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1 RESEARCH & DEVELOPMENT COSTS POLICY PERSPECTIVE Amounts spent on research and development are closely monitored by management and investors, especially in the data processing industry. This policy establishes standards of research and development financial accounting and reporting based upon the Financial Accounting Standards Board (FASB) Statement #2, "Accounting for Research and Development Costs," and FASB #86, "Accounting For the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed." The implementation of FAS 86 requires the capitalization of some software costs. The Company is accomplishing this at the Corporate level through input from the affected business units. POLICY Research and development costs are to be expensed when incurred. POLICY STATEMENTS 1. The definitions of "research" and "development" are as follows: Research -A planned search or critical investigation aimed at discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service or a new process or technique or in bringing about a significant r improvement to an existing product or process. Development -Translation of research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process whether intended for sale or use. It 1

2 includes the conceptual formulation, design, and testing of product alternatives, construction of prototypes, operation of pilot plants, and general application and basic software. It does not include routine or periodic alterations to existing products, production lines, manufacturing processes, and other ongoing operations even though those alterations may represent improvements and it does not include market research or market testing activities. Refer to the supplement to this policy for examples of activities that typically would (and would not) be included in research and development. 2. Cost elements associated with Research and Development activities include the following: - Equipment and Facilities -The cost of equipment and facilities that are acquired or constructed for research and development activities. - Personnel -Salaries, wages, and related costs of personnel engaged in research and development activities shall be included in research and development costs. - Intangibles -The costs of intangibles (patents, licenses) applicable to research and development activities shall be included in research and development costs. - Contract Services -The costs of services performed by others in connection with the research and development activities, including research and development conducted by others on behalf of the company, shall be included in research and development costs. - Overhead -Research and development costs shall include a reasonable allocation of overhead. However, general administrative costs (e.g., Corporate headquarters expense) that are not clearly related to research and development activities should not be included in research and development costs. 2

3 3. Equipment and facilities that have alternative future uses (in research and development projects or otherwise) are to be capitalized as intangible assets when acquired or constructed. The depreciation of such equipment or facilities used in those activities are research and development costs. The following are examples of what type of equipment is to be capitalized. - General purpose laboratory equipment and instrumentation (scopes, meters, etc.). - Items from current company product lines that are to be used without major modification for testing new features or peripherals. - General purpose mini-computers. - EDP peripherals which have general application within the R&D organization, or which can be returned to the rental pool within two-three years. 4. Equipment and facilities that are acquired or constructed for a particular research and development project and which have no alternative future uses (in other research and development projects or otherwise) are research and development costs when incurred. The following are examples of the type of equipment that is charged to R&D expense immediately and not capitalized: - Items from current company product lines which will be modified to the extent that reversal of the modification is impractical and alternative uses beyond the specific R&D project are not foreseen. - Product test equipment designed for evaluation of a particular R&D project. Software 5. Systems Software and General Application Software are defined as follows: 3

4 - Systems Software -The software which provides basic executive function, system control, data manipulation capability and management of input/output peripheral functions. Also included in this category are: firmware (microcode) residing in processing elements other than the main memory of the machine, special diagnostic software for use in equipment repair and maintenance, and compilers and utilities. - General Application Software -The software which enables a machine to perform a particular application through system generation, parameterization, customization, or user programming. 6. Development costs of Systems Software and General Application Software to be sold or provided to the company customers are R&D expenses. However, the software offerings must have general applicability to multiple customers across or within a definite vocation or market area, and therefore be planned for general release and availability. Included as R&D are the following: - The cost of Systems Software and General Application Software development that is subcontracted to outside vendors. The company must be at least partially responsible for the product development process and contribute to specification and design control. - Outside software packages purchased for use as development tools. 7. Costs incurred after all planning, designing, coding, and testing is completed (technical feasibility) under General Customer Availability will be capitalized at the Corporate level as software production costs. See the policy on Software Development Costs Reporting for further details on capitalization requirements. 8. Software Maintenance costs, when undertaken in support of a software product that has reached General Customer Availability status (when Customer Verification Testing is complete), are not R&D expense. Software 4

5 Maintenance activities are patches, bug fixes, or minor corrective repairs to the software product. 9. The costs of enhancements to a software product which result in a subsequent Base Release (significant improvements, or the addition of new functions to an existing Base Release) are to be classified as R&D expense. 10. Marketing units frequently incur R&D expenses in the development of application software. If the software is developed for more than a single or narrow base of customers, then the expenses, for corporate external reporting, are R&D expenses. Thus, as defined in this policy, the dollar amounts associated with application software development for a broad base of customers in a marketing unit should be reported as tactical R&D. The reported amount should exclude software maintenance efforts and any OEM license fees. 11. The following software costs are excluded from Research and Development costs: - The development of specific Application Software which is not intended for general release and customer availability but rather for a specific customer and/or for a relatively narrow base of specific customers. - OEM license fees related to application software development. - The customization of General Application Software for a specific customer and/or for a relatively narrow base of specific customers. - The ongoing maintenance (centralized or in-field) of all software. Maintenance is the correction of covert errors and correction of omissions of minor features to software once in a general delivery status. 5

6 Technical Publications 12. Technical publications costs are to be classified as R&D expense when performed as a parallel effort to, and are an integral part of the product development process. 13. Technical publication costs are the costs associated with the planning, developing, researching, writing, testing, and maintaining the product documentation required by the company customers, the Customer Services Division, system analysts, and the sales force. 14. Technical publications costs in support of software maintenance are excluded from Research and Development costs. Plant Maintainability 15. Plant Maintainability costs are those costs associated with the planning, developing, researching, and implementing a product service methodology. Plant Maintainability Specialists function as marketing's representative to ensure the company products are maintainable, with input to the development process and by planning for maintenance activities. Also, Plant Maintainability Specialists solve problems that the field is experiencing in servicing installed customer equipment. Examples of Plant Maintainability activities would include preparation of the: service philosophy, site preparation, modification philosophy, documentation requirements, diagnostic requirements, spare part requirements, Field Support philosophy, Field Follow Plan, as well as ensuring that the overall technical and operational considerations are appropriately addressed in the product development process. 16. Costs associated with the following Plant Maintainability activities should be reported as R&D. This requirement applies to U.S. only. 6

7 - Those efforts that establish serviceability and maintainability requirements. - Those efforts that contribute towards the development of service philosophy. - Those efforts related to the development of the Field Engineering Diagnostics Requirement (FEDR). - Those efforts that ensure that the FEDR requirements are being incorporated into the development of the product. - Those efforts that significantly revise an existing FEDR. - Those efforts related to the development and initial issuance of the Service Aid Mini-Manual (SAMM). - Those efforts related to assisting plants in vendor selection and qualification. 17. Plant Maintainability costs associated with the following activities should be excluded from R&D: - Routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of an existing FEDR. - Those efforts associated with direct field support. - Those efforts related to training customer or company personnel - Routine revisions to the Service Aid Mini-Manual (SAMM). - Assisting plant personnel with existing product cost reduction activities. - Efforts related to assisting marketing with vendor selection and qualification. Course Development 18. These costs are associated with the product-related development of course requirements, content, and materials. Course Development activities begin with approval of the Product Business Plan, at the start of the product development process. 7

8 19. Course Development costs are classified as R&D expense when they are incurred as a parallel effort to and are an integral part of the product development process. 20. Technical Publication costs incurred in support of Course Development should be classified as R&D expense. Advanced Manufacturing Engineering 21. Advanced Manufacturing Engineering costs are those costs associated with the planning, developing, researching, and initial implementation of advanced manufacturing tools, products, or processes whether intended for sale or use. Examples of advanced manufacturing engineering would include: design and development of flexible automation tools and systems including robotics and "smart carts"; surface mounted devices technology investigation and implementation; manufacturing operations productivity tools such as CAE/CAM for cabinet design and construction; investigation of new or improved material and/or information handling techniques such as distributed shop floor controls. 22. Advanced Manufacturing Engineering costs are to be classified as R&D Costs when the following events occur as a result of those costs: - Significant modification of the formulation or design of a tool, product, or process. - Design of tools or molds involving new technology. 23. Advanced Manufacturing engineering costs that should be excluded from R&D Costs are: - Routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of an existing product or process. - Routine changes in design of tools, molds, models, and dies. 8

9 Continuation Engineering 24. Engineering efforts which are undertaken subsequent to completion of the first production unit are Continuation Engineering. Examples of this are: - Engineering support of the manufacturing process. - Cost reduction efforts. 25. Expenditures for Continuation Engineering are not Research and Development. However, under certain circumstances costs incurred after completion of the first production unit may be R&D expense. Engineering costs which are required to bring the product up to its original specifications (performance, cost, or quality objections) are R&D expense, if incurred within 12 months of the first production unit. Product Management 26. Product Management activities are classified as R&D expense, when incurred as an integral part of the product development process. The efforts of Product Management are directed at evaluating, planning, and developing new products. The following are examples of Product Management's R&D activities: - Definition of a product's functional requirements. - Formulation of product development programs. - Management of product cost/benefit decisions. Pre-production Models 27. The following definitions apply to pre-production models: - "A test: R&D test of product feasibility. - B test: R&D test to evaluate a product's design characteristics relative to its original specifications. - C test: Quality Assurance test of product manufacturability. 9

10 - C models: Unit(s) produced after the C" test--the initial serialized production unit(s). - Pre-production models: AII units produced prior to the first C" model. - Actual cost of pre-production models: Actual cost of materials and labor, plus the applied burden associated with building the models. 28. The actual cost of pre-production models used for "A or e test is to be charged to R&D expense. The actual cost of all other pre-production models is to be expensed as Supplies and Indirect Materials. The functional operation in which the unit is utilized determines the applicable Financial Category. 29. C" models which are retained for internal use are to be accounted for as regular production units. POLICY SUPPLEMENT The following are examples of activities that typically would be included in research and development : - 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. - Design, construction, and testing of pre-production prototypes and models. - Design of tools, jigs, molds, and dies involving new technology. - Design, construction, and operation of a pilot plant that is not of a scale economically feasible to the Corporation for commercial production. 10

11 - Engineering activity required to advance the design of a product to the point that it meets specific functional and economic requirements and is ready for manufacture. - Development of Systems Software (including Firmware) and General Application Software. - Drafting product specifications for development engineers (publications activity occurring before the development stage of a product is completed). - Technical Publications which are developed as a parallel/integral effort to the product development process. - Course Development costs incurred parallel to, and an integral part of the product development process. The following are examples of activities that would be excluded from research and development in accordance with Company policy: - Engineering follow-through in an early phase of commercial product. - Quality control during commercial production including routing testing of products. - Trouble-shooting in connection with break-downs during commercial production. - Routine, ongoing efforts to refine, enrich, or otherwise improve upon the qualities of an existing product. - Adaptation of an existing capability to a particular requirement or customer's need as part of a continuing commercial activity. - Seasonal or other periodic design changes to existing products. - Routine design of tools, jigs, models, and dies. - Activity, including design and construction engineering, related to the construction, relocation, rearrangement, or start-up of facilities or equipment other than pilot plants and facilities or equipment whose sole use is for a particular research and development project. 11

12 - Legal work in connection with patent applications or litigation and the sale or licensing of patents. 12