Since many pharmaceutical life sciences and biotechnology companies spend substantial amounts of money on research and development, understanding how to account for r and d costs is important to understanding these companies. Financial statements. Firstly, with regards to r and d costs are the cost associated with acquiring research and development assets.

This is where another company has spent money on research and development, and the output of that is acquired.

In such cases, the acquiring company under both US GAP and IFRS should account for that acquisition, the acquired r and d asset, as an asset on their balance sheet. Another way of saying this is that the r and d assets should be capitalized.

The second aspect of research and development costs is with regards to costs incurred by a company directly Here. There is a difference between US GAAP and IFRS, whereby under US Gap, the rules are much more straightforward in that all r and D costs, with the exception of software costs, should be expensed straight into the income statement as they are incurred under IFRS.

It's a bit more complicated.

Firstly, all research costs should be expensed as they are incurred. However, for development costs cost incurred in the development of a product for final sale to customers, those development costs should be capitalized, but only after the feasibility of the product which is being developed be an asset or maybe a pharmaceutical drug has been established.

So the question then becomes how do we determine the feasibility of a particular pharmaceutical drug with the accounting rules, with regards to determining the feasibility of a particular product, depend on a couple of factors.

Firstly, it must be possible to demonstrate that the company that is developing this product is going to be able to complete it to such an extent that they can sell it to somebody else or use it themselves.

Secondly, we also must be able to demonstrate that we can generate some revenue from this, either sale proceeds of the asset that has been developed itself or from actually selling the goods to customers.

With regards to pharmaceutical companies, the feasibility of a drug is quite complicated because there are many clinical trials that pharmaceutical drugs have to get over the hurdles of before it can actually be sold to customers.

The stages of clinical trials for pharmaceutical drugs tend to fall into four stages.

Stage one is when we are testing the, uh, safety of the product itself, and the necessary level of dosage tends to be relatively small in size, maybe 20 to a hundred people and lasts several months.

Stage two is when we're looking to test the efficacy of the product, so whether it works or not, and if there are any side effects, there's A wider trial over several hundred people and may last up to two years.

Then we move into stage three when again, we're still testing for the efficacy of the product, but also looking more generally for any adverse reactions to taking the drug itself.

This is, again, wider as a trial, 300 to 3000 people and again, takes a longer period of time up to potentially four years.

So getting through these first three stages of clinical trials could take up to six years for a particular product.

And don't forget that the clock is already running with regards to the 20 year patent or license that pharmaceutical companies get with regards to new products.

That license or patent will have been filed before the beginning of the stage one trials.

Once the drug is completed, the stage three clinical trials, it then typically moves forward for regulatory approval.

The FDA is the Food and Drug Administration and are the US regulator once the drug has been approved by the necessary regulator.

We then move on to stage four clinical trials involving many more thousand people, and again, testing for safety and efficacy.

With regards to the capitalization of development costs, the feasibility of new drugs is generally taken to be demonstrated once regulatory approval has been achieved.

If we look at an example from a Spanish pharmaceutical company, laboratories, pharmaceutical costs rovy, the footnotes from their financial statements state that the development costs on pharmaceutical products will be capitalized when the drugs have been approved for marketing by the health authorities.