Development costs accounting turns on which framework you report under. Under US GAAP, research and development spending is expensed as incurred, and software is the significant exception. Under IFRS, research is expensed but development costs must be capitalized once a project clears six feasibility tests. That single divergence is why two companies spending the same money on the same project can post very different earnings.
Research Costs Versus Development Costs
Both frameworks separate research from development, and the line matters because it controls when capitalization is even on the table. Research is exploratory: experiments, literature reviews, testing new theoretical approaches. Development starts when the company applies what it learned to build something specific, such as a prototype, a pilot plant, or a working software model.
The reason for the split is uncertainty. In research, nobody knows whether the work will produce anything commercially useful. Once a project reaches development, the company has enough knowledge to aim at a concrete product or process, and that reduced risk is what opens the door to capitalization under IFRS and, in narrower circumstances, under US GAAP.
US GAAP: Expense R&D as Incurred
Under ASC 730, the baseline rule is to charge all R&D costs to expense when incurred.1Internal Revenue Service. Appendix E – Directive Definitions That covers researcher salaries, materials consumed in testing, overhead allocated to R&D, and depreciation on equipment used solely for R&D. There is no general capitalization option for development costs the way IFRS provides.
The FASB rejected broader capitalization on the reasoning that R&D is uncertain enough that companies would end up parking costs on the balance sheet that never generate returns. If it is R&D under ASC 730, it hits the income statement immediately.
The exceptions are narrow. ASC 730 does not apply to software development costs (which have their own rules), R&D performed under contract for someone else, or intangible assets acquired in a business combination. Materials, equipment, and facilities that have alternative future uses beyond a single R&D project can be capitalized and depreciated normally, with the R&D portion expensed as those assets are used.
IFRS: Capitalize Development Costs When Six Tests Are Met
Companies reporting under IFRS follow IAS 38, which takes the opposite approach once a project leaves the research phase. Research costs are still expensed immediately. Development costs must be capitalized as an intangible asset when the company can demonstrate all six of the following at the same time:
- Technical feasibility of completing the asset so it will be available for use or sale.
- Management’s intent to complete the asset and either use it or sell it.
- Ability to use or sell the asset, with a market for it or a specific internal use planned.
- Probable future economic benefits, meaning revenue or cost savings that exceed the development costs.
- Adequate financial, technical, and other resources to finish development and bring the asset to market.
- Reliable measurement of the expenditures attributable to the development phase.
Anything spent before that threshold is met is expensed. Once all six criteria are satisfied, capitalization is not optional under IFRS. The company is required to begin recording qualifying costs as an intangible asset. This mandatory capitalization is the single biggest difference between the two frameworks in the R&D space.
Software Development Costs Under US GAAP
Software is where US GAAP carves out its most significant exception to expensing everything. Treatment depends on whether the software is being built for external sale or for the company’s own internal use.
Software Built for Sale or License
Under ASC 985-20, costs on software a company plans to sell or license are expensed as R&D until the project reaches “technological feasibility.” The definition is demanding: the company must have completed all planning, designing, coding, and testing needed to confirm the product can be built to meet its design specifications.2U.S. Securities and Exchange Commission. Note 1 – Summary of Significant Accounting Policies: Software Development Costs In practice, that means either a detailed program design that has been reviewed and validated, or a completed working model tested against the product design.
Once technological feasibility is established, the company capitalizes costs such as programmer salaries, testing, and materials until the product is available for general release. After release, further costs are expensed. Because the bar is set high, most software companies expense the majority of their development spending. A beta version released for customer testing is often the practical marker, though the specific evidence depends on the company’s process.
Internal-Use Software
Software built for the company’s own operations follows ASC 350-40. The current rules split the process into three stages:
- Preliminary project stage. All costs are expensed. This covers evaluating alternatives, selecting vendors, determining functionality requirements, and deciding whether to proceed.
- Application development stage. Costs directly tied to building the software are capitalized, including coding, configuration, testing, and direct labor. Training and data conversion costs are expensed even during this stage.
- Post-implementation stage. All costs are expensed. Routine maintenance, bug fixes, and minor tweaks do not extend the asset’s value.
Capitalization begins when the preliminary stage is complete, management has authorized and committed to funding the project, and it is probable the project will be completed and the software will perform its intended function. Capitalization stops when the software is substantially complete and ready for use.
Cloud Computing Arrangements
When a company pays for cloud-based software through a service contract rather than owning the software, ASC 350-40 still governs the implementation costs. Custom coding, configuration, system integration, and data migration essential to getting the system running can be capitalized during the application development stage. Ongoing subscription fees, staff training, and routine maintenance are expensed as incurred. The capitalized implementation costs are amortized over the term of the hosting arrangement rather than a traditional useful life.
Upcoming Change: ASU 2025-06
The FASB issued ASU 2025-06 to simplify the internal-use software rules. The update removes references to the three development stages, making the guidance neutral to how a company actually builds software, including agile and other non-linear methods.3FASB. FASB Issues Standard That Makes Targeted Improvements to Internal-Use Software Guidance Under the new rules, capitalization hinges on two criteria: management has authorized and committed to funding the project, and it is probable the project will be completed and used as intended. The update is effective for annual reporting periods beginning after December 15, 2027, and early adoption is permitted.4FASB. Accounting Standards Update Effective Dates Companies that have not early adopted continue applying the current stage-based framework through their 2027 fiscal year.
Amortizing Capitalized Development Costs
Once development costs qualify for capitalization, they sit on the balance sheet as an intangible asset. That asset is then amortized. Its cost is spread as an expense across the periods that benefit from it, the same way depreciation works for a building or a piece of equipment.
The amortization method should reflect how the company actually consumes the asset’s economic benefits. If the asset delivers relatively steady value, straight-line is standard. For software sold to customers, companies sometimes tie amortization to the ratio of current-period revenue to total expected revenue from the product, which front-loads the expense when sales are highest. When the consumption pattern cannot be reliably estimated, straight-line is the default.
The amortization period is the asset’s useful life. If a legal constraint like a patent term is shorter than the expected useful life, the amortization period cannot exceed that limit. Useful life must be reassessed each reporting period. If circumstances change, the remaining carrying amount is amortized over the revised, shorter period going forward, treated as a change in estimate rather than a restatement of prior periods.
Impairment and Abandonment
Capitalized development costs are finite-lived intangibles, so they do not require annual impairment testing. A company tests for impairment only when a triggering event signals that carrying value might not be recoverable. Common triggers include a sharp drop in the asset’s market value, a major shift in how it is being used, negative changes in the legal or competitive environment, costs running significantly over budget, or ongoing operating losses tied to the asset.
When a trigger occurs, the company compares the asset’s carrying value to the undiscounted future cash flows it expects the asset to generate. If carrying value exceeds those cash flows, the asset is impaired and written down to fair value, with the difference recorded as an impairment loss. Under US GAAP, once written down, the asset cannot be written back up even if conditions improve.
If a project is abandoned entirely, the remaining balance is written off as a loss. The abandonment has to be genuine rather than a temporary pause, and it should be documented through internal records such as board resolutions or formal project cancellations.
Tax Treatment Is a Separate Question
Book treatment does not drive tax treatment. For tax purposes, Section 174 governs, and the two do not have to match. Under Section 174A, enacted through the One Big Beautiful Bill Act, domestic research and experimental expenditures can be fully deducted in the year paid or incurred for tax years beginning after December 31, 2024.5Office of the Law Revision Counsel. 26 U.S. Code 174A – Domestic Research or Experimental Expenditures That reversed the TCJA provision that had required five-year amortization of domestic R&D costs starting in 2022.
Foreign R&E expenditures do not receive the same treatment. R&D costs attributable to research conducted outside the United States must be capitalized and amortized over 15 years under Section 174. Software development costs follow the Section 174 rules for tax purposes regardless of how the company treats them on its GAAP or IFRS financial statements.
Why the Framework Choice Moves the Numbers
The impact of these rules is bigger than most people expect. An IFRS company that capitalizes development costs will show higher current-period income because those costs do not hit the income statement right away, but it will carry a larger intangible asset that flows through later as amortization expense. A US GAAP company expensing the same costs immediately shows lower current earnings and has no future amortization drag.
For anyone comparing companies across frameworks, headline earnings are not directly comparable without adjusting for the R&D treatment difference. For finance teams deciding how aggressively to pursue capitalization, particularly on software, the treatment affects reported profitability, EBITDA, and potentially debt covenants tied to financial ratios. Misclassifying in either direction, whether capitalizing costs that should be expensed or expensing costs that qualify for capitalization under IFRS, can lead to restatements and regulatory scrutiny.