Thomas Plastics is in the process of developing a revolutionary new plastic valve. A new division of the company was formed to develop, manufacture, and market this new product. As of year-end (December 31, 2011), the new product has not been manufactured for sale; however, prototype units were built and are in operation.

Throughout 2011, the new division incurred a variety of costs. These costs included expenses (including salaries of administrative personnel) and market research costs. In addition, approximately $500,000 in equipment (estimated useful life of 10 years) was purchased for use in developing and manufacturing the new valve. Approximately $200,000 of this equipment was built specifically for developing the design of the new product; the remaining $300,000 of the equipment was used to manufacture the preproduction prototypes and will be used to manufacture the new product once it is in commercial production.

The president of the company, Sally Rogers, has been told that research and development costs must be expensed as incurred, but she does not understand this treatment. She believes the research will lead to a profitable product and to increased future revenues. Also, she wonders how to account for the $500,000 of equipment purchased by the new division. “I thought I understood accounting,” she growled. “Explain to me why expenditures that benefit our future revenues are expensed rather than capitalized!”

Required:

Write a one-to two-page report to Sally Rogers explaining the generally accepted accounting principles relevant to this issue. The report should also address the treatment of the equipment purchases.