Accounting Treatment of Drug Research Costs: Capitalization versus Expensing in First Year Operations
Overview
This case study examines two accounting approaches for treating drug research expenses during a company's first operational year: expensing costs immediately versus capitalizing them as balance sheet assets. The analysis evaluates the accuracy and acceptability of each method under GAAP guidelines, concluding that capitalization of research expenses provides more logically sound financial reporting despite measurement challenges.
What this case study covers
- Analysis of two accounting approaches for $10.5 million drug research costs and determination of which most accurately reflects financial operations
- Examination of both expensing and capitalization methods as acceptable treatments under GAAP, with discussion of advantages and limitations
- Evaluation of how accounting framework selection impacts financial reporting outcomes and asset recognition
Preview
Case Study 5-1
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Case Study 5-1
1. Which of the approaches in the case most accurately reflects the financial operations of the company for their first year of operation?
The case study shows that ASM has two approaches for carrying out accounting regarding drug research costs during its first operational year. In the first approach, this firm can monitor the expenses of $10.5 million without a corresponding profit, hence, incurring a loss of a similar amount in its initial operational year. Likewise, ASM can treat $10.5 million as capital investment cost in the balance sheet. This aspect shows that the above company will not report any expense or revenues in its leading financial year. In the second method, ASM should account for research costs, hence, ascertaining that the capital investment expenses are available in the organizational commercial operations statements (Harrison & Harrison, 2013). By considering the above tactics, it occurs that handling research expenses as capital assets is more accurate and logical. People need to note that expensing research charges does not offer precise information about financial operations because it paves the way for recording the immediate offsetting revenue (Shannon-Baker, 2016).
2. What are the two different accounting treatments offered? Do you find both acceptable, and why or why not?
There exist two accounting methods for treating drug research expenses, and they include expensing the yearly research costs or handling annual study costs from future sales as capital investment.