![]() How Tech Companies Deal With Software Development Costs. In the world of startup/emerging growth technology, there is a reoccurring accounting question that inevitably requires serious consideration: should I be capitalizing my software development costs, or should I expense them all or a portion of them? If you are also asking this question, take comfort in that determining whether to capitalize software costs is no walk in the park. Although the accounting standards specifically address this issue at great length, applying the rules is a matter of subjectivity and opinion. However, a well- informed CEO/CFO/Controller needs to understand the accounting standards surrounding capitalized software costs in order to determine, and more importantly support, your company’s policy on software capitalization costs. You may be wondering why you should care. Simply put, high- tech startups generally devote a significant amount of their time and money into software development; the treatment of these costs will most likely have a huge impact on not only your current financial performance but future financials as well. There are a few distinctions that need to be made prior to diving into the accounting rules. First, the accounting standards under GAAP define two types of software: 1) software to be sold, leased or marketed and 2) software for internal- use. The standards provide specific, differing accounting rules for each type of software. It is important to determine which type of software is being developed in order to properly ascertain the amount of costs that should be expensed or capitalized. Second, for purposes of this article, I will be addressing the accounting rules under GAAP and not under the IRS Code. However, it is important to note that whatever determination is made regarding companies treatment of software development costs under GAAP, that determination does not necessarily influence your company’s treatment of the costs under the IRS Code (i. GAAP and expensing for tax may be ok). Third, this article will address the basics of the rules and will be a good starting point. This article does not substitute the need to consult with your CPA firm prior to making any significant decisions. SOFTWARE TO BE SOLD, LEASED OR MARKETEDIf your company is developing software to eventually sell, lease or market to the general public, this section is for you. This software is developed with the intention of earning future revenues and should not provide benefit to the internal operations of your firm (see internal- use software below). When I speak to clients about which development costs to capitalize or expense relating to software to be marketed externally, the most important question I ask is when did the software project achieve “technological feasibility?” This is important because the accounting standards state that all costs incurred on a software project prior to the establishment of technological feasibility are to be expensed as incurred. We provide excellent essay writing service 24/7. Enjoy proficient essay writing and custom writing services provided by professional academic writers. How Tech Companies Deal With Software Development Costs: Insights From A CPA. Web portal for building-related information with a "whole building" focus provided by the National Institute of Building Sciences. Areas include Design Guidance. The standards also state that costs incurred subsequent to the establishment of technological feasibility may be capitalized. Capitalization of the costs should cease when the software is available for general release to customers. Any future costs relating to the software project should be expensed as incurred. What is technological feasibility? Technological feasibility is a term used to describe a certain point during a software project when the research and development phase has substantially been completed. The standards provide specific guidance as to when a project has achieved technological feasibility. The following is an excerpt directly from the standards: …the computer software product includes a detail program design (defined below) [which incorporates] all of the following: The product design and the detail program design have been completed, and the entity has established that the necessary skills, hardware and software technology are available to the company to produce the product. The completeness of the detail program design and its consistency with the product design have been confirmed by documenting and tracing the detail program design to product specifications. The detail program design has been reviewed for high- risk development issues (for example, novel, unique, unproven functions and features or technological innovations), and any uncertainties related to identified high- risk development issues have been resolved through coding and testing. A Detail Program Design is defined by the standards as follows: The detail design of a computer software product that takes product function, feature and technical requirements to their most detailed, logical form and is ready for coding. I’ll now pause so you can take an accounting breather…Okay. As with any accounting topic, the above guidance is open for management’s interpretation. In the profession you will find companies that have significant capitalized software development costs and others that have expensed all of their software development costs. Many companies take the position that technological feasibility is established at the same time the software product can be used or consumed in any form by the public; thus they expense most development costs. This position is typically the most conservative position and will likely face less scrutiny from your auditors. Others take the position that technological feasibility occurs prior to the product being available for sale. The costs that are eligible for capitalization, post technological feasibility, are as follows: Programmer’s compensation for time directly attributable to coding the software. An allocated amount of indirect costs, such as overhead related to programmers and the facilities they occupy. Costs associated with testing the software for market (i. Other direct production costs that are incurred to bring the software to market. Some other points of consideration are: Costs of maintenance, bug fixes and customer support are to be expensed as incurred. We have seen clients factor in inefficiencies when determining the amount of programmer’s compensation to capitalize (i. The accounting rules also touch upon a concept known as a working model which was left out of this discussion. In our experience, the working model concept does not influence the majority of our clients’ decisions with respect to whether or not to capitalize software costs. INTERNAL- USE SOFTWAREIf your company is developing software internally solely to meet your company’s internal needs, this section is for you. There can be no plan to market the software externally, even into the future (determined at the time of development). Internal- use software is typically monitoring, analytic and accounting modules. The accounting standards split the development process of internal- use software into three different stages. Management should determine at which point the software development enters and exits each stage. Depending on the stage, the associated development costs will be expensed or capitalized. The three internal- use software stages along with their definitions are as follows: Preliminary Project Stage – When a computer software project is in this phase, your company will likely do the following. Make strategic decisions to allocate resources between alternative projects at a given point in time. Determine what your company needs the software to do and the system requirements therein. Determine the technology needed in order to achieve the system requirements. Explore the best implementation solution for the software. For example, determining whether to develop or buy thesoftware. Application Development Stage – This stage typically begins once an internal- use software project is chosen and development is about to begin. Activities performed during the application development stage include. Design of chosen path, including software configuration and software interfaces. Coding. Installation to hardware. Testing. Postimplementation- Operating Stage – This stage typically begins once the software development is complete and the internaluse software has been implemented. Activities performed during the post implementation- operating stage include. Training. Maintenance. Once you have split the development process into the three stages, the following are the accounting treatment considerations for each stage: Preliminary Project Stage. All development costs incurred during this stage should be expensed as incurred.
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