Capitalizing costs software development

Even if audited, outside accountants faced with well-reasoned arguments from their clients, are no longer requiring capitalization. So even if you do not fully buy into the arguments below, your SaaS company is in the minority if it is still capitalizing software development expenses. Before the emergence of the SaaS business model, most software firms would make major product releases every few years.

So, during the product development phase, the salary expenses of the developers were not expensed, but rather they were capitalized and put on the balance sheet. The tracking of development costs quickly gets convoluted and relatively arbitrary, and the more costs that are capitalized, the farther the GAAP books drift from the actual cost of running the business.

For the reasons above, we think the original concept of capitalizing software development expenses for software companies with infrequent releases was suspect at best. For SaaS businesses today, however, capitalization makes no sense at all. Modern SaaS companies update their products constantly. Quite a bit, especially in the decision regarding software that is sold to the public. Companies that are conservative generally classify software as available for sale once it reaches technological feasibility.

Less conservative companies may allocate most costs to the stage where the software is technologically feasible but not yet available for sale. Similarly, the decision to classify internally used software as in the development stage vs. AthenaHealth capitalizes a significant amount of development costs for internally used software. In their 10K , they explain that it is for internal use software called AthenaNet:. We capitalize certain costs related to the development of athenaNet services and other internal-use software.

Costs incurred during the application development phase are capitalized only when we believe it is probable the development will result in new or additional functionality.

The types of costs capitalized during the application development phase include employee compensation, as well as consulting fees for third-party developers working on these projects. Costs related to the preliminary project stage and post-implementation activities are expensed as incurred.

Internal-use software is amortized on a straight-line basis over the estimated useful life of the asset, which ranges from two to five years. When internal-use software that was previously capitalized is abandoned, the cost less the accumulated amortization, if any, is recorded as amortization expense. Fully amortized capitalized internal-use software costs are removed from their respective accounts.

On top of that, the accounting team may lack visibility into a few vital pieces of information needed to properly identify and account for development costs. One of those pieces is when functionality is no longer available for on-premises deployment which could be the case when new functionality is only available in the cloud.

Another is which planning, application development, and maintenance costs are unique to the cloud functionality and which costs relate to on-premises functionality. The takeaway is that cloud delivery models and agile development techniques each have unique accounting considerations and impacts. Together, they can significantly increase process complexity for the organizations that adopt them.

So where can finance, accounting, and IT leaders go from here? Start by taking the following steps:. Cloud computing and agile development lie at the heart of many digital transformation efforts, offering organizations speed and flexibility alongside the potential for continuous innovation.

The flipside is that they can also make the accounting for software development costs significantly more complex. By working together, IT and finance can craft a common language that brings insight and control to the application dev elopment phase of a product development life cycle. This article touches on the broader challenges of capitalizing software in an agile or cloud environment. However, every organization has its own complexities to consider.

What is agile software development? The basic approach is to break projects up into small, time-limited chunks called sprints. Each sprint addresses at least one user requirement, or story , quickly resulting in a working prototype. An epic is a series of user stories.

Users get frequent demos of the software as it is being developed, with a chance to offer their feedback to the development teams. The teams then generate a new version that incorporates this user feedback.

This process is repeated until the functionality is right. He is a CPA and has 20 years of experience assisting large complex In this role, Chris consults with engagement teams and clients on complex accounting matters and wo Fullwidth SCC.

Do not delete! Historically, companies have expensed cloud-computing costs as the costs were incurred, whereas internal-use-software costs have been capitalizable. Within these phases, implementation costs incurred in a hosting arrangement are fees incurred by the customer to get the hosted service implemented, set up, and ready for use. In some instances, the FASB leaders believed this discouraged companies from evaluating cloud computing as a potential solution to business needs.

ASU provided two main clarifications to ASC guidelines for which specific implementation costs could be capitalized, whether a software license existed or not; and guidelines to determine, for capitalization purposes, what the asset is. One criterion considered, for example, is whether or not the cost provides a benefit to the organization over time. Capitalization allows for allocation of cost over the life of the asset.

Generally, entities look at capitalizable costs more favorably because it reduces the impact to net income for the period incurred.

For public companies, a smoother impact on earnings can be critical.