The American Corporation and the French Corporation are identical in every way.
ID: 2600981 • Letter: T
Question
The American Corporation and the French Corporation are identical in every way. Both companies spend $200,000 for research costs in Year One as well as $100,000 in development costs during that same year. The American Corporation follows U.S. GAAP. The French Corporation follows IFRS and believes these development costs meet the criteria for capitalization. The capitalized costs are amortized over four years using the straight-line method and the half-year convention. a. What is the difference in reported net income between these two companies for Year One? b. Assuming no further amounts were spent for research and development in Year Two, what is the difference in reported net income between these two companies in that second year?
Explanation / Answer
In US GAAP, the research and developement costs are expenses as they are incurred. Only development cost of softwares developed for external use are capitalised.
Under IFRS, reaserch costs are expenses as they are incurred. But the developement costs are to be capitalised if they meet the criteria for capitalization. The capitalizes development cost is to be amortized in over the period for which there is inflow of economic benefits from the asset.
A. Difference between reported net income of first year of two companies:
American corporation will show total research and developement cost of $300,000 as expense.
French corporation will show the research cost of $200,000 as expense. It will capitalised development cost of $100,000 and will amortized it over period of four years using straight line method and half-year convention. Half-year convention means any asset aquired during the year is considered as acquired during the middle of the year and qualifies for half year depreciation in the first year. Therefore, depreciation cost= Half of ($100,000)/4 = $12,500. Total of research and development cost shown in income statement of French corporation = $200,000+$12,500=$212,500.
Therefore, the net income of French corpartion will be $87,500 higher than American corporation.
b. Difference in reported income of two companies for second year:
There is no research and development cost to be recognised in American corporation in the second year. However,
French corporation will amortise the development cost of $25,000 ($100,000/4).
Therefore, the net income of French corporation will be lower by $25,000 than the American corporation in the second year.
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