The following decision tree depicts the logic behind deciding whether the costs should be capitalized or expensed related to both new software development and upgrades:. Once the software is put into service, all capitalized costs related to internal use software are amortized over the estimated useful life of the software, which is typically 3 — 5 years. For any questions on the stages of internal use software development, please contact Danielle Meyer at dmeyer aronsonllc. Please submit your questions using the form below.
We look forward to connecting soon. Main: Costs of developing or modifying internal-use computer software significantly exceed the amount originally expected to develop or modify the software.
When it is no longer probable that computer software being developed will be completed and placed in service, the asset shall be reported at the lower of the carrying amount or fair value, if any, less costs to sell.
The rebuttable presumption is that such uncompleted software has a fair value of zero. Indications that the software may no longer be expected to be completed and placed in service include the following: a. A lack of expenditures budgeted or incurred for the project. Programming difficulties that cannot be resolved on a timely basis. Significant cost overruns. Information has been obtained indicating that the costs of internally developed software will significantly exceed the cost of comparable third-party software or software products, so that management intends to obtain the third-party software or software products instead of completing the internally developed software.
Technologies are introduced in the marketplace, so that management intends to obtain the third-party software or software products instead of completing the internally developed software. Business segment or unit to which the software relates is unprofitable or has been or will be discontinued. All rights reserved.
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Your go-to resource for timely and relevant accounting, auditing, reporting and business insights. Follow along as we demonstrate how to use the site. My favorites. You haven't set any favorites so far. View all favorites. Add to favorites. Favorited Content. ASC provides the guidance for software developed or obtained for internal use. The cost guidance in ASC is similar to the cost guidance for other long-lived assets with respect to what costs are capitalized and how the costs are subsequently amortized and tested for impairment.
A software license purchased for internal use should be accounted for as an asset for the acquisition of an intangible and a liability, to the extent any or all of the software licensing fees are still outstanding on the acquisition date of the license. See BCG 8. If a reporting entity is developing, modifying, or implementing software for internal use, the assessment of whether costs should be expensed or capitalized depends on the project stage during which the costs are incurred.
The guidance describes the development of internal-use software as having three stages:. Only costs incurred during the application development stage are eligible for capitalization. When the software development process does not follow the same order as outlined above, reporting entities should apply the guidance in ASC based on the nature of the costs incurred. For example, an agile or iterative software development approach may not have the distinct project stages contemplated in ASC In that case, the reporting entity should apply judgment to categorize costs based on the activities being performed e.
See PPE 7. For guidance on the presentation and disclosure of software developed or obtained for internal use, see FSP 8. The first stage of development described in ASC is the preliminary project stage. Definition from ASC Master Glossary Preliminary Project Stage: When a computer software project is in the preliminary project stage, entities will likely do the following:.
These costs are generally incurred in the early stages of a project, when the reporting entity is exploring its technological needs and exploring various alternatives. Internal and external costs incurred during the preliminary project stage should be expensed as incurred.
Once the preliminary project phase has been completed, the next stage of development described in ASC is the application development stage. This stage is the period between when the preliminary project phase ends once the specifics of the software have been decided and the software is being developed and prior to the software being completed and ready for its intended use. The following activities are considered to be within the application development stage:.
During this stage, some costs should be capitalized while other costs should be expensed as incurred. ASC specifies the types of costs that can be capitalized. ASC Costs of computer software developed or obtained for internal-use that shall be capitalized include only the following:. Examples of those costs include but are not limited to the following:. Fees paid to third parties for services provided to develop the software during the application development stage.
Costs incurred to obtain computer software from third parties. The following types of costs are expensed as incurred, even during the application development stage:. If the reporting entity suspends substantially all of the software development activities, interest capitalization should cease until activities are resumed. In summary, costs that are directly correlated to the actual development of the software application should be capitalized, while indirect costs related to the software development e.
Capitalization of qualifying costs during the application development stage should begin when both of the following occur:. Capitalization should cease no later than the point at which a software project is substantially completed and ready for its intended use. Software is ready for its intended use after all substantial testing is completed.
This may occur before the software is placed in service. If it is no longer probable that a software project will be completed and placed into service, costs should no longer be capitalized.
At that point, the software should be assessed for impairment. Refer to PPE 7. The SOP says the entity must apply Statement no. An entity conceivably could follow SOP in the early stages of development to capitalize more costs and thus show less expense and then, later in the development cycle, decide to sell the software.
One typical activity an entity performs during this stage is determining whether the technology exists to develop the software. One might compare this to determining whether the technology and tools exist to build a state-of-the-art, high-tech manufacturing plant.
If the technology does not exist to develop the internal-use software, a project would not leave the preliminary stage because it would be considered similar to a research and development effort. The existence of technology question is different from the issue of whether management believes it has the right talent to do the job or whether it will be able to fund the project in the event of cost overruns.
Many of the comment letters the AICPA received on the exposure draft said entities could have difficulty dividing internal software development efforts between maintenance and upgrades.
The purchase price may cover some or all of the features the seller provides. Eligible employees are those who help build the software, including, for example, programmers and end users who test the software. Eligible employees do not include administrative assistants, because they are not involved directly with the development effort.
The SOP cautions that internal-use software often has a relatively short useful life. Simply put, entities should not amortize Windows 95 over a year life, given the frequency of upgrades to the Windows operating system.
In those instances, SOP requires entities to capitalize the acquisition price. Content development costs usually are greater than software costs for a Web site. Content development costs deemed to be advertising costs should be accounted for under SOP , Reporting on Advertising Costs. Otherwise, entities will have a tough time finding authoritative support for capitalizing content development costs.
SOP provides a reasonable way to report those benefits as assets. Now it is up to CPAs to use good judgment when reporting those assets. Internal-use software is software an entity has no substantive plans to market externally.
The entity must show it has or is working on a substantive plan to market the software. To make this easier, the SOP gives entities an out when upgrades are insignificant.
When an entity cannot separate the costs, it should expense them as incurred.
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