Accounting professionals began to take into account the capitalization of software development costs in 1985. Over 35 years ago the FASB issued Statement No. There was previously no specific guidance, but Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed now does. It should be noted that although general accounting guidelines for computer software were published, nothing specifically addressed internally developed software for sale.
Since the 1980s, both business and commerce have experienced rapid growth, as has the accounting profession. As our use of software has increased and the variety of software arrangements available has increased, several new rules pertaining to software have either been published or amended. The most recent version, ASC 350 Intangibles – Goodwill and Others, was first released in early 2015 and will take effect in 2016.
However, after the comment period and after the updated rules were put into effect throughout 2016, stakeholders asked for more clarification. ASC 350-40 was modified by the FASB in 2018 with internal use software in mind. For fiscal years beginning after December 15, 2019, as well as interim periods of public entities within those fiscal years, the revisions to ASC 350-40 are in force. Consequently, as of January 1, 2020, a public entity with a calendar year end adopted the revised ASC 350-40. The revised ASC 350-40 for non-public entities is applicable for annual reporting periods beginning after December 15, 2020.
Similar to FASB, state and local government software capitalization has a long history To ensure consistency in how organizations should account for intangible assets, GASB 51, Accounting and Financial Reporting for Intangible Assets, published in June 2007, provides a summary of rules regarding software capitalization. However, as technology advanced and software usage increased, more precise standards were needed. In 2020, therefore, GASB issued statement No. 96, Subscription-based IT Arrangements applicable to Software Services Contracts for Fiscal Years Commencing After June 15, 2022
Computer software was initially purchased on a floppy disk or diskette. The disk itself had little value, but the data or computer-coded instructions it contained might be considered an intangible asset. Even though software is no longer frequently sold on disks, there are still times when a business needs to buy “out-of-the-box” or “off-the-shelf” software. This phrase is used when the software purchased doesn’t require any modifications or improvements.
According to US GAAP, software that is bought by an entity and used right away is recorded on the balance sheet as an intangible asset at the purchase price and amortized over its economic or legal life, whichever is shorter. The economic life is the time frame during which an intangible asset contributes to an organization’s cash flows. The intangible asset’s contractual term is its legal life. The asset must be periodically evaluated for value impairment if it has an indefinite useful life and is not amortized.
Computer software is specifically mentioned in GASB 51 as an intangible asset that state and local governments own. Software is handled as a capital asset under this guidance, recorded on the statement of financial position at its purchase price, and amortized using a logical and systematic method over its useful life, or not amortized if its usefulness is determined to be indefinite.
More customization emerged as organizations grew accustomed to and more dependent on technology. A company now wanted software created for their specific needs in order to outperform rivals. Either an organization developed the software internally, or it purchased pre-made software to improve it and hired a vendor to customize it. In both instances, additional guidelines that allowed for the capitalization of some development costs were published. Additionally, as more businesses entered the technology sector, standards were also created to establish guidelines for the sale of internally developed software.
Under US GAAP, the capitalization rules for software that has been developed or purchased and is intended for internal use differ from those that apply to software that will be sold. In general, internal-use software implementation costs, or costs incurred after planning and design, are capitalizable, but ongoing maintenance costs are not. To explain further, costs related to:
Software developed for external use or for sale is given a slightly different accounting treatment. The guidance becomes more specific, but the capitalizable and non-capitalizable costs are still distinguished by when or where in the process they occur. Software development costs are not capitalized until they are deemed technologically feasible. Technological feasibility is determined after planning, designing, coding, and testing. The remaining development work for features and functionality, from both internal resources and third parties, can be capitalized if these initial steps result in a realistic product.
Software accounting under the GASB is handled differently than under US GAAP. Software intended for internal use is determined to be an intangible asset and is regarded as falling within the purview of GASB 51. However, GASB’s capitalization regulations for software costs are comparable to FASB’s. Costs associated with the application development phase of software creation may be capitalized under GASB 51. The stage of application development is viewed as coming after the product’s technological viability has been established but before maintenance and ongoing operation.
As an asset held by the government primarily for the purpose of profit, external-use software, or software developed for the market, is excluded from the scope of GASB 51 and should adhere to the investment guidance in GASB 72 Fair Value Measurement and Application. Investments under GASB 72 are generally measured at fair value.
Software and its use have changed more recently as a result of a trend toward cloud computing and software subscriptions. With these kinds of agreements, a company instead purchases a license or subscription to use the software for a predetermined amount of time rather than a specific piece of software. In addition, as technology advanced, licenses and subscriptions began to be made available online or in the cloud.
The release of FASB Subtopic ASC 350-40 Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contact (ASC 350-40) in 2018 is FASB’s response to this evolution. Certain implementation costs for cloud computing or hosting arrangements can now be capitalized in accordance with ASC 350-40. For more information on this accounting update, see our article ASC 350-40: Internal-Use Software Accounting & Capitalization.
In order to address accounting for IT services, GASB also released new guidance. GASB 96 Subscription-based Information Technology Arrangements (GASB 96) was released in 2020 and will be applicable to all reporting periods starting after June 15, 2022, for organizations. When an organization determines they have a SBITA that falls under the purview of GASB 96, they establish a subscription asset and subscription liability based on the total expected payments to be made over the subscription term. This is similar to how GASB 87 was written.
The accounting boards are updating the accounting treatment for software contracts in a similar manner to how they do with leases to increase consistency and transparency in financial reporting. Contrary to lease accounting, where a brand-new standard was released after forty years, accounting for technology has undergone a number of updates over the past few decades as entities’ adoption of different software has advanced.
Capitalized Software
Software capitalization terms
You may find the following definitions and terms useful in understanding the idea of software capitalization:
What is software capitalization?
The process of recognizing software as a type of fixed asset is known as software capitalization. Software intended for either internal or external use can be subject to this process. Business and financial team members list costs on the balance sheet to capitalize software and postpone full expense recognition. Companies can capitalize costs, then amortize or depreciate them after updating existing software or buying new software. This is referring to the recognition of costs over time as opposed to a one-time expense.
Costs can be straight-lined amortized or depreciated over the software asset’s estimated useful life, which can be between two and five years. Software development costs can be capitalized, which is advantageous because it enables company members to record lower expenses and higher net income in their books. This method of depreciating assets reduces a company’s taxable income and liability, giving investors a more appealing and accurate picture of the business’s true earnings.
When can you capitalize software?
When deciding whether to capitalize software costs or write them off as they are incurred, business leaders must weigh their own preferences against GAAP regulations. Capitalization typically starts after the initial phase of software development, when there is a reliable source of funding and a high probability that the project will materialize. It ends once a software project has been tested and finished. For the following facets of software development, you may capitalize costs:
Accounting guidelines for capitalizing software
Software capitalization is a type of accounting activity that is used to determine the asset value of a company. Every accounting procedure is governed by a number of rules established by the GAAP. Before beginning a project, it is a good idea to plan the accounting treatment by working with the project management team and subject-matter experts. This can guarantee that the company is completing the appropriate paperwork for capitalization and expense decisions. The application development stage for internal software and the technological feasibility stage for external software make up the main criteria for software capitalization. Here are the accounting guidelines for capitalizing software:
Software capitalization rules for internal-use software
Software designed for internal use within a company, as opposed to being made available to the general public, is referred to as internal-use software. In some circumstances, businesses may categorize this software as a tangible asset. Accounting, customer management, cash management, membership, and production automation systems are some examples of internal-use software. Depending on the stage of the project, the accounting treatment for internal-use software may change. All other costs are operational, so you can only capitalize costs that involve purchasing new software or enhancing an existing one. Heres an explanation of the various stages:
Software capitalization rules for external-use software
Unlike internal-use software, external-use software has different capitalization rules that can be more stringent. Tools that a business intends to sell, lease, or market to outside users are referred to as “external-use software.” Here are the stages of this process:
FAQ
Is software capitalized or expensed?
Accounting regulations permit businesses to capitalize software as if it were a tangible asset even though it is not physically present or tangible in the conventional sense. Software can be treated as property, plant, and equipment (PP&E) if it is purchased by a company that fits certain requirements.
How long is software capitalized?
174 to reduce the current tax liability, but for all tax years after 2021, software development costs must be capitalized with a 5-year useful life or a 15-year useful life for costs outside the U S.
Is software intangible capitalized?
Software that will be sold, leased, or otherwise marketed should generally be classified as an amortizable intangible asset, whether it was purchased or developed internally. If the software was bought from someone else and will be sold again, inventory classification may be appropriate.
Can software be a capital asset?
The most common type of intangible capital asset is computer software.
