Smarter Accounting for Research and Development Costs

The plight of a longtime, part-time CFO seemingly includes cleaning up accounting messes. Oddly, many of these messes are created by well-meaning tax accountants who have never worked in the controller’s chair at a mid-sized business. Accordingly, the chart of accounts is not structured around CEO decision-making, but filling in boxes on a tax return.

About two in ten clients I work with do some form of research and development. In some instances, third parties perform the research and development function.

However, in cases where research and development are performed in-house, I rarely see a good account structure that allows the manager to plan and review their costs. I find that a bit baffling because many accounting messes include too many stray and forgotten accounts. That’s never the case for research and development. Instead, that cost is relegated to just one account.

We won’t go overboard, but I suggest limiting your research and development activities to no more than five accounts.

From here on out, I’ll abbreviate ‘research and development’ to ‘R&D’.

Revisiting the Overall Chart Structure

You are already familiar with my account structure for the income statement. We use the 6000s for compensation. That includes the R&D manager as well.

For R&D, pick a series that has not been used from 6000 to 6999. If the outlays are large, I’d try your 6300s or 6400s if they are available. In my example, I’ll use the 6300s.

Only Five Accounts Are Needed for R&D

Here are my five suggestions:

1. 6300 R&D – Materials and Parts
2. 6301 R&D – Testing
3. 6302 R&D – Contract Labor
4. 6304 R&D – Consultants
5. 6350 R&D – Software

This is not an exhaustive list, but rather a starting point. I’m confident your situation will require at least four of the accounts, if not all five.

As a good starting point, meet with your R&D manager and review their list of future costs, categorizing them into standard buckets. You may find yourself adding a few more, which is fine.

Incidentally, I have purposely ignored the balance sheet. Please follow the GAAP guidance from your auditors on what items should be capitalized and when. My short version for R&D capitalization is when a product or idea starts deriving monetary value from customers. In that case, you only need one intangible account to house those expenditures. Accordingly, the account structure above is for costs that should be expensed per GAAP.