- shop overheads.
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This method implies that higher the total shop cost (no of units X cost per unit) of a model, the
greater is the burden of D&D expenditure shared by it. The idea probably is that: let the model with larger
production (and sales) value bear a bigger proportion of D&D costs incurred for that product.
It is not clear, however, as to whether the product-wise D&D costs, which are apportioned to
various models, are a summation of the overheads of the D&D department apportioned to the particular
product (which may, in turn, include share of apportioned corporate overhead costs) and the direct costs
of each of the three D&D projects for that product. In our view this would be a simpler process to adopt.
While it may be useful to apportion D&D overheads to individual D&D projects for their costing, for model
wise costing this step is redundant.
(D) We have just referred to the question of D&D overheads being absorbed into various D&D
projects. Let us exemplify this aspect too. In another Division of the same company mentioned in C. which
has a 'Research Centre (probably indicating a genuine difference in the nature of R&D work done in the
two Divisions), the method of project wise overhead absorption is as follows.
The Research Centre itself being quite large, it has several distinct 'cost centres'. Each such
centre has its own manpower allotment for a given year. This available manpower is converted into
'engineer man-hours' available for the year. Next, the 'overheads' of each cost centre are computed
(implying a sharing out of the Research Centre's own common facilities and expenses to the various R&D
cost centres.) With these two pieces of information, a man hour rate or shop rate is calculated, as simply
as below, for each cost centre:
Cost centre overheads
Shop rate = ——————————
Engineer Man Hours
Finally, when actual engineer man-hours spent on each project within a cost centre are known,
this figure is multiplied by the shop rate to find out the overhead cost for each project within a cost centre.
It is obvious that by this method, under or over-absorbed overheads may arise. They will need to be
appropriately disposed of.
The point to note is that while this process of accounting for project-wise R&D overheads is
necessary from the viewpoint of project cost control, product costing with respect to R&D costs need not
be affected by any particular method adopted for apportionment, or even by non-apportionment altogether
to R&D projects. This is because R&D cost centres is non-conterminous with manufacturing cost centres.
Where, however, a certain R&D project is identified with a specific product then of course the method
used for R&D project costing will affect product costing too.
(E) In the large chemicals and consumer goods firm we have been mentioning earlier, the practice
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apparently is to include Research & Development expenses within corporate overheads. At the same
time, an explanation is offered that whatever Research & Development expenses can be identified with
various profits or business centres on the basis of original requisitions and approvals are first allocated to
them properly. If this is to be conceded, then the first version of the treatment of Research & Development
costs is rendered meaningless. In fact, for the firm cited in (B) too we catch a glimpse of this anomaly.
Both these instances show that where the enterprise is divided into distinct business or profit centres, and
the Research & Development unit woks for all of them on the basis of requests and approvals, there is no
point in first saying that Research & Development costs are treated as corporate overheads, and then
beginning to qualify it.
A description was given in para D, section II of the previous chapter about the method adopted in
this firm for project cost estimation via 'standard unit manpower cost' (i.e., estimated total revenue costs
of R&D for the year, divided by total manpower units in terms of standard units for various categories-the
latter being multiplied by available hours during the year). This total revenue cost estimate has three
components of roughly the following magnitudes:
- chemicals and glassware : 15 %
- salaries : 50 %
- rest (i.e., overheads) : 35 %
From this it is obvious that R&D project cost estimation is done in a direct manner within the R&D
function itself. If there is at all a corporate overheads category, the R&D function must be receiving a
share thereof, which is merged in the 'rest' above.
Let us come back to the treatment of R&D costs for 'product costing'. While it is true that directly
traceable R&D costs find their way into the respective operational or business centres of the firm, the
question still remains as to whether the allocated R&D costs are debited in lump sum to the operating
income of the division, or they also find their way into product cost (and thence to product pricing) through
one or other category of divisional overhead costs. We got no clear answer to this question in our first
round of discussions with R&D personnel.
A second round of discussions with corporate finance personnel, however, brought more clarity
and insight into the picture. For accounting purposes a strict distinction is maintained between Research
and Development. The latter is carried out in the manufacturing sites of each business centre with a
separate set of personnel reporting to the Head of Manufacturing. Upto bench scale work (in the
Research Centre) on any project, all costs are considered as Research. Beyond that, there is a formal
transfer of Research results to Development in the relevant manufacturing site, and all costs relating to
Development form a part of the 'manufacturing overheads' of that business centre. In other words, all
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products in that centre are loaded with a share of' Development costs via manufacturing overheads.
So far as Research is concerned, there is a Research Centre with elaborate facilities in a location
physically distant from all the manufacturing sites. Here Research projects are identified separately for
existing products or processes, as well as for new ones for each business centre. In fact 80% of the
budget of the Research Centre (treated entirely as Research) consists of such projects handed over to
the Centre by various business centres. Within the Centre separate costing is maintained for each such
project. For product costing within each business centre, however, the total Research costs incurred on
its behalf during a period are included as a part of its administrative overhead. This is in contrast to
Development costs, which become a part of 'manufacturing overheads'.
But what happens to the balance 20 per cent of the Research budget, which is funded by the
corporate level for futuristic corporate R&D (and not for any ongoing business centre)? Although no clear
answer emerged on this point, we could infer that this was charged off directly to the profit and loss
account add did not enter into product costing.
This problem was raised with a large pharmaceutical firm too. Here also the discussion was
insightful. If the R&D work is essentially Development work related to specific products, then such cost is
a legitimate part of the cost of current production and sale of such items. It could, therefore, enter into
product cost via the administrative overhead cost heading. In this method product-specific costing is
sacrificed however.
But difficulty arises when there are centralised Research costs of a basic or background nature.
They are not usually connected with any of the ongoing production operations. So, it might be argued,
why should current products be burdened with a share of these costs? The answer, therefore, would
seem to be: debit Research costs to the corporate profit and loss account without taking it through any
overhead cost heading. The counter-argument is that, since Research is a continuous activity, and since
current products are receiving the benefits of past research, and future products will be reaping the
advantage of current Research, on the whole their effects and incidences balance out. So it is equitable if
basic R costs also find a place in current product costs. However, in order to achieve this, it might be
sensible to amalgamate R with corporate overheads and from thence distribute it to business centres and
to their products.
By way of comparison between the previous consumer goods firm and the pharmaceutical firm, it
appears that in the Research Centre of the latter almost the whole of the expenditure is on futuristic
Research, unlike a mere 20 % for the former. And hence, practically the entire amount of R probably
remains outside product costing. This aspect has, however, broader implications regarding pricing policy
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under the Drug Price Control Order (to be discussed in a later section of this chapter).
It may be noted that the 'shop rate' of the firm in (D), and the 'standard unit man-power cost' in (E)
are different in two major ways:
(a) In (D), it is only the cost centre overheads which appear in the numerator, whereas in the case of
(E) it is the total revenue cost of the entire R&D unit which appears in the numerator.
(b) In (D) the engineer hours of each cost centre only are aggregated. But in (E) all
categories of R&D personnel as a whole are expressed in terms of standard units. It
appears that the additional refinement in (E) could lead to more sensitive cost estimation
of R&D projects in terms of widely divergent combinations of various categories 'of
manpower budgeted for each.
(F) In a pharmaceutical and consumer goods firm (not the one referred to in E) all costs of the R&D
unit are treated as 'overhead' costs. They arc then apportioned to the three manufacturing plants in
proportion to the net assets employed in them. Within each plant, the apportioned R&D cost finds its way
into various products in proportion to machine hours used by each product.
It thus appears that this firm steers clear of the vagaries of sales revenue or gross profit of each
plant in apportioning R&D costs. Perhaps gross assets would be even better from that point of view.
In-plant apportionment to products, based as it is on machine hours, seems to indicate a manufacturing
overhead cost treatment for R&D costs. Obviously R&D costs enter into product pricing decisions.
Interestingly enough in this firm Research has three times the revenue outlay for Development
(as against 50:50 in the consumer goods firm in E), yet product costing does not seem to take cognisance
of this distinction along the lines mentioned in E above. Of course, the internal impact of ignoring this
important management accounting distinction could be small, although for various government regulation
purposes it may be rather significant (see section III later).
(G) So far as R&D 'project costing' is concerned, in the pharmaceutical firm cited in F above the
practice is quite straightforward. No project-wise cost collection is done. At the year-end the Head of R&D
gives the total number of management man-hours spent on all projects (obviously this datum is logged
project-wise). Total R&D costs are apportioned to projects in proportion to their respective usage of R&D
management man-hours. Broadly, it is a correct approach because management manpower is the major
and critical cost element in R&D. And MBO results guides include management man-hours spent as an
important objective to assess the effectiveness of progress made in R&D projects.
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(H) A smaller pharmaceuticals company makes on apportionment of costs to the R&D function from
other parts of the factory system for internal costing purposes. Costs incurred directly within R&D are
included in 'miscellaneous expenses' for the Profit and Loss account. Nor are any efforts made to trace
R&D costs to the individual products. Thus, a straight charge against annual revenue is made. For a small
firm, pharmaceuticals would be a highly competitive business to be' in, and so the cost structure of each
product is probably not allowed to be influenced by R&D cost allocations.
(I) A paints and chemicals company follows almost the same practice as described for the firm in F
above. The central R&D costs are apportioned to each product group on the basis of net capital
employed. This apportioned cost, along with the product group's own separate R&D activity costs, is then
apportioned to individual product lines in terms of recorded machine hours used by each one of them.
For project costing, however, man-hour is the relevant apportionment as well as assessment
parameter.
In another paints company, R&D expenses are combined with 'administrative overheads', which
is charged to the Profit and Loss Account. While this may be true for financial accounting, it is not clear
whether for product costing too the R&D costs remain out of the picture. Neither project nor product
costing for R&D costs seems to be established on a clear footing in this case.
(J) In a public sector drugs and formulations manufacturing company the Head of R&D maintained
that strictly speaking project-wise budgeting was not done in this case. Flexibility was more important, and
that budgeting served this aim adequately. No project-wise justification was also needed to be submitted
to the top management. However, at the completion of a specific project (e.g., for an anti-malarial drug)
retrospective cost computation was attempted on an approximate basis.
The Research Centre has three divisions: biology which carries out only basic Research,
chemicals which does both Research and Development, and the pilot plant which performs only
Development work. The laboratories and manpower are clearly demarcated for all the three units of the
Research Centre. And yet all the costs of this centre are treated as 'general overheads'. For monthly cost
sheets they form a part of administrative overheads and are charged to various products as a percentage
of cost of materials and operating supplies.
Discussions with the Head of Finance, however, revealed that cost of R&D projects on existing
products is charged to those products in the annual cost sheet. On the other hand, costs of projects on
future products are deferred in the annual cost sheet. They are charged off later when commercial
production of such new products begins. In other words, existing products do not seem to bear the cost of
Research on future products.
Costs
(K) In a defence-related public sector enterprise each project in the Design and Development (in lieu
of R&D) department is separately budgeted. At the time of commencement of each project a
Development Work Order is issued. In it are booked all costs of the project (labour hours x man-hour rate,
materials, fabrication and testing costs etc.) On project completion the Work Order is closed. The total
accumulated project cost is capitalised and treated as deferred revenue expenditure in the balance sheet.
These costs are later charged off during three to five years to the concerned products when their actual
production commences after incorporating the improvements. Whenever a project ends in failure, its
accumulated costs are not deferred. The entire cost is written off to the year's profit and loss account after
obtaining the approval of the Board. For projects which are treated at first as deferred revenue
expenditure, and subsequently charged off to production costs, the latter form a part of the cost structure
used for pricing purposes. On the other hand, the cost of unsuccessful R&D projects does not affect
product costing and pricing.
In sum, our findings from the above survey broadly conform to what the 1979 NAA report has
found to be the practice in the USA: 'A prevalent technique used to control R&D expense is to apply all
costs (both direct and indirect) of the R&D function to projects. All firms interviewed were using the
full-costing approach'.
There is, however, one noticeable difference between the 1979 NAA study and ours. The former
does observe: "When the R&D function is centralised, it is general practice to distribute the costs of R&D
to operating divisions. The purpose of this procedure is to determine the profit or loss of each division2
While this is a legitimate part of a management control system, the report stops short of exploring the next
step i.e., how do such distributed R&D costs find their way into product costs and prices in the respective
divisions? Neither is there any reference to the distinction between R costs and D costs in terms of
current product costing and pricing. Our survey of Literature suggests that there are indeed very few
references to this aspect of management accounting for R&D.
Thus, Batty makes the point that basic research, applied research, product development and
fixed assets development-all these four accounts, with all their accumulated costs, will be transferred to
either 'cost of sales' or 'profit and loss', or 'asset' account. There might be an implied hint of charging R&D
costs to product costs under the first option of debiting to cost-of-sales account. The other two methods
do not carry even this implied suggestion.
The earlier NAA Report of 1955 had, however, devoted about five pages to this topic. The survey
underlying this report discovered that normally D costs were recovered through product costing and
pricing by estimating the number of units to be sold with the new development, and dividing the D costs
Costs
by the estimated units. It should be appreciated that such charging of D costs to product costs for pricing
is a management accounting exercise, quite independent of the financial accounting treatment in terms of
debiting to the Profit and Loss Account or transferring to the Balance Sheet. Fundamental or basic or
general R&D costs may not, however, be charged in this fashion to individual products because there is
no specific relationship between these costs and the manufacture and sale of such products. It is this
class of R&D costs, which might be charged off directly to the Profit and Loss Account.
In our own survey we have examined the case of a large engineering firm, which is in the
business of designing and constructing big chemical, cement, fertiliser and similar plants for client firms.
Either this engineering firm, or its client(s) enter(s) into foreign collaboration agreements. 'Technology
adaptation' therefore becomes a vital aspect of executing such orders, and this task is performed by the
firm's R&D centre. Since, however, each order is of a unique type, the corresponding R&D work too is a
one-time exercise. There are no repetitive, continuous sales throughout the year stemming from such
R&D work. Accordingly, the issue of product costing-cum-pricing, incorporating R&D costs, does not
occur in this firm in the same way as the preceding paragraphs have indicated. Assuming that cost of
materials and labour on construction site are provided for by the client, this firm builds up its own bid price
estimate, including design and development costs, in the following style (figures are imaginary):
1. Manpower cost Rs. 7,20,000

2. Components and Materials Rs. 1,50,000
3. Overhead Costs @ 60 % of manpower costs Rs. 4,32,000
4. Transport and Sundries Rs. 1,00,000
Rs.14,02,000
5. Add, Margin of 100% Rs.14,02,000
6. Price Quoted Rs.28,04,000
==========
Reverting back again to the more common case of continuous manufacture of given product(s),
the fundamental questions underlying R&D cost allocation are:
(a) Should current customers pay for R&D outlay currently incurred?
(b) Should future customers pay for R&D outlay currently incurred?
(c) Should shareholders pay for R&D outlay currently incurred?
Option (a) entails costing of current products with R&D outlays - either directly, or through an
overhead absorption rate. Option (b) entails deferring current R&D outlay as an asset, and costing future
production through an overhead rate or directly by including an amortised amount. Option (c) implies no
charge of R&D costs to production-either through an overhead rate, or as a direct charge. There is a
straight debit to the P & L A/c - either as a charge or an appropriation. If it is a charge then, of course, the
Costs
government also bears a part of the R&D cost. A choice amongst these three options shall always
depend on the management's judgment about the strength of competition, discretion enjoyed in pricing,
level of profits anticipated, and shareholders' attitudes. As a general guideline the following scheme might
be worth considering:
(a) For Development work relating to a specific product, a direct charge to the product could be made
by estimating its total sales, say, over the next 5 years (if it is a joint product, suitable
apportionment may have to be done). This charge mayor may not be included for pricing,
depending on assessment of competitive strength.
(b) For Development work relating generally to all products, a charge to all products through a
general overhead rate, which mayor may not be included for pricing.
(c) For Research work, straight debit to P&L a/c.
While options (a) and (b) will affect product profitability - either with or without pricing being
affected by R&D, option (c) will affect company profitability without affecting product profitability. A firm
facing stiff competition and squeezed margins may prefer to choose option (c) for Development as well,
and thus pass on the cost of R&D to the government and shareholders.
II Project wise Monitoring of R&D Costs
Project-wise control is probably the only sensible way of monitoring R&D costs. This is so
because projects are allotted to individuals, or teams of individuals with leaders, and then the
responsibility centre concept for accountability becomes operative. Let us examine some of the practices.
(A) In the public sector chemicals company mentioned earlier, there is a quarter/y review for all
laboratory trial phase projects. This review is done by a Technical Subcommittee comprising the:
- Chairman and Managing Director
- Technical Director on the Board
- R&D Manager.
For pilot plant R&D projects, however, much more elaborate monitoring arrangements exist-
obviously because the outlays and stakes in them are much greater. Chart 6.1 shows the layout of the
reporting format for pilot plant projects in which data are periodically sent up to the Board and the
concerned Ministry.
(B) In a container-manufacturing firm the principal monitoring method is to review each project on the
basis of two monthly reports - one for costs, and the other for physical progress. Charts 6.2 and 6.3 show
the formats of these two reports.
As a policy in this firm, if a more than 15 per cent overrun is revealed-either for time or cost-as a
sequel to project review, then the project originator has to submit revised data, and go through the
process of submitting a fresh Project Initiation Report (PIR). This automatically ensures some measure of
Costs
control and discipline.
Costs
MIS FORMAT (PILOT PLANT)
A. Basic Information
1. Capacity of plant
2. Completion date
B. Physical Progress
C. Financial Progress
1. Sanctioned cost.
2. Expenditure upto (say) March 1980,
3. Budget for the year (say) 1980-81.
4. Expenditure incurred during April 1980. 5. Balance likely expenditure during 1980-81.
6. (a) Commitments already entered upto April 1980.
(b) Likely to be liquidated in 1980-81
(c) Likely to be liquidated in subsequent years.
7. (a) Further commitments likely to be made during the year.
(b) Likely to be liquidated in 1980-81.
(c) Likely to be liquidated in subsequent years.
8. Balance to be committed in subsequent years.
Chart 1
PROJECT EXPENDITURE STATEMENT (MONTHLY)

PIRNO: DESCRIPTION:
AUTHORlSED AMT: TOTAL EXP. UPTO: BALANCE AVAILABLE:
Capital
Revenue
Total
PRESENT ESTIMATED EXPENDITURE:
FOR PROJECT COMPLETION:
REMARKS:
Chart 2
Costs
PROJECT STATUS REPORT (MONTHLY)
PIR NO.: DESCRIPTION:

PRESENT STATUS:
REASONS FOR DELAY:
DATE OF APPROVAL OF PROJECT:
EXPECCED DATE OF COMPLETION:
Chart 3
(C) In a storage battery making firm there is a system of quarterly review of total R&D expenditure
according to expense heads as well as in terms of projects.
Since manpower resources are the major constraint, special attention is claimed to be given to
the control of usage of this resource by individual projects. To facilitate this central objective, a milestone
achievement report for each project is prepared every quarter.
There is an R&D Committee, consisting of representatives from R&D, manufacturing and

marketing, which meet every month to review progress.
Since it is a multinational company, the Indian R&D outfit has an overall liaison man to coordinate
between the international R&D centre and its Indian counterpart. Further, each project leader in India has
a corresponding linkman at the international R&D centre. All control and -review reports are regularly sent
there.
(D) For the Division of a large engineering company referred to in (C) in Section I above, the
monitoring process is like this. It has a Product Development Committee comprising the Divisional
Manager, Production Managers for various products, Sales Managers and Design and Development
Manager. This PDC meets every month to review the progress of each project. A computerised report is
made available as shown in Chart 4.
PROJECT-WISE CONTROL REPORT
Debiting Depts. Labour Hours Labour Cost Materials Cost Overhead Total (Rs.)
Chart 4
Costs
It is obvious that the data contained in Chart 6.4 alone are insufficient for proper control. It does
not show budgeted figures. Physical progress data should also be available in addition. However,
complementary to the project-wise financial data reporting, department or cost centre-wise financial data
are reported in a separate format as shown in Chart 6.5. In Chart 6.5 too there is nothing to show relative
performances of the departments in respect of physical progress of R&D work in them.
(E) For the identical Division referred to in (D) in Section I above, the monitoring system is somewhat
more sophisticated. In this Division project selection itself is done on the basis of decision trees and
probabilities. Accordingly, the approved decision tree for each project itself provides useful benchmarks
for monitoring its progress. It has been said that after the implementation of this methodology, coupled
with some version of MBO system, both time and cost over-runs have been brought down to nominal
levels.
Year to date DEP ARTEMENTWISE This Month

Actual Variance Annual Budget R&D COST Actual Variance
Dept. 1
Dept. salaries and Overheads
Direct MatIs. and other exp.
Dept. 2
Dept. salaries and Overheads

Direct MatIs. and other exp.
Dept. 3
Dept. salaries and overheads

Direct MatIs. and other exp. and so on
Chart 5
There is also a three-tier system of R&D project review:
- Every month the 'group leader' of a set of projects reviews all the projects under him with the
individual 'project leaders'.
- Every three months the Head of R&D holds reviews with the 'group leaders'.
Costs
- Every six months the Research Advisory Committee conducts a review session in a hall with all
the R&D personnel. While the Head of R&D and group leaders do the main talking and
explaining, other R&D personnel also stay there as observers. This is deemed to be a useful
training and orientation opportunity for junior personnel. The basic premise is said to be: R&D
bears the whole technical risk and liability of the company; hence their work must bear thorough
and comprehensive scrutiny.
Since the major cost of R&D is in respect of manpower, scrupulous time logging by R&D
personnel in printed cards is a standard and accepted practice within the Division. At the beginning of
each year each researcher has to prepare an estimated break-up of his total time to be spent on project
and non-project work respectively. The latter comprise visiting clients, attending conferences, doing
library work, spending time with design or production or marketing people and the like. The aggregate
distribution pattern between these two categories across an categories of R&D personnel is roughly
60:40.
The R&D department utilises in-company computer services for further help in monitoring and
controlling R&D activities. The Head of R&D receives the three following monthly reports from the
computer :,
(a) Project-wise data on manpower time and cost, materials and overhead costs
(b) Staff category-wise time spent on project and non-project work.
(c) Detailed manpower cost sheet.
Not all of them yet give full control information, because they confine themselves by and large to providing
the actual data only. Budgeted/estimated figures will need to be incorporated to enhance the utility of the
sound framework already created.
(F) In one of the three pharmaceutical firms covered in our study a monthly control report on each
project is prepared and sent to the parent company abroad. It seems to concentrate only on the
manpower (time spent) aspect of each project. It uses an index called 'manpower units' (MPU). This is
budgeted in total for each project, and periodic cumulative actual are compared against this budgeted
figure. A typical report for a project for a month appears as in Chart 6.
Chart 6
Project Monthly Project Report Year& Month
Budgeted MPU's Actual MPU's To-date
Group leader
Rest (excluding workers)
Costs
The nominal man-hours are multiplied by a certain standard fraction to derive the manpower
units. This is done most probably as a weighting device to account for diverse categories of research
personnel involved in each project.
Besides this monthly report, an annual report is also sent to the parent company, built on the following
lines (Chart 7).
Chart 7
ANNUAL REPORT
(A) Summary Budget Actual

(a) Section I: (i) No. of Ph.D's
(ii) Total salaries (Ph.D's)
(iii) Consultancy fees
(b) Section II: Do
(c) Section III: Do
(B) Project Details

(a) Section I: Narrative details of progress in various projects.
(b) Section II: Do
(c) Section III: Do
The 'sections' in Chart 7 refer to the various disciplines in which R&D work is carried on. It
appears that this research centre undertakes projects for outside clients at a price. Hence the entry
'consultancy fees'. Or, it may also mean fees paid to other agencies for R&D work farmed out to them.
(G) In the large chemical and consumer goods firm we have been referring to, review of R&D is done
at two levels. First, each project is reviewed quarterly within the R&D Centre along with the concerned
research scientists. In the second round, a review is done for each project three times a year by a group
consisting of profit centre Heads, the Chairman, Director (Technical) and the Head of R&D. The basic
data sheet for such project-wise reviews is of the style shown in Chart 8.
'Estimated units' in the upper right hand portion of Chart 8 refers to the standard manpower units
(after conversion of different categories of manpower into equivalent standard unit). Chart 8 does not
provide for separate mention of manpower, materials and overheads costs for each project. Nor does it
seem to provide for any indication of physical completion of the project.
Costs
LABORATORY PROJECT REPORT
Project Name and No. Year

Business Centre Project Coordinator
Concern Objective Section Percent Estimated Estimated Start Finish

Project No. Units Cost for Date Date
the year
Research Objective:
Review Estimated Estimated Actual Total Total Next Prepared

Date Completion Cost Cost Estimated Cost to Review by
Date Year Year Cost Date
Chart 8
(H) In a pharmaceutical firm which employs MBO there are two types of reviews for R&D work. One is
the twice-a-year MBO reviews based on the results guide of each individual, including that of the Head of
R&D. Performance against specific and agreed 'objectives' is reviewed in these sessions. The other
review is at the Board level, which has the following composition when the turn of R&D comes:
- Managing Director, MBO adviser, Corporate Planner, Finance
Director, Divisional Directors, and Head of R&D.
(I) In a paints-cum-chemicals firm major emphasis is laid on monitoring the apportionment (i.e., use)
of the time of top R&D personnel such as R&D Manager and Project Supervisors amongst various
projects. For lower level personnel, although no daily individual time cards are maintained, logbook
entries are available at one place where records are kept about the number of hours spent on individual
projects.
(J) In a very well-reputed private sector basic industry firm, with an annual revenue budget for R&D of
the order of Rs.2 crores, we came across an interesting case of how closer project-wise monitoring of
R&D costs was just being ushered in, and how the Head of R &D-originally a production man, and
thereafter associated with R&D for more than a decade and a half-was facing upto this change.
Costs
When we repeatedly pursued the idea of whether any standard project proposal format was in
use for R&D projects, the answer provided was that unlike in government laboratories (he is a nominee
on the Governing bodies of a few of them) 'much waste of time and effort on such formalities was avoided
in his set up. No project-wise man-hour budgets were built up either. According to the Head, monitoring
against budget formats did not seem to be practical, although theoretically that might be a right method.
Until now costs have not been monitored in any tangible way. But today top management was beginning
to ask for monthly cost sheets. What did this mean to and cost the R&D centre? Each month his
department would issue at least 500 stores requisitions, 200 purchase requisitions, import requisitions,
work orders to other departments, and so on. Keeping track of all this on a continuous basis was today
entailing the whole time deployment of four R&D engineers for every week in each month. He did not
think that this was a more useful employment of research manpower by any standard. When we showed
him a detailed manual for monitoring R&D projects in a large public sector company, he quipped with a
smile that this was like the hero in one of the plays of the French dramatist Moliere who had been talking
prose all his life without knowing it. Detailed discussions over two days did indicate that substantive
achievements and contributions had indeed been rendered by this R & D centre over the years-without
any elaborate budgeting and monitoring paraphernalia. It seems to us that such problems of transition
from informal to more formal controls will tend to be a recurring phenomenon in older and successful R &
D centres which are headed by senior researchers with effective personal styles of getting good results
out of their people. But in new organisations with multiple, far-flung and diverse units of operations, more
formal as well as relatively more acceptable systems might be introduced right from the beginning.
(K) We may now briefly discuss the monitoring and review system being used in the large public
sector heavy engineering firm just alluded to in (J) above.
Each project leader has to submit a 'project status report' to his group head who, in turn, passes it
on to the concerned general or deputy general manager (engineering) under which the concerned
engineering research group falls. This G.M. or DGM (Engg.) has a 'Working Group' to help him in the
monitoring process. Chart 6.9 shows the PSR format.
These PSR data are accompanied by a 'Quarterly Project-wise Engineering Man-hours and
Related Cost' Report. Engineering man-hour cost is here shown under three columns: estimated, this
quarter, and cumulative. Similar is the depiction of engineering man-hours.
Monograph on Accounting for Research and
Development Costs
P.S.R. FORMAT
For The Period:
Project No.:
Project Details:
(i) Project Title

(ii) Project Leader's name, dept. and division
(iii) Planned Date of Commencement
(iv) Actual Date of Commencement
(v) Planned Date of Completion
(vi) Expected Date of Completion
(vii) Project is on Schedule/behind schedule/before schedule.
Progress During Review Period (including status of the Project, reasons for delay, and effects on
Projected benefits)
Anticipated Activities During Next Review Period:
Chart 9
The frequency of the PSR is, however, left to the concerned research unit to decide
upon.
A Financial Status Report is also submitted for each project for each quarter to the
Corporate Research & Development office. This format is shown in Chart 10.
The format in Chart 10 appears defective because there are no columns for 'budgeted'
figures corresponding to column headings 4, 5, and 6.
While all these data are analytically very sound, their scope does indicate the extent of
minute and detailed accounting support required making a success of the system - in proper time.
In this enterprise there is another level of monitoring where the technical review of
Research & Development projects is done by concerned 'Technical Committees' covering several
Working Groups and including line personnel also. Except for small projects (each costing less
than Rs.50,000/-), all other projects are reviewed by the Technical Committees every quarter.
The same data as in formats 9 and 10 are submitted to these bodies. They record their
comments and prepare 'exception reports' on the status of research projects for submission to the
Board. Copies of the minutes of Technical Committees are sent to concerned research groups
and project leaders for necessary action.
Development Costs
Thus, the detailed formal monitoring procedure for this firm presents a study in contrast to
that mentioned in (J) above.
QUARTERLY FINANCIAL STATUS REPORT FOR PROJECT
Project Expenditure
Expense Head ————————————————————————————————————
Total Total Exp. During Cumulative Exp.
Approved Budget Review period ——————————
Outlay for the During Till
Year Year date
(a) Engg. Man-hour

cost
(b) Drafting man-hours

cost
(c) Sub-contracting for

R&D
(d) Travelling expenses

(foreign travel only)
(e) Computer expenses
(f) Materials:
- Imported
- Indigenous
(g) Equipment
- Imported
- Indigenous
(h) Prototype Mfg. cost
(i) Civil works
(j) TOTAL
(k) Foreign Exchange

Component
REASONS FOR VARIANCE
Chart 10
Development Costs
Our survey has confirmed on the whole that, in conformity with general practice regarding
managed or policy costs, Research & Development costs too are not controlled by way of
variance analysis in the same style as manufacturing costs. Indian firms too do not consider an
adverse Research & Development cost variance-cost or time-to be necessarily a weakness. Nor
do so-called favourable variances invariably pass off as creditable achievements. The very fact
that most of the control formats illustrated above do not include budgeted figures is probably an
indication that while budgeting of some sort is normal practice, budgetary control is an exception.
Whether this is done consciously, or goes just by default is however a matter of debate. While
people like Dearden warn against controlling Research & Development by variances in the
conventional style, and insist that much of such control for Research & Development has to be
subjective, people like Batty nevertheless plead that some amount of control through properly
constructed budgets is possible, and necessary at least from the cash flow point of, view, if not
cost?
III Some Government Regulations For R&D Costs And Their Impact on Product Costing
and Pricing.
One of the most universal issues in his regard pertains to the concepts of 'manufacturing costs'
and 'manufacturing profits' for the determination of 'real value' used in calculating excise duty on
production and manufacture of goods under Section 4 of the Central Excise and Salt Act, 19448.
According to the Supreme Court of India (A. K. Roy Vs. Voltas Limited) real value can include
only manufacturing cost and manufacturing profit, since Excise duty is a tax on production or
manufacture.
From the point of view of this study the key question is : is Research & Development expenditure
a manufacturing cost? There is always a likelihood of tussle between the enterprise and the tax
authorities about non-inclusion or inclusion of Research & Development outlay in manufacturing
cost to serve as a tax base. The former would obviously like to exclude it, while the latter would
insist on its inclusion.
The ICWAI Guidelines referred to above categorically states that manufacturing costs are distinct
from research costs, development costs, marketing costs, general administration costs and
financing costs. More positively, manufacturing costs should include: .
- direct material cost.

- direct wages costs,
Development Costs
- direct expenses, and
- absorbed production overheads for normal activity
In listing out what items of cost should constitute absorbed production overhead, the Guidelines
does not include either Research or Developemnt.
However, the Guidelines has adopted the terminology of the Institute of Cost and Management
Accountants, London. Research and Development are defined therein as follows:
'Research cost is the cost of searching for new or improved products, new applications of
materials, or new improved methods.'
'Development cost is the cost of the process that begins with the implementation of the
decision to produce a new or improved product, or to employ a new or improved method
and ends with the commencement of formal production of that product or by that method.'
Now, although manufacturing cost computation is suggested to cover the cost of such, 'service'
departments as factory administration, industrial engineering, production planning, maintenance
of factory buildings plant and machinery, stores, inspection, quality control, purchase department
(part) and timekeeping, the name of the Research & Development activity is not a part of this list.
Thus, following the ICMA definitions, the ICWAI Guidelines states that Research costs will not be
included in manufacturing costs. However, Development costs may be included only to the extent
they are traceable to the specific end-product. This seems to imply that such D costs shall not
constitute a part of general production overhead for computing the overhead absorption rate, but
will be a direct product cost.
In those cases where quality control and R&D are combined into one department, and our survey
has revealed a number of such instances, it is obvious that costs of the quality control activity
have to be suitably identified from those of R&D for inclusion in manufacturing cost. It also implies
that separate costing for Research and Development have also to be done, since only a part of
latter is eligible for inclusion in manufacturing cost.
Incidentally, this Guidelines should prompt enterprises to interpret as much of R&D costs as
Research costs so that the excise duty tax base is lower to that extent. However, given the nature
of R&D work done in most Indian enterprises today, it should be very difficult to justify such
outlays as R, and not D. It is also a moot question as to how the enterprise-tax authority duel is
resolved where there is a separate and geographically isolated Research Centre, complemented
Development Costs
by Development Cells in various manufacturing sites.
Thus, in the case of the firm cited in (E) in Section I above, in a recent year Research outlay was
Rs. 3.5 crores, and an equal amount was spent on Development. And these two activities were
carried out by distinct people in distinct locations. We were informed by the enterprise that all
Development costs formed a part of manufacturing cost. Probably the decision would be more
complex where there are single R&D centres on the manufacturing sites themselves. Of course,
there is an increasing trend to construct new R&D centres in separate premises, even if they are
adjacent to or near the production sites.
As a point in passing, after scrutinising the list of expense items included under financing,
marketing and general administration costs one finds that Research is included nowhere in the
Guidelines. One may legitimately ask: where is the fugitive Research cost going to find its home?
We shall now take a look at the provisions of the Cost Accounting Records Rules issued by the
Department of Company Affairs for a few industries insofar as they relate to R&D costs. Thus, the
relevant rules for Sulphuric Acid (1980) speak about R&D Expenses in the following manner:
"Proper records showing the details of expenses if any incurred by the company for the research
and development of sulphuric acid according to the nature viz., development of products-existing
and new, processes of manufacture-existing and new, design and development of new plant
facilities, market research for the existing and new products etc., shall be maintained separately.
Where the utility of such research extends over more than one financial year, such expenses
shall be treated as deferred expenses and charged to cost of production of sulphuric acid and
other products on a reasonable basis and applied consistently".
The following salient points emerge from the above excerpt:
(a) No distinction is drawn between Research and Development as in the case of

manufacturing cost Guidelines referred to earlier.
(b) Deferred or otherwise, such R&D costs are to be charged to 'cost of production', which is
the same as cost of manufacture. Thus, the implications for costing of R&D into products
in terms of excise duty regulations and in terms of cost accounting record rules are not
identical.
(c) Market research is included within R&D, and is thus made a part of cost of production. In
Development Costs
the manufacturing cost Guidelines, although not separately listed under 'Marketing
Costs', market research cost could most reasonably be supposed to be included under
this heading. Once again there is divergence of product costing under the two sets of
rules-so far as market research cost falls within or outside R&D outlay.
While the record rules provide explicitly for deferred treatment of R&D costs, they do not
distinguish between Research costs and Development costs-in fact it is clearly stated that R costs
can be deferred: It is worthwhile to emphasise here that the International Accounting Standards
Committee Guideline in this matter expressly disallows deferment of Research costs. Only
Development costs can be deferred provided:
(a) the product or process in clearly defined, and the costs attributable to the product or
process can be separately identified;
(b) the technical feasibility of the product or process has been demonstrated;
(c) the management of the enterprise has indicated its intention to produce and market, or
use the product or process;
(d) there is a clear indication of a future market for the product or process or, if it is to be
used internally rather than sold, its usefulness to the enterprise can be demonstrated;
(e) adequate resources exist, or are reasonably expected to be available, to complete the
project and market the product or process.
While our survey amongst Indian enterprises indicates that the major bulk of their R&D outlay is
really for existing products or processes, usually manufactured under collaboration agreements
with foreign companies, and that, therefore, they should usually be all able to satisfy the aforesaid
criteria, this is no reason why the future Cost Accounting Record Rules should not expressly take
note of this distinction and provide for it.
As we examine Proforma A-I for showing 'The Cost of Production of Sulphuric Acid' we observe
no separate mention of R&D costs as an element of the cost records. Apart from entries for cost
of sulphur dioxide, catalysts, salaries and wages, utilities, repairs, depreciation, adjustment for
cost variance, there are two more entries, namely, 'Other Works Overheads' and 'Share of
Administration Overheads'. Where would R&D costs be included? There is no clarification on this
Development Costs
point either in the footnotes to the proforma, or in the main body of the rules.
When we scrutinise the relevant guideline for R&D in the Cost Accounting Record Rules (Dyes),
19761, exactly the same sentences as for Sulphuric Acid occur, except on one point. Regarding
the charging of deferred R&D expenses the Dyes rule states that they should be 'charged to the
cost of the products'. If we go strictly by this wording then it has a different implication from that
for charging to 'cost of production'. This is manufacturing cost, and nothing more. But 'cost of
product' could be the cost of sales and thus R&D could become here a non-manufacturing cost.
However, it seems that this was a loose usage, for in the very next sentence we hear about the
'method followed for charging these expenses to the cost - of production .'.
In the case of Dyes too the sheet proformae accompanying the rules do not show R&D
separately. Nor do they make it clear as to which of the cost categories overhead or otherwise-
such costs would belong to.
In the same month of April 1976, the Department of Company Affairs had issued another set of
Cost Accounting Record rules for Rayon . The distinctiveness of the statement on R&D in this
case merits full reproduction of the relevant paragraph:
"Adequate records showing the details of expenses incurred by the company for the development
of existing products or processes, if any shall be maintained separately. Such records sball
indicate the expenses incurred on generic research and brand promotion separately. Expenses
incurred on brand promotion shall be excluded from costs and charged to profit directly. If the
R&D department is also engaged in the design and development of plant facilities, the
appropriate share thereof shall be capitalised. The method of charging R&D expenses to the cost
of production shall be indicated in the cost records, . . . . . . . . . . . . . . . . Wherever the utility of
such research extends over more than one financial year such expenses shall be treated as
deferred expenses and charged to cost of production on some reasonable basis which is to be
followed consistently.
"Expenses incurred by the R&D Department for furnishing technical knowhow to outsiders shall
be recorded separately and excluded from the cost of rayon products. . . . . . . . The amounts
recovered for providing technical knowhow to outsiders shall also be indicated separately." (All
italics ours).
The distinguishing elements of the provisions for Rayon, from those for Sulphuric acid, are as
follows:
Development Costs
(a) Market research does not appear in the wordings anywhere.
(b) Generic research is asked to be demarcated from brand promotion expenses. The latter are
not to be considered as R.& D, and are excluded from cost computations.
(c) Cost of design and development of new plant facilities is not mentioned in the same breath as
R&D for products/processes. The capitatisation treatment of former costs is also a distinct
feature.
(d) R&D work for outsiders at a fee is separately recognised and guidelines offered for its
treatment.
We cannot venture to suggest too strongly as to whether such distinctiveness in the Rayon rules
followed from the nature of this industry, or from the greater thoroughness of approach amongst
the set of people in the Department who framed the provisions for this industry. In fact, this
tendency for precision is also in evidence in Proformae A and A-III for cost of production of
Viscose Staple Fibre and Acetate Yarn respectively. In both cases R&D expense is shown as a
separate item in the proformae. It is only logical that if the rules devote a separate paragraph to
R&D costs, as for repairs and maintenance, and others, the corresponding proformae should also
mention R&D separately as is done for the rest.
To sum up then, allowing for inter-se variations amongst various cost accounting record rules,
they all envisage R&D costs without any distinction between R and D to be a part of cost of
production. But so far as manufacturing cost computation for excise duty purposes is concerned,
the preceding cost-of-production figures have to be adjusted to exclude Research cost, market
research costs, and non-product traceable Development costs.
It is important to note in this respect that the International Accounting Standard 9 has pronounced
in clause 8 that market research activities undertaken prier to the start of commercial production
to establish the usefulness of a product, or of the existence of a potential market are similar to
Development activities. In these cases the related costs are sometimes treated in the same way
as D cost and are written off or deferred on the same considerations. And clause 7 of the same
standard expressly excludes cost of sales promotion of existing products and related market
research activities.
We have examined above how for excise duty purposes enterprises could be tempted not to
Development Costs
include as much of R&D outlays in manufacturing cost as possible. But the same enterprises,
especially in the drugs and pharmaceutical industry, could be seen to make efforts to include as
much of R&D costs as possible in the cost of 'bulk drugs' category for the purpose of price fixation
under the Drug (Prices Control) Order, 1979 of the Government of India. Let us examine some of
the relevant provisions of the said DPCO in this regard.
Para 3 of DPCO : Vide clause (2) it is stated that while fixing the maximum price of a bulk drug
the government may take into account the average cost of production of such bulk drug
manufactured by an efficient manufacturer, and allow a reasonable return on net worth. (An
efficient manufacturer means one whose share in the total production of the drug in the country is
large, or one who employs efficient technology in the production of such drug).
No definitions or clarifications about 'Average' and 'cost of production' are provided anywhere in
the Order. Moreover, the computation of net worth attributable to bulk drugs in a bulk-drug-cum-
formulations enterprise would pose practical problems. The Order does not offer any hint or clue
on this matter either.
Para 10 of DPCO : The retail price of formulation is to be computed according to the following
formula:
R.P ::_ (MC + CC + PM + PC) x ( I + MU/100 ) + ED, where:
R.P = retail price
MC = material cost and includes cost of drugs etc.
CC = conversion cost
PM = cost of packing material
PC = packing charges
MU = mark-up
ED = excise duty
So far as MC, CC, PM and PC are concerned, they are all to be worked out according to such
Development Costs
norms as may be specified by the Government from time to time by notification in the Official
Gazette.
Thus, neither in para 3 nor in para 10 do we find any express mention about the treatment of
R&D costs for either bulk drug or formulation pricing.
Now, a typical large enterprise in this industry (with annual sales turnover exceeding Rs. 6 crores)
is a combination of drug and formulation manufacture, the former being used as captive raw
material for the latter in a large measure. The formulation mark-ups today range from 40% to
100%, depending on the category, to which formulations belong. Let us suppose on a given date
a certain enterprise employs 50 per cent of its net worth in producing a bulk drug, and the rest in
making formulations in the 100% mark up category. Let us assume that revenue R&D expense
during a year is Rs. 1 crore. Also, the whole of the bulk drug is consumed internally. Suppose
also that the enterprise succeeds in getting the whole of R&D outlay of Rs. 1 crore accepted as
being for bulk drugs. In that case this cost is included in cost of production for computing return
on net worth, and yielding a price for the bulk drug. This price then, in turn, becomes the MC cost
of formulations, over which a 100 % mark up is available. Thus, through product pricing the firm
may be able to recoup twice the amount of actual R&D outlay. However, if, say, only 50 per cent
of the R&D outlay were allowed as being for bulk drug, and the balance for formulations covered
in CC (assumed) for the retail price formula, then product pricing would recover only 1.5 times the
amount of R&D outlay (Rs. 0.50 crores at bulk drug pricing stage + Rs. 0.50 crores as 100%
mark-up on bulk drug material cost + Rs. 0.50 crores as 100% mark-up on CC for formulation
which is assumed to include R&D cost)
But nowhere is it stated whether CC for formulations is to include R&D costs, nor as to how R&D
costs are to be split between the drugs and formulations segments of the business. Section 6 of
proforma 6 (pp. 47-48) of the DPCO provides a Table for the allocation of income and expenses
between these two segments. R&D appears therein as a separate expense item. But the last
column of the proforma is headed as 'basis for allocation'. It this basis then left to the choice of
each enterprise for each item of expense?
Government officials face the policy dilemma that apparently unconscionably large sums of R&D
outlay are attempted to be pushed into the bulk drugs category of current production, whereas
most such research might actually be on items non relevant to the needs of India, or for future
products for which current product costs are unduly inflated, leading to unreasonably higher
prices for the consumer. Such dilemmas seem to be inevitable when one moves away from the
concept of what the market will bear to the normative realm of what an average Indian should pay
for the medicine he buys.
Development Costs
At least a part of this problem could be tackled by inducing the drugs firms to maintain separate
and distinct cost records for each R&D project under the two categories of bulk drugs and
formulations. The R&D organisation could also be structured accordingly. These two steps should
then avoid the need for arbitrary apportionments of R&D between bulk drugs and formulations.
And then the task of resolving which bulk-drug R&D outlays are for the remote future, or which
are not quite relevant to India (especially in the case of foreign drug companies) may be handled
a little more systematically. But subjective wrangles in this respect will always persist.
In sum, the DPCO needs to incorporate the accumulated experience of coping with R&D costs in
pricing decisions in fresh and more specific terms in a revised and updated version of the 1979
order.
It will be appropriate to mention here that the Cost Accounting Record Rules for Bulk Drugs were
promulgated as early as in March 1974. Para XV therein relates to R&D costs. In comparison with
later rules, this paragraph is much less substantive e.g., it does not mention anything about
deferral, leaving aside the matter of distinction between Rand D. The ICW AI pamphlet on cost
audit for bulk drugs, incorporating the above rule, devotes a para on R&D. It opens with a rather
ambiguous sentence. 'Expenses on Research and Development are recorded separately'. Does it
mean R&D as a whole separately from others, or Research and Development as distinct from
each other? Most probably the former sense is implied. But the most significant statement is :
'As regards new products, if expenses are of considerable value, these are treated as deferred
revenue expenditure and are spread over a reasonable number of years.' (Italics ours).
Without attributing to it the character of an ICWAI recommendation, the import of the practice of
deferment if expenses are of considerable value is both ambiguous and serious. If, as is most
likely, considerable value is judged in terms of high amount of expenditure only, then in the light
of current thinking, without linking it to visible D results which are proved, deferment would be
totally inadvisable. The Rolls Royce debacle (caused partly by deferring mounting excess R&D
costs resulting in widened discrepancy between the P&L A/C and cash flow) is probably a case in
point. As mentioned in a previous chapter, this is a standing temptation for losing or low profit
enterprises to treat R&D expenses as deferred cost.
IV. Summary and Recommendations
1. In most of the cases explored R&D costs do find their way into current production costs and
Development Costs
into product pricing.
2. This is achieved by adding R&D costs usually to administrative and at times to manufacturing
overheads.
3. We came across at least one instance where R&D costs did not percolate down to product
costing, but were directly debited to the P&L A/C.
4. Project-costing, especially for manpower costs and overheads, is being done in rather
sophisticated ways in certain very large and diversified companies having an R&D set-up. The
responsibility centre concept for overhead allocation, and standard manpower unit conversions
are employed in a few cases only.
5. The range of practices regarding project cost monitoring is also very wide. Amongst them, the
various formats illustrated above highlight the crucial aspects of R&D monitoring in some of the
organisations surveyed by us. Many R&D Heads, however believe in aggregate R&D budgeting,
but not in project wise budgeting.
6. As a sequel to the last stance mentioned above, specific tracing of R&D costs to individual
projects is rare to find (see point 2 above also). Obviously, project-budgeting and project-costing
for R&D should be implemented by all concerned.
7. Little evidence could be collected on the manner of apportioning common overhead costs of
the enterprise to the R&D centre.
8. Filling up of time spent record cards by researchers was in clear evidence (supported by
printed formats) in only two firms. Though manhour time cost is the largest single category of
R&D costs, research personnel, including their Heads, usually resent the time-logging formality.
The 1979 NAA study also concludes that while time reporting is an important area, the amount of
control in it must be weighed against a possible loss in research productivity.
9. Often the rules and regulations of the Department of Company Affairs, the Indirect Tax
Authorities, and price regulating Ministries provide conflicting motivations to enterprises in the
treatment of R&D costs for product costing and pricing. .
10. The Cost Accounting Record Rules should draw a clear distinction between Research and
Development-so far as deferred revenue expenditure treatment is permitted. Besides, the costing
formats should provide R&D costs with a separate identity, or explain under which existing head it
Development Costs
is to be incorporated.
11. Wherever firms draw a distinction between Research and Development, explicit policies
should be framed regarding who should bear these two types of costs-the existing consumer, or
the future consumer or the shareholder?
(Extract from “ Management and Accounting for Research and Development – The Indian
Praxis” by Prof. S.K.Chakraborty in collaboration with Mr. Bipul K.Bhaumik, and ICWAI
Publication.)
Note by the author: The discussions in the above chapter, are still relevant as the basic nature of
R & D Costs have remained the same. The cost accounting records rules (Formats) and the cost
audit report formats have undergone some basic changes, but the information on R & D costs
have remained more or less the same and same have been already covered in detail under the
earlier chapters.
REFERENCES:
1. Glossary of Management Accounting Terms – ICWAI Publication.
2. Cost Accounting Standard 1 to 4 – ICWAI Publication.
3. Terminology of Management Accounting – CIMA Publication.
4. Management and Accounting for R & D costs –Prof.S.K.Chakroborty- ICWAI
Publication.
5. Accounting Standards issued by ICAI.
6. Management Accountant Journal of ICWAI (Various Issues).

Accounting For Research and Development Cost

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Monograph on Accounting for Research and Development

main theme of “ Competency Building under Global Competition under WTO

scenario”, opens the key issues relating to Accounting of Research and

Development – The Indian Praxis” by Prof. S.K.Chakraborty in collaboration with

appropriate to include it as part of this monograph. The Accounting Standard –8 –

Accounting for Research and Development is also included as a reference, as the

accounting treatment is a key issue on the treatment of Research and Development

can be helpful to the management accounting fraternity and various users.

Mr.S.Ganapathisubramanian, Cost Accountant, Chennai, helped in producing this

well thought out monograph.

We also acknowledge the help rendered by S/Sri.A.S.Durgaprasad, A.N.Raman,

We are also grateful to Dr.H.R.Subramanya, President, ICWAI, who germinated the

Chairman- Technical Committtee.

Diamond Jubilee Celebrations.

MONOGRAPH ON ACCOUNTING FOR RESEARCH & DEVELOPMENT COSTS

1. Research & Development scenario in India

a) Departments of the Central Government and the various research

laboratories functioning under their jurisdiction

b) Research in various higher centers of learning, viz., IITs and Universities

c) Private sector Industrial undertakings

1. Department of Science and Technology

3. Department of Atomic Energy

4. Council of Scientific and Industrial Research (CSIR)

5. Defence Research and Development Organisation (DRDO)

6. Research Design and Standardisation Organisation, Railways (RDSO)

7. Indian Council of Agricultural Research (ICAR)

8. Indian council of Medical Research (ICMR)

component of CSIR's current turnover of about $80 million.

and Private sector industries.

with the Department of Science and technology.

Products and technologies developed by the government research laboratories are

taken up for commercial exploitation by the National Research Development

2. Private sector initiative - A historical perspective

considerations. A number of industries had foreign technical collaboration and the

3. Need for fresh approach:

approach of private sector industry to R&D activity.

1. Rapid technological advancement, especially in the information technology,

electronics, bio-technology and pharmaceutical sectors.

2. Number of multi national companies setting up shop in India with huge

investment and infrastructure exclusively for R&D

3. Multi national pharma companies outsourcing R&D activity in India

5. Changes in patent laws/trade related intellectual property rights (TRIPS)

- the number of patent filings by Indian companies through the Patent

Co-operation Treaty (PCT) route available with the World Intellectual

property organisation (WIPO) is increasing year after year.

accounting and tax planning considerations to strategic planning and survival in a

globally competitive market.

accounting thereof, which will help the management in

b) Pricing of intellectual property rights (fixing of royalty rates etc.)

c) Deciding on the amount of funds to be invested in R&D

d) Meeting of requirements of tax laws/other statutory regulatory bodies.

4. Types of R&D activity

a. Improvements in existing products

b. Design and development of new products

c. Development of new processes

d. Adaptation of imported technology to suit Indian conditions

e. Import substitution of material/ components

g. Market research for existing and new products

5. Evolution of accounting standards

Treatment of costs of R&D in financial statements is a controversial accounting area.

International accounting standards have been introduced to improve quality, degree of

gives the definition of the terms "Research" and "development" as follows