Kieso etc. (2009) refers development as a kind of translation of research findings of other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use. It usually contains the design, construction and testing of pre-production or pre-use prototype and models. According to the description of the context, Project X contains the activities of construction and testing of pre-use prototype trains, in which the design has been extensively tested and minor technical issues have been resolved, so it can be seen as the development activities. At the same time, project X contains a fixed price of £600 million construction contract with an intention for sale, which will generate probable future economic benefits, and the cost of £500 million for the overall contract can be predicted with reasonable certainty. According to the principle of IAS 38, the project X will be recognized as an intangible asset, and the development expenditure of £100 million should be capitalized.
In addition, this activity can also be seen as a fixed-price contract, which should apply the percentage of completion method to recognize a proportion of net income over the period of the contract.
Research activity is controlled by the enterprise and is as a result of past events but there is no reasonable certainty that the intended economic benefits will be achieved. According to the description of project Y, it is in the phrase of research because so far the material developed has proven too weak to be used in any manufacturing process. As IAS 38 required, the research expenditure of £20,000,000 will be recognized as an expense when it is incurred.
According to the description of Project Z, it can be seen that the development has involved the construction of a new engine and has contained a fixed-price contract of £40 million which offers a reasonable assurance to the future economic benefits, at the same time, the expenditure of the development can be reliably measured with £38 million. So, if we compared the facts mentioned above with the definition of intangible assets and the criteria of assets recognition, we would probably classify the development into intangible assets, and apply the corresponding accounting treatments to the development activities by capitalizing the incurred expenditure of £4 million. However, if we read the paragraph more and think it further, the result would be different. Because it can be seen that the customer has been disputing the invoice and no payments on account have been received, it probably happens that the customer would violate the contract and no future economic benefits or little would be received. Since with no future economic benefits coming into Fastrains plc, the development will not satisfy the criteria of intangible assets recognition, and the expenditure of £4 million incurred should be expensed.