Business and Personal Finance: Small High-Tech Companies

Unique Issues for Specific Businesses – Small High-Tech Companies

The technology industry lives by constant innovation. To the people on the outside, these advances seem instantaneous. The entrepreneurs and developers working within the highly competitive high-tech industry know the real story: what seems instant to the rest of us can take years and years of development.

That poses an interesting accounting problem: how to account properly for expenses that are incurred years before any revenues can possibly be earned, if ever. The answer comes in some special accounting rules specifically created to deal with research and development. Although business expenses are supposed to connect with the revenues they help create, that matching principle just doesn’t make much sense in the case of research and development. For that reason, no matter what accounting method your company uses, research and development costs are usually recorded as expenses as soon as they are actually incurred, whether or not they eventually result in revenues.

The Technology Industry Responds

The research and development accounting rules come with a lot of controversy, mainly from the technology industry itself. The industry’s argument is that the research and development can lead to a patent (in the case of hardware) or copyright (in the case of software), so the expenses should be capitalized (which means treated like an asset). That would help both their balance sheets and statements of profit and loss look better during the research and development phases.

The accounting industry, though, always takes the path of conservatism. Whenever there’s any doubt, it takes the path that leads to lower profits and fewer assets rather than the opposite. Since research and development costs are not guaranteed to turn into patents or copyrights, they must be recorded as immediate expenses. In addition, it can be tough to figure out which costs go with which projects, as many technology companies have more than one development in the works at a time.

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Different countries use different guidelines when it comes to research and development costs. Japan, for example, lets those expenses be capitalized as incurred, then amortized over time. That means if a Japanese company and an American company spent the exact same amount on research and development, the Japanese company would show higher profits on its current financial statements.

Software Development

Many small businesses create computer programs that will eventually be sold to companies and individuals. During the research and development phase, all the expenses are booked right away. However, as soon as that product is proven to be viable, and a complete working program exists, you have an asset on your hands; after that point, all the money spent to pro- duce the software will be debits to an asset account instead of an expense account. That asset then is amortized over its estimated life, which is how long you reasonably believe it will be a salable product.

The accounting works differently when your company has been contracted to develop software for someone else, according to their specifications. Any costs that will be covered under your contract (which usually include direct costs, some overhead, and a profit) and will be paid by the hiring firm can be recorded as an account receivable on your books. Since those expenses will be reimbursed, they’re not really expenses of your company, and you don’t have to record them that way.