Cost Accounting Standard (CAS) 20: Research and Development Costs

Cost Accounting Standard (CAS) 20: Research and Development Costs – A Complete Guide

Introduction to CAS 20

Cost Accounting Standard (CAS) 20 deals with the identification, measurement, and allocation of research and development (R&D) costs in cost accounting. It ensures transparency and uniformity in handling these expenses across industries.

In this article, we will cover:

• The scope and objectives of CAS 20
• Key definitions and principles
• Classification of R&D costs
• Methods for allocation and treatment
• Compliance and disclosure requirements
• FAQs for better understanding

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Scope and Applicability of CAS 20

CAS 20 applies to organizations involved in:

• Pharmaceuticals – Drug discovery and clinical trials
• Technology & Software – Product innovation and development
• Automobile & Aerospace – Engine, safety, and fuel efficiency improvements
• Manufacturing – Process enhancements and material research

However, CAS 20 does not apply to basic education, employee training, or routine quality control costs.

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Key Definitions Under CAS 20

1. Research Costs

Costs incurred to discover new knowledge without a direct commercial application yet.

Example: A pharma company researching a new molecule without certainty of success.

2. Development Costs

Costs incurred to apply research findings into a tangible product or process.

Example: Developing a vaccine after identifying a virus strain.

3. Amortization of R&D Costs

Spreading the cost of R&D over multiple periods instead of expensing it immediately.

4. Government Grants for R&D

Funds received from the government to support R&D projects, which may impact cost allocation.

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Principles of R&D Cost Allocation in CAS 20

1. Classification of R&D Costs

CAS 20 categorizes R&D costs as:

• Direct Costs – Materials, salaries, and lab equipment for R&D
• Indirect Costs – Overheads like facility rent, utilities, and administrative support

2. Treatment of R&D Costs

• Research Costs → Expensed in the period incurred
• Development Costs → Capitalized if future benefits are expected

3. Allocation of Indirect R&D Costs

CAS 20 prescribes a systematic approach to allocating R&D overheads.

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Methods for Allocating R&D Costs

1. Direct Cost Allocation Method

Assigns all identifiable R&D costs directly to specific projects.

Formula:
R&D Cost for a Project = Sum of All Direct R&D Expenses

Example:
A software company spends ₹10,00,000 on a new AI model. This entire cost is assigned to the AI research project.

2. Overhead Allocation Based on Usage

Allocates indirect costs based on the resources consumed by each R&D project.

Formula:
Allocated R&D Cost = (Project Hours ÷ Total R&D Hours) × Total Indirect R&D Cost

Example:
A company has total R&D overheads of ₹50,00,000 and conducts two projects:

• Project A: 4,000 hours
• Project B: 6,000 hours

Total R&D hours = 10,000 hours

• Project A’s allocation = (4,000 / 10,000) × 50,00,000 = ₹20,00,000
• Project B’s allocation = (6,000 / 10,000) × 50,00,000 = ₹30,00,000

3. Cost Allocation Based on Revenue Potential

Distributes R&D costs based on the expected revenue contribution of each project.

Formula:
Allocated R&D Cost = (Estimated Revenue from Project ÷ Total Expected Revenue) × Total R&D Cost

Example:
A company expects revenues of:

• ₹2 crore from Product X
• ₹3 crore from Product Y

Total R&D investment = ₹50,00,000

• Product X’s allocation = (2/5) × 50,00,000 = ₹20,00,000
• Product Y’s allocation = (3/5) × 50,00,000 = ₹30,00,000

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Practical Application of CAS 20 in Different Industries

1. Pharmaceutical Industry

New drug research incurs huge R&D expenses, making CAS 20 essential for proper cost tracking.

2. Technology Sector

Tech companies allocate R&D costs for software and hardware innovations.

3. Automobile & Aerospace

New engine technologies, fuel efficiency improvements, and safety systems require structured R&D cost allocation.

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Compliance and Disclosure Requirements Under CAS 20

1. Disclosure of R&D Costs

Businesses must disclose:

• Total R&D expenses incurred
• Allocation methodology used
• Treatment of government grants

2. Audit and Compliance

Auditors ensure:

• Accurate classification of R&D costs
• Proper allocation of indirect costs
• Compliance with CAS 20 guidelines

3. Impact on Financial Statements

R&D costs affect:

• Profitability and cost control strategies
• Amortization and financial reporting
• Tax benefits and deductions

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Common Mistakes in Applying CAS 20 (And How to Avoid Them)

1. Incorrect Classification of R&D Costs

Mistake: Treating research costs as development costs to capitalize expenses.
Solution: Maintain separate accounts for research and development costs.

2. Improper Allocation of Indirect R&D Costs

Mistake: Allocating overheads equally instead of based on actual usage.
Solution: Use time tracking or resource allocation methods.

3. Ignoring Government Grants in Cost Allocation

Mistake: Not reducing R&D costs by the amount of government funding received.
Solution: Disclose and account for grants properly under CAS 20.

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Frequently Asked Questions (FAQs) on CAS 20

Q1: What is the objective of CAS 20?

To ensure proper classification, allocation, and treatment of R&D costs in financial reporting.

Q2: How should indirect R&D costs be allocated?

They should be distributed based on actual resource usage or estimated revenue potential.

Q3: Can R&D costs be capitalized under CAS 20?

Yes, development costs can be capitalized if they meet criteria for future economic benefits.

Q4: How does CAS 20 impact financial performance?

It affects profitability, tax calculations, and investment decisions.

Q5: How are government grants treated in R&D costs?

Grants reduce total R&D expenses and should be disclosed separately.

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Conclusion: Key Takeaways from CAS 20

• CAS 20 ensures standardized R&D cost allocation for better transparency.
• Companies must differentiate between research and development costs.
• Proper allocation methods improve financial reporting and compliance.

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