When an asset purchased for R&D activities has an alternative future use, its cost should be capitalized. The depreciation on the asset is then allocated to R&D expense for the periods it is used in R&D. The annual straight-line depreciation is calculated as (Cost - Salvage Value) / Useful Life. In this case, it is ($500,000 - $50,000) / 5 years = $90,000 per year. This amount is the R&D expense for Year 1.

For software to be sold, leased, or otherwise marketed, all costs incurred to establish technological feasibility are considered research and development costs. Therefore, they must be expensed as incurred. Capitalization of software development costs begins only after technological feasibility has been established.

Costs incurred after technological feasibility has been established but before the product is available for general release to customers should be capitalized. This includes coding and testing after feasibility ($200,000) and the production of product masters ($30,000). The total amount to be capitalized is $200,000 + $30,000 = $230,000. Costs incurred before technological feasibility ($50,000 + $120,000) must be expensed as R&D.

When R&D is acquired in a transaction other than a business combination (i.e., an asset acquisition), the treatment depends on whether the assets have an alternative future use. If, as in this case, there is no alternative future use, the entire cost must be expensed immediately as research and development expense.

Under U.S. GAAP, all internal R&D costs ($500,000) incurred to develop a product or process must be expensed as incurred. However, the legal fees and other direct costs associated with securing a patent ($35,000) are capitalized as an intangible asset (the patent) and amortized over its legal or useful life, whichever is shorter.

ASC 730 explicitly excludes routine or periodic alterations to existing products, production lines, manufacturing processes, and other on-going operations from the definition of R&D. The other three options (conceptual formulation, prototype design/testing, and laboratory research) are core examples of activities that are included in R&D.

Amortization of capitalized software costs is the greater of the amount computed by (1) the straight-line method or (2) the ratio of current gross revenues to total anticipated gross revenues.

1. Straight-line: $600,000 / 5 years = $120,000.
2. Revenue ratio: ($200,000 current revenue / $1,000,000 total anticipated revenue) * $600,000 = 0.20 * $600,000 = $120,000. Since both methods result in $120,000, the amortization expense is $120,000.

According to ASC 985-20, technological feasibility is established upon completion of a detailed program design or, in its absence, completion of a working model that has been tested to be consistent with the product's design specifications. The other options represent activities that occur either before (business plan) or after (beta testing) the point of technological feasibility.

Capitalized software costs are tested for impairment by comparing the carrying amount to the net realizable value (NRV). NRV is the estimated future net cash flows from the product. Since the carrying amount ($800,000) exceeds the NRV ($500,000), an impairment loss of $300,000 ($800,000 - $500,000) must be recognized. The entry is: Debit Impairment Loss $300,000; Credit Capitalized Software Costs $300,000.

Costs incurred during the start-up of commercial production are explicitly excluded from the definition of research and development. These costs, such as troubleshooting production issues, are considered normal operating expenses (either manufacturing overhead or a period cost) and should be expensed as incurred.