Software Development: Expensed or Capitalized?
Jerry Goldberg (Principal, Strategic Capital Corp)
| Aug 3, 2011I have a client who is paying an outsourced development firm on a monthly basis to develop a proprietary software platform. Total time will be 24 months at #240K total, and then contiued maintenance updates and additional development as needed. My question is on how the monthly amounts should either be expensed or capitalized or partiall both given the ongoing development and the fact that the 'finished' product wil be used for many years during and after initial development? Thoughts?
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Software capitalization is a difficult item and I highly recommend you discussing this with your auditor before settling on accounting treatment or else you'll be looking at a restatement or an argument :).
This is a good paper from a finance professor at GA Tech: http://smartech.gatech.edu/bitstream/handle/1853/15598/FAL_ga_tech_software_dev_2006.pdf?sequence=1. To quote this paper, "Software companies are required by SFAS No. 86 to capitalize certain development costs of software to be sold, leased or otherwise marketed. Capitalization occurs once technological feasibility has been reached and costs are determined to be recoverable. Capitalization ends and amortization begins when the product is available for general release to customers. These guidelines provide a great deal of flexibility to management in determining “technological feasibility” and amortization parameters."
The "flexibility" he mentions leads to all sorts of fun b/c who can really tell when feasibility has been reached? Prepare your arguments. What is determinable is your ship date, of course. But your case points to the future, 2 years out. Your product may never ship! So discuss with your auditor the particulars of your situation and together determine how to handle. The cash is the same regardless, but when to turn on R&D expense collection on the balance sheet and what period you should amortize will vary.
Company: Strategic Capital Corp
Thx Mark. The issue with my client is the software is being developed for internal use only, not for resale to customers.
Company: The Accounting Onion
Jerry,
The official literature can be found at FASB Codification Topic 350-40. To summarize, internal and external costs (i.e., to your contractor) incurred during the preliminary project stage are to be expensed as incurred. This stage includes the following activities: conceptual formulation of the idea and alternatives, evaluation of alternative, determination of existence of needed technology and final selection of alternatives.
Basically, all other costs, except for training and application maintenance are capitalized. Let me know if I can be of further help.