LuluZPharma Inc DRAFT For Discussion Purposes Only Memorandum To LuluZPharma Inc Accounting Files From Researcher Date 12 4 2023 Re Accounting for Research and Development Facts (Background) LuluZPharma Inc , a pharmaceutical company, has been developing a new drug, ShefaAlQalb, which promises to revolutionize the treatment of chronic heart conditions The drug is in the final stages of clinical trials and has shown promising results LuluZPharma Inc has been capitalizing on all the costs associated with the research and development (R D) of ShefaAlQalb These costs include labor, materials, and a proportion of overheads The total capitalized amount as of the end of the financial year is $44 5 million LuluZPharma Inc expects to receive FDA approval within the next fiscal year and has started to prepare its marketing and distribution channels Issue(s) Is LuluZPharma Inc 's treatment of the $44 5 million costs of developing ShefaAlQalb in line with ASC 730 Analysis The Financial Accounting Standards Board (FASB) Codification topic relevant to this scenario is ASC 730, Research and Development First, we need to identify if LuluZPharma Inc activities qualify as R D The relevant codification for this scenario is ASC 730 10 As stated, the following elements and activities are included within R D 25 2 Elements of costs shall be identified with research and development activities as follows (see Subtopic 350 50 for guidance related to website development) Materials, equipment, and facilities The costs of materials (whether from the entity's normal inventory or acquired specially for research and development activities) and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses (in research and development projects or otherwise) shall be capitalized as tangible assets when acquired or constructed The cost of such materials consumed in research and development activities and the depreciation of such equipment or facilities used in those activities are research and development costs However, the costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred See Topic 360 for guidance Personnel Salaries, wages, and other related costs of personnel engaged in research and development activities shall be included in research and development costs 55 1 The following activities typically would be considered research and development within the scope of this Topic Laboratory research aimed at discovery of new knowledge Searching for applications of new research findings or other knowledge Conceptual formulation and design of possible product or process alternatives Testing in search for or evaluation of product or process alternatives Modification of the formulation or design of a product or process According to ASC 730 10 25 and ASC 730 10 55, expenses related to purchasing or building materials, equipment, and facilities for research and development tasks, which can be utilized for other purposes in the future can be capitalized However, activities associated with developing ShefaAlQalb are considered within the scope of research and development Costs incurred in research and development activities should be expensed as they are incurred Costs that have been capitalized should be reviewed for impairment and, if applicable, expensed Conclusion LuluZPharma Inc 's approach to capitalizing on the costs related to the development of ShefaAlQalb is not in line with the guidance provided in ASC 730 For compliance with the FASB Codification, LuluZPharma Inc should revise its financial statements to expense the R D costs associated with the development of ShefaAlQalb This adjustment would result in a decrease in assets (due to the removal of capitalized costs) and an increase in expenses, which would reduce net income for the period This adjustment will ensure their financial reporting aligns with the US GAAP standards per ASC 730 Financial Statement and Disclosure Impacts LuluZPharma Inc will need to reflect the expense of previously capitalized R D costs as follows DR R D Expenses $ xx,xxx,xxx CR Capitalized R D Costs $ xx,xxx,xxx LuluZPharma Inc 's should also ensure adequate disclosure of its R D activities, including the nature of the costs incurred and the accounting policy adopted, in the notes to its financial statements Question Provide a high level summary of (1) the accounting issues, (2) the areas of subjectivity, and (3) the key guidance that helped you arrive at your conclusion

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LuluZPharma Inc. DRAFT - For Discussion Purposes Only Memorandum To: LuluZPharma Inc. Accounting Files From: Researcher Date: 12/4/2023 Re: Accounting for Research and Development Facts

LuluZPharma Inc.

DRAFT - For Discussion Purposes Only

Memorandum

To: LuluZPharma Inc. Accounting Files

From: Researcher

Date: 12/4/2023

Re: Accounting for Research and Development

Facts (Background)

LuluZPharma Inc., a pharmaceutical company, has been developing a new drug, ShefaAlQalb, which promises to revolutionize the treatment of chronic heart conditions. The drug is in the final stages of clinical trials and has shown promising results.

LuluZPharma Inc. has been capitalizing on all the costs associated with the research and development (R&D) of ShefaAlQalb. These costs include labor, materials, and a proportion of overheads. The total capitalized amount as of the end of the financial year is $44.5 million. LuluZPharma Inc. expects to receive FDA approval within the next fiscal year and has started to prepare its marketing and distribution channels.

Issue(s):

Is LuluZPharma Inc.'s treatment of the $44.5 million costs of developing ShefaAlQalb in line with ASC 730?

Analysis

The Financial Accounting Standards Board (FASB) Codification topic relevant to this scenario is ASC 730, Research and Development. First, we need to identify if LuluZPharma Inc. activities qualify as R&D. The relevant codification for this scenario is ASC 730- 10. As stated, the following elements and activities are included within R&D:

25-2 "Elements of costs shall be identified with research and development activities as follows (see Subtopic 350-50 for guidance related to website development):

Materials, equipment, and facilities. The costs of materials (whether from the entity's normal inventory or acquired specially for research and development activities) and equipment or facilities that are acquired or constructed for research and development activities and that have alternative future uses (in research and development projects or otherwise) shall be capitalized as tangible assets when acquired or constructed. The cost of such materials consumed in research and development activities and the depreciation of such equipment or facilities used in those activities are research and development costs. However, the costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred. See Topic 360 for guidance.
Personnel. Salaries, wages, and other related costs of personnel engaged in research and development activities shall be included in research and development costs . . .."

55-1 "The following activities typically would be considered research and development within the scope of this Topic:

Laboratory research aimed at discovery of new knowledge
Searching for applications of new research findings or other knowledge
Conceptual formulation and design of possible product or process alternatives
Testing in search for or evaluation of product or process alternatives
Modification of the formulation or design of a product or process . . .."

According to ASC 730-10-25 and ASC 730-10-55, expenses related to purchasing or building materials, equipment, and facilities for research and development tasks, which can be utilized for other purposes in the future can be capitalized. However, activities associated with developing ShefaAlQalb are considered within the scope of research and development. Costs incurred in research and development activities should be expensed as they are incurred. Costs that have been capitalized should be reviewed for impairment and, if applicable, expensed.

Conclusion

LuluZPharma Inc.'s approach to capitalizing on the costs related to the development of ShefaAlQalb is not in line with the guidance provided in ASC 730. For compliance with the FASB Codification, LuluZPharma Inc. should revise its financial statements to expense the R&D costs associated with the development of ShefaAlQalb. This adjustment would result in a decrease in assets (due to the removal of capitalized costs) and an increase in expenses, which would reduce net income for the period. This adjustment will ensure their financial reporting aligns with the US GAAP standards per ASC 730.

Financial Statement and Disclosure Impacts

LuluZPharma Inc. will need to reflect the expense of previously capitalized R&D costs as follows:

DR. R&D Expenses $ xx,xxx,xxx

CR. Capitalized R&D Costs $ xx,xxx,xxx

LuluZPharma Inc.'s should also ensure adequate disclosure of its R&D activities, including the nature of the costs incurred and the accounting policy adopted, in the notes to its financial statements.

Question:

Provide a high-level summary of (1) the accounting issues, (2) the areas of subjectivity, and (3) the key guidance that helped you arrive at your conclusion.