Australian START UP’s Financial Statements Reporting of R&D Rebate Income and Intangible Assets

Auditors of Australian and New Zealand Intellectual Property ("IP") Startup Companies are currently qualifying their opinions on financial statements reporting income from R&D rebates and intangible assets from Research and Development (“R&D") activities unless R&D Rebate grant income is set off against the value of intangible R&D assets created.

The basis of this accounting treatment of R&D rebate income related to eligible R&D non-capital expenditure subsequently capitalised is to report it as a "negative asset". This has the effect of Startup Companies not reporting R&D rebate income and reducing the cost value of Intangible Assets carried forward on their Balance sheets.

The Australia New Zealand Accounting and Auditing profession is accordingly not complying with the requirements of associated accounting standards (AASB120 - Grant Income, AASB138 - Intangible Assets) and acting contrary to the intentions and reasoning of Government R&D rebate legislation and regulation. This has a negative impact on Australian startup companies in the intellectual property innovation environment by reducing the strength of their balance sheets and thereby reducing access to finance.

Auditors maintain that the underlying basis for this treatment and the resulting audit qualifications is the "matching principle".

However, the fundamental purpose of Generally Accepted Accounting Practice ("GAAP") is to provide information about the economic activities undertaken by a Company during a reporting period and the financial position of a Company at the end of a reporting period.

The contention of this article is that the Australia New Zealand Accounting and Auditing profession is in contravention of GAAP and does not comply with requirements of AASB 120 and AASB 138 for the following reasons.

a) Information about the activities of the Company is under-reported.
b) information about the financial position of the Company's is under-reported (Assets under-reported)
c) capital expenditure is not eligible for R&D rebates and precludes matching it with rebate revenue.

It is in contravention of GAAP and the matching principle for the following reasons: -

a) revenue from non-R&D activities (rebate claim) is matched against R&D activities.
b) cost of non-capital R&D activities undertaken and incurred by a Company cannot be matched by the receipt of R&D rebates because: -
i) parties to receiving and making the affected payments and receipts are not connected.
ii) payments and receipts are related to different activities. eg R&D wages expenditure by the Company is received by employees and contractor’s for work done and R&D rebate payments are made by the Govt and received by the Company for Company compliance with R&D eligibility requirements.
iii) receipt of R&D rebate funds are not dependent or related to capitalisation of R&D expenditure. i.e. eligible R&D Rebates are receivable irrespective of capitalisation of R&D expenditure.

Revenue treatment is in contravention of AASB 120 - Government grants revenue recognition requirements.

Grants related to income are government grants other than those related to assets. (NOTE:- R&D Asset purchases are not eligible for R&D Rebates and thus not rebated).

Para 17 - In most cases the periods over which an entity recognises the costs or expenses related to a government grant are readily ascertainable. Thus grants in recognition of specific expenses are recognised in profit or loss in the same period as the relevant expenses. Similarly, grants related to depreciable assets are usually recognised in profit or loss over the periods and in the proportions in which depreciation expense on those assets is recognised. (NOTE R&D Rebates are not made in relation to depreciable assets or otherwise because there is no requirement to capitalise R&D expenditure in order to receive R&D Rebates. The principle R&D rebate non-capital expenditure eligibility requirements are related to proof of technical risk and generation of new knowledge).

Para 20 - A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate financial support to the entity with no future related costs shall be recognised in profit or loss of the period in which it becomes receivable. (NOTE - Ditto note above).

Intangible Asset treatment is in contravention of AASB138 - Recognition and Reporting of Intangible Assets.

The matching principle is applied by ASSB138 to Intangible Assets using defined concepts of Amortisation, Depreciable Amount, Cost of Intangible Assets and Useful life.

• Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its useful life.

• Depreciable Amount is the Cost of an Intangible Asset or other amount substituted for cost, less its residual value.

• Cost of an Intangible Asset is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction, for, when applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other Australian Accounting Standards, e.g. AASB 2 Share-based Payment.

21 An intangible asset shall be recognised if, and only if:
(a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity, and,
(b) the cost of the asset can be measured reliably.
22 An entity shall assess the probability of expected future economic benefits using reasonable and supportable assumptions that represent management’s best estimate of the set of economic conditions that will exist over the useful life of the asset.
23 An entity uses judgement to assess the degree of certainty attached to the flow of future economic benefits that are attributable to the use of the asset on the basis of the evidence available at the time of initial recognition, giving greater weight to the external evidence.
24 An intangible asset shall be measured initially at cost. (Note – cost, not net cost after Govt revenue).
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65 The cost of internally generated intangible assets for the purpose of paragraph 24, is the sum of expenditure incurred from the date when the intangible assets first meet the recognition criteria in paragraphs 21, 22 and 57. Paragraph 71 prohibits reinstatement of expenditure previously recognised as an expense.
66 The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Examples of directly attributable costs are:
(a) costs of materials and services used or consumed in generating the intangible asset;
(b) costs of employee benefits (as defined in AASB 119) arising from the generation of the intangible asset;
(c) fees to register a legal right; and,
(d) amortisation of patents and licenses that are used to generate the intangible asset. AASB 123 specifies criteria for the recognition of interest as an element of the cost of an internally generated intangible asset.
67 The following are not components of the cost of an internally generated intangible asset:
(a) selling, administrative and other general overhead expenditure unless this expenditure can be directly attributed to preparing the asset for use;
(b) identified inefficiencies and initial operating losses incurred before the asset achieves planned performance, and,
(c) expenditure on training staff to operate the asset.

(NOTE: - AASB 138 has no requirement to offset methods or means of financing R&D activities when determining Intangible Asset costs)

Example

The current incorrect application by the Australian Accounting and Auditing profession of AASB120 and AASB138 with regard to financial reporting of R&D Rebates and Intangible assets is illustrated more clearly by the example of a 100% R&D rebate (currently 45%) and a start-up company creating AASB 138 compliant intangible assets valued at, say $1,000,000 and earning no commercial revenue in the year.

Currently, the Company's auditors would require the financial statements to report: -

a) Income statement reporting no revenue despite receiving a $1,000,000 R&D rebate from the Government in cash.
b) Balance Sheet reporting no Intangible Assets carried forward despite the Company creating an Intangible Asset worth $1,000,000 in compliance with AASB138 (i.e. not in compliance with the requirements of AASB 138).

If the Startup Company's financial statements reported the more accurate and truthful position showing results of operations comprising $1,000,000 R&D grant income on the Income Statement and Intangible Assets of $1,000,000 on the balance sheet, their accounts would be would be qualified by their auditors.

Conclusion

This treatment is contrary to GAAP and not in the interests of Australia’s drive to support and encourage intellectual property innovation and development. It is in need of urgent review.