Capitalised development costs
AccountingDevelopment spend carried on the balance sheet as an intangible under IAS 38 rather than expensed, and amortised later.
Also written: capitalised development, capitalised software development, development costs
IAS 38 splits internally generated intangibles in two. Research must be expensed as incurred. Development must be capitalised once the entity can demonstrate technical feasibility, intention and ability to complete, probable future economic benefits, adequate resources, and reliable measurement of the spend. Once those six tests are met capitalisation is required, not permitted.
The effect on the accounts is straightforward and large. Capitalising removes the cost from this period's operating expenses, raising reported operating profit and margin, and returns it over several years as amortisation. It also moves the cash outflow from the operating section of the cash flow statement to the investing section, so operating cash flow rises while free cash flow measured after the spend does not move at all.
US GAAP diverges here, and the divergence is genuine rather than presentational. The general rule is that research and development is expensed as incurred, with narrow software specific exceptions: costs after technological feasibility for software to be sold, and application development stage costs for internal use software. A US listed peer therefore often carries little or nothing on the balance sheet for the same activity.
Judgement about when the IAS 38 criteria are met also varies between IFRS filers, so two European companies can differ as well. The normalisation is the same in every case: add capitalised development back into costs, or compare EBITDA less capitalised development, before putting two margins side by side.
Worked example
Two identical companies each spend 100 on development. The IFRS filer meets the IAS 38 criteria on 60 of it and capitalises that, so operating costs fall by 60 and operating profit rises by 60 before any amortisation.
The US filer expenses all 100. Same activity, same cash, and a 60 point gap in reported operating profit that has nothing to do with the businesses.
Adding the 60 back to the IFRS filer's costs puts the two on one basis, which is the only state in which the margins mean anything.
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