(Editor’s Note. We have received numerous inquiries on what qualifies as research and development costs and what is the proper way to account for such costs. The diversity of costs related to research and product/service development, whether incurred in-house, expended by an affiliate or purchased outside, has led to a blurring of what is and is not R&D. Following cessation of limits on R&D costs audit scrutiny subsided but the government’s increased budgets for R&D, expansion of numerous federal programs affecting R&D expenditures (e.g. other transactions, SBIR’s, etc.) and the fact it is often a significant G&A cost has caused audit attention to recently increase. We thought it would be a good idea to review the basics of the cost principles, discuss allocation and review audit guidance. Whereas R&D and bid and proposal costs are usually lumped together in regulations (e.g. FAR, CAS 418) they are significantly different to warrant a separate treatment so we will discuss B&P costs in a separate article. Though we do not use any particular reference authority, we have relied on some of our favorite texts, Mathew Bender’s "Accounting for Government Contracts" for both Federal Acquisition Regulations and Cost Accounting Standards as well as the referenced DCAA Contract Audit Manual.)


Research and development includes basic and applied research, development and systems and other concept formulation studies. At the least practical level is basic research whose purpose is to increase scientific knowledge where emphasis is on obtaining a fuller understanding of a field rather than discovering practical applications. At the next level is applied research that seeks to exploit scientific gains or advance the state of the art but does not include efforts to design or develop actual products or services. Development refers to the use of scientific or technical knowledge to design and develop new products or services. Finally the systems and other concept formulation studies are analyses and study efforts either related to specific R&D projects or directed toward identifying desirable new or improved systems, equipment or components. R&D costs are sometimes confused with other categories of costs such as precontract costs (FAR 31.205-32), selling costs (FAR 31.205-38) and manufacturing and production engineering costs (FAR 31.205-25) and judgement and clear definitions within the company should be established if confusion is anticipated.

The regulations address distinct types of effort: (1) sponsored research and development (simply R&D) that is required in performing a contract or grant and (2) Independent research and development (IR&D) that includes the four types of effort described above. Each type has significantly different cost recovery rules. In addition there are technical efforts expended to support a bid or proposal and these are not considered bid and proposal costs not IR&D.

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