R&D and development costs: getting capitalisation right before listing

For technology, pharmaceutical and engineering companies, research and development is often the largest discretionary cost. How it is accounted for, as an expense or as an asset, has a direct effect on reported profit. In a private company that choice rarely attracts attention. In an IPO it attracts a great deal, because it affects the very figures that decide eligibility.

Why capitalisation matters more before a listing

It moves EBITDA. SEBI now requires an SME issuer to have EBITDA of at least ₹1 crore from operations in two of the three preceding financial years. Development costs that are capitalised leave the profit and loss account and return later as amortisation, which sits below EBITDA. A company that capitalises aggressively can report a higher EBITDA than one that expenses the same spend. Examining auditors and merchant bankers know this, and a capitalisation policy that looks designed to clear a threshold will be tested hard.

It does not help tangible assets. BSE SME requires net tangible assets of at least ₹3 crore. Capitalised development is an intangible asset and does not count.

It does not change cash flow. Money spent on development leaves the bank either way. NSE Emerge’s free cash flow to equity test is based on cash flows, so capitalisation cannot improve it.

It must be consistent across three years. The restated financial information applies the same accounting policies to every year presented. If the policy changed during the period, or was applied loosely, the restatement adjusts the earlier years, and the eligibility figures change with it.

Which accounting standard applies

The Companies (Indian Accounting Standards) Rules, 2015 do not require companies listed, or in the process of listing, on an SME exchange to adopt Ind AS. Most SME issuers therefore follow AS 26, Intangible Assets, under the Companies (Accounting Standards) Rules, 2021. A company that already follows Ind AS, for example because it adopted it voluntarily, applies Ind AS 38 instead. The principles for internally generated intangibles are closely aligned; the main differences are noted below.

Research is always an expense

Both standards divide an internal project into a research phase and a development phase. Research is original investigation aimed at gaining new knowledge, such as searching for alternative materials, testing formulations or exploring possible product designs. Research costs are always expensed.

If a company cannot distinguish the research phase from the development phase of a project, the whole project is treated as research. Poor record-keeping therefore leads directly to expensing.

When development costs can be capitalised

Development is the application of research to a plan for new or substantially improved products, processes or systems before commercial production or use, such as designing and testing pre-production prototypes or building a pilot plant. Development costs are capitalised only if the company can demonstrate all six of the following:

1. technical feasibility of completing the asset so that it will be available for use or sale;
2. its intention to complete the asset and use or sell it;
3. its ability to use or sell the asset;
4. how the asset will generate probable future economic benefits, for example a market for its output or its usefulness internally;
5. adequate technical, financial and other resources to complete development;
6. its ability to measure the expenditure attributable to the asset reliably.

Capitalisation starts only from the date all six are met. Costs expensed before that date cannot later be reinstated as part of the asset. Only directly attributable costs qualify, such as salaries of staff working on the project, materials and services consumed; general overheads, training and selling costs do not.

Internally generated brands, customer lists and similar items cannot be capitalised under either standard.

After capitalisation

Amortisation begins when the asset is available for use. Under AS 26 there is a rebuttable presumption that the useful life does not exceed ten years from that date. Ind AS 38 has no such presumption and allows an indefinite useful life in limited cases. Under both, an intangible asset that is not yet available for use must be tested for impairment at least annually, which is where long-running development projects in the balance sheet tend to be written down.

How this plays out by sector

Healthcare and life sciences

Regulatory approval is the dominant uncertainty. Until approval is obtained or reasonably assured, it is often difficult to demonstrate technical feasibility and probable economic benefits, and many companies therefore expense development costs up to that point. Whatever the policy, it has to be applied consistently across products and years, supported by documentation of the stage each product had reached.

Technology and SaaS

The line to draw is between new functionality that meets the six criteria and routine work that does not, such as maintenance, bug fixes and minor enhancements. Credible capitalisation depends on project-level time records for engineers, a written feasibility assessment at the point capitalisation starts, and a clear date when each module went live. Costs of configuring or customising software the company does not control, such as a third-party cloud application, generally do not create an asset of the company.

Manufacturing and engineering

Process development, prototypes and pilot plants can qualify, but initial operating losses and costs incurred while ramping up to normal production levels are expenses. Tooling and equipment used in development are property, plant and equipment rather than intangibles, and depreciation on them can form part of development cost.

What diligence will ask for

• the written capitalisation policy and the date it was adopted;
• a project-wise schedule of amounts capitalised and expensed in each of the three years;
• evidence for the six criteria at the start date of each capitalised project;
• time records and cost allocation workings;
• impairment assessments for projects still under development;
• a reconciliation of the tax treatment, which follows its own rules and usually gives rise to deferred tax.

What to do now

If you plan to list within the next two to three years, review your policy against the standard now, apply it consistently from the earliest year that will be restated, and start keeping the records an examiner will want. If past capitalisation does not meet the criteria, it is better to correct it before the restatement than to have the examining auditor adjust it, particularly if the correction changes whether you meet the EBITDA test.

This article is general information on accounting standards and regulations as understood in September 2026 and is not advice on any specific situation. Confirm the current position and the standards applicable to your company before acting.