FRS 105 and development costs

A micro entity applying FRS 105 must write off all research and development spending as an expense when it is incurred, because paragraph 13.4 bans recognising any internally generated intangible asset. If the company previously capitalised development costs under FRS 102, those balances are removed on transition, with the adjustment taken to reserves at the date of transition rather than through the current year’s profit.

What does FRS 105 actually say about development costs?

Section 13 of FRS 105 deals with intangible assets other than goodwill and draws a hard line between two kinds. A micro entity must recognise all separately acquired intangible assets (paragraph 13.3). By contrast, an internally generated intangible shall not be recognised as an asset, and all expenditure incurred must be recognised as an expense immediately in profit or loss (paragraph 13.4).

Paragraph 13.5 then lists items that must be expensed and never recognised as intangible assets. The first item is expenditure on research and development activities. The list continues with internally generated brands, logos, publishing titles and customer lists, start up and pre opening costs, training, advertising and promotion, relocation or reorganisation, and internally generated goodwill. The list is expressly not exhaustive.

The glossary defines development as the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Under FRS 105 the label hardly affects the outcome: research and development spending is expensed either way.

Why does FRS 105 not allow capitalisation when FRS 102 does?

FRS 102 gives an option. An entity may capitalise development expenditure that meets the conditions in paragraph 18.8H, and if it chooses that policy it must apply it consistently to all qualifying expenditure, expensing everything else (paragraph 18.8K). For more on that option, see capitalising development costs under FRS 102.

The FRC deliberately removed the option for micro entities. Its Basis for Conclusions explains that accounting policy options would add complexity for preparers and could confuse users, given how little detail micro entity accounts and notes contain, so FRS 105 contains no policy options except on first time adoption and in all cases mandates the most straightforward option (paragraph 17). Paragraph 19(f) records the specific decision: all borrowing and development costs must be expensed, because this is the simplest treatment for these costs. There is no route around this within FRS 105; a company that wants to carry development costs on its balance sheet needs to prepare its accounts under FRS 102 instead. The wider differences are set out in FRS 105 compared with Section 1A.

Which intangible assets can a micro entity still recognise?

Separately acquired intangibles remain on the balance sheet. A purchased software licence, a bought in patent or a domain name acquired from a third party is recognised at cost, being its purchase price plus directly attributable costs of preparing it for use (paragraph 13.6). It is then carried at cost less amortisation and impairment (paragraph 13.8). Every intangible is treated as having a finite useful life, and where that life cannot be reliably estimated it may not exceed ten years (paragraphs 13.9 and 13.10).

Two further restrictions catch people out. Intangible assets acquired in a trade and asset purchase are not separately identified; they are subsumed within goodwill (paragraph 14.1(a)). And FRS 105 does not define separately acquired, so where outside developers build the company’s own product or platform, consider whether the company has bought a finished asset or is simply funding its own development activity, which paragraph 13.5(a) requires to be expensed. Website costs raise similar questions, covered in website and software development costs.

What happens to development costs capitalised before switching to FRS 105?

Section 28 governs the move. A company whose last accounts were prepared under FRS 102 is a first time adopter (paragraph 28.4(b)). Its date of transition is the beginning of the earliest period presented with full comparatives (paragraph 28.6). In its opening balance sheet at that date it must not recognise items as assets if FRS 105 does not permit them (paragraph 28.7(b)). Capitalised development costs fall squarely within that rule, and none of the optional exemptions in paragraph 28.10 preserves them.

The adjustment arises from transactions before the date of transition, so it is recognised directly in equity reserves at that date (paragraph 28.8). The comparative year is then restated as if FRS 105 had always applied: any amortisation charged on the old asset is reversed, and any development spending capitalised in the comparative year is expensed instead.

Worked example

Illustration only. A company with a 31 December year end moves from FRS 102 Section 1A to FRS 105 for 2026. Its date of transition is 1 January 2025. Under FRS 102 it carried development costs of £60,000 at that date, charged £12,000 of amortisation in 2025 and capitalised a further £20,000 of 2025 spending.

Step	Effect
Opening balance sheet at 1 January 2025	Remove £60,000 asset; reduce retained earnings by £60,000
Restated 2025 profit and loss	Reverse £12,000 amortisation; expense £20,000 development spend; net reduction of £8,000
2026 onwards	All research and development spending expensed as incurred

The current year profit is not hit by the £60,000 write off. A common error is to run the whole balance through the 2026 profit and loss account as a one time charge.

Does the write off reduce distributable profits?

Often not by much. Section 844 of the Companies Act 2006 already treats any development costs shown as an asset as a realised loss when calculating profits available for distribution. The exception, in section 844(3), applies only where there are special circumstances justifying a different decision by the directors and the accounts note says so and explains why. Where a company had not used that exception, its distributable reserves were already reduced by the capitalised amount, so removing the asset on transition largely aligns the accounts with a position company law had already imposed.

How does the tax position work?

Revenue research and development spending is not denied a deduction just because it was capitalised in the accounts; section 1308 of the Corporation Tax Act 2009 allows it, and the same applies for the R&D relief rules in Part 13. Where that deduction was taken, section 1308(5) prevents any further deduction for writing down the part of the asset attributable to that expenditure, and section 1308(6) blocks a second deduction for expenditure already deducted in an earlier period. So a transition write off of costs already relieved gives no extra tax deduction. Check the history of each balance before preparing the computation. For the relief schemes themselves, see research and development tax relief.

What mistakes should preparers avoid?

• Carrying forward an FRS 102 development asset into FRS 105 accounts because the figure was already in the trial balance.
• Writing off the transition balance through current year profit instead of opening reserves at the date of transition.
• Capitalising staff time on an internal software or product project on the basis that contractors were also involved.
• Claiming a second tax deduction for development costs that were deducted when incurred.
• Choosing FRS 105 without weighing the effect on a company whose balance sheet strength depends on capitalised development; moving back later is covered in moving from FRS 105 to FRS 102.

Solar Protect provides tax investigation insurance for businesses and fee protection schemes for accountancy practices. Read how our cover works or get a quote.

Related Accountapedia entries

• Capitalising development costs under FRS 102
• Moving from FRS 105 to FRS 102
• Accounting for website and software development costs
• FRS 105 and micro entity accounts
• Government grants under FRS 105

Sources

• Financial Reporting Council: FRS 105 September 2024
• Financial Reporting Council: FRS 102 September 2024 tmKYWO6
• legislation.gov.uk: Act 2006 c. 46, section 844
• legislation.gov.uk: Act 2009 c. 4, section 1308

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.