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Reporting Requirements for Annual Financial Reports of State Agencies and Universities

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Reporting Requirements for Annual Financial Reports of State Agencies and Universities

Specialized Accounting

Research and Development Arrangements

Most research and development (R&D) activities, particularly those involving internally-generated software or other intangible outputs, are governed by GASB 51, along with general guidance on liabilities, revenues, and expenditures or expenses. Accounting for these arrangements must have an emphasis on the substance of the transaction rather than its form. Agencies must evaluate each arrangement to determine whether it represents:

  • An exchange transaction
  • A nonexchange transaction
  • The creation of an asset
    –OR–
  • The incurrence of a liability

R&D activities that result in internally-generated assets (like software) must be evaluated as prescribed in GASB 51. As per GASB 51:

  • Costs incurred during the preliminary project stage are expensed as incurred.
  • Costs incurred during the application development stage may be capitalized if the project meets the required criteria.
  • Capitalized costs must be amortized over the estimated useful life of the asset.
  • Post-implementation and operational costs are expensed as incurred.

Agencies must ensure that only qualifying costs are capitalized and that capitalization begins and ends in accordance with GASB 51 requirements.

Forms of R&D Arrangements

Other factors may be present and relevant when determining the nature of an agency’s obligation related to R&D arrangements and how that obligation is reported.

Liability to repay to other parties

When an agency enters an arrangement to fund R&D performed by another party, the accounting depends on if:

  • The arrangement is exchange or nonexchange in nature
    –AND–
  • Repayment is required

If the agency is obligated to make payments regardless of the outcome of the R&D activities, the arrangement creates a present obligation and must be recognized as a liability when incurred, with related expenditures or expenses recognized as the R&D activity occurs. This is a common scenario when agencies provide funding through grants or similar arrangements in which they do not receive direct, commensurate value in return.

If the agency’s payment obligation is contingent upon the successful outcome of the R&D activities, the arrangement must be evaluated as a performance-based contract. In these cases, the agency is effectively purchasing R&D services and the transaction must be accounted for as an exchange transaction. Expenses are recognized as services are received and any related liabilities are recognized based on the terms of the contract and the extent of performance.

Obligation to perform contractual services

When the agency performs R&D activities for another party, the arrangement is generally an exchange transaction in which the agency acts as the service provider. Revenue must be recognized as it is earned in accordance with the underlying contractual terms and expenses must be recognized as incurred. The timing of revenue recognition must reflect the transfer of services to the counterparty, consistent with GASB exchange transaction principles.

Loan to other parties

In certain arrangements, funding may be structured as a loan to another party, with repayment contingent upon the success of the R&D activities. These arrangements require careful evaluation of substance over form. If repayment is not assured, the transaction may represent participation in the R&D effort rather than a traditional lending arrangement. The costs must be treated as R&D expenditures or expenses. If the funding can be clearly associated with another activity (such as marketing or commercialization efforts) the costs must be classified and reported based on their underlying nature rather than as R&D.

Disclosures

Financial statement disclosures for R&D arrangements must provide sufficient detail of the nature and financial impact of these activities. For material arrangements, agencies must disclose the:

  • Nature and purpose of significant R&D agreements.
  • Key terms and conditions in effect as of the reporting date, including:
    • Provisions related to royalties
    • Licensing
    • Purchase commitments
    • Additional funding obligations
  • Amounts recognized, including:
    • Expenses or expenditures incurred
    • Revenues recognized (if applicable)
    • Any outstanding commitments or contingencies associated with the arrangements