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EX 4.3.2.1 – Application of development costs recognition criteria to ‘green’ solutions to climate change
Publication date: 03 Mar 2023
uk In depth INT2023-02
An entity involved in developing new ‘green’ technology (such as Carbon Capture and Storage), might incur significant research and development costs. Following EX 21.32.1 – Application of recognition criteria to each stage of the product life cycle in PwC’s Manual of Accounting, management should consider the product life cycle and then apply the recognition criteria listed in paragraph 57 of IAS 38 at each stage of that cycle. There is no generic indicator of the commencement point for capitalising such internal development costs. Management needs to use judgement based on the facts and circumstances of each project.
Costs incurred in developing these new technologies may include studies regarding technological innovation, conceptual project design, technical, commercial and economic feasibility and potential locations. These activities occur before the entity moves onto more detailed front-end engineering and design (commonly known as FEED) of a pilot facility or pre-use prototype.
The entity may expect there to be significant growth opportunities in the market over the coming years since such projects are a major part of many countries’ net zero proposals. When evaluating whether these types of projects meet the recognition criteria listed in paragraph 57 of IAS 38,
“An intangible asset arising from development (or from the development phase of an internal project) should be recognised if, and only if, an entity can demonstrate all of the following:
- the technical feasibility of completing the intangible asset so that it will be available for use or sale.
- its intention to complete the intangible asset and use or sell it.
- its ability to use or sell the intangible asset.
- how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
- the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
- its ability to measure reliably the expenditure attributable to the intangible asset during its development.”
The following considerations are helpful:
- In meeting criteria (a), whether there are doubts about the technical feasibility of the project due to the extent the technology or product has been previously proven to work. Understanding the probability of success may be easier, for example, where there are adaptations of previous technologies for a different purpose rather than entirely new technology.
- In meeting criteria (d), whether there are barriers to generating economic benefits due to the need for approval by a government or regulator. Some regulatory requirements may be easier to meet than others. A failure to meet regulatory requirements with a completely new product, could mean that the entire project fails. However, in many cases entities may have received pre-approval for certain aspects or be on an accelerated regulatory approval process to progress a country’s climate goals.
- In meeting criteria (e), whether the availability of financial resources is sufficient to achieve a commercial production stage or pilot facility. Often ‘single purpose’ companies may have financing available only to a certain stage of their research. This may be a good indication of how feasible investors perceive the project to be. However, this may be less of a constraint for a larger well capitalised company that is generating revenue from other projects.
If the conclusion around capitalising these development costs is judgemental an entity should consider whether this should be disclosed as a significant judgement under IAS 1 para 122 in the financial statements.
As well as these intangible development costs, physical assets with a possible alternative use may be purchased as part of the development phase. These should be separately assessed for capitalisation under the recognition and measurement requirements of IAS 16 ‘Property, plant and equipment’ and depreciated over their useful economic life.
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