Accounting for software development costs

Even when technological feasibility is established, not all agile development costs can be capitalized. In most cases, only some of the costs in each sprint can be capitalized.

But large portions of the costs incurred to develop and test such features often should be capitalized if technological feasibility is achieved. These costs include the actual coding, testing, and associated labor costs. Bear in mind, however, that any maintenance-related or error-correction costs that are incurred during the sprint may need to be expensed rather than capitalized, as many activities during the sprint may not be coding and testing but may be activities such as troubleshooting and discovery.

Moreover, capitalization ends once the project is complete and the software is ready for use. Distinguishing between costs that can be capitalized and those that cannot be capitalized can complicate the project accounting, reporting, and documentation steps within each sprint somewhat. But the additional administrative work does not have to be onerous. In most cases the various tasks and deliverables within each sprint can be segmented into broad categories, so that all costs associated with that task can be either expensed or capitalized.

Deciding which external-use software development costs can be capitalized in an agile project environment involves a certain amount of judgment. In many cases, the specific facts and circumstances surrounding the type of software being developed will drive the treatment of costs. Careful planning can aid in the analysis of which costs to capitalize versus expense.

For this reason, it usually is advisable to discuss the accounting treatment with the project management team and subject-matter experts before starting any large development project.

It also is important to understand from the outset of a project the level of support and documentation that will be needed to enable the appropriate decisions regarding capitalization of costs. In addition, a clear understanding is required of the level of documentation that will need to be maintained for auditors to evaluate and affirm the capitalization and expensing decisions. It also is important to maintain additional internal controls such as monthly reviews of activities, capitalized and expensed amounts, and communication templates that project managers can fill out to verify that employee time is coded correctly.

Although some industry discussion of updating the relevant standards to make them more applicable to the agile framework has occurred, such updates typically entail several years of planning, discussion, proposals, and industry feedback. That means that, for the foreseeable future, companies that use an agile model to develop software for external sale or licensing will need to continue coordinating closely with their accounting teams to apply the existing GAAP guidance and capitalize development costs appropriately.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, a JofA editorial director, at Kenneth. Tysiac aicpa-cima. Read more about the change and get tips on how to access the new flipbook digital issues.

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Toggle search Toggle navigation. Breaking News. Accounting for external-use software development costs in an agile environment By Ryan P. Richards, CPA. If these criteria are met, the related software development costs are within the scope of ASC In practice, however, these criteria are not met very often in SAAS arrangements. As a result, the related software development costs would typically be within the scope of ASC because the software is considered to be for the entity's internal use to provide a service to the customer.

Note that in many situations, an entity may not have entered into any revenue arrangements for software under development. In other words, the entity is incurring software development costs before it enters into any revenue arrangements that include the software. To properly account for the software development costs in these situations, an entity must determine whether it expects future revenue arrangements related to the software under development to meet the criteria in the preceding paragraph.

Furthermore, if an entity concludes that any of its future revenue arrangements relating to the software under development will meet this criteria, all related software development costs would be within the scope of ASC This is because ASC only applies if the software is or will be used solely for internal purposes.

Receive Financial Reporting Insights by Email. Financial Reporting Resource Center. ASC , ASC , ASC All entities Relevant dates Effective immediately Key impacts A single roadmap to accounting for software and website costs — helping you to compare and contrast the different models, including: Internal-use software and cloud computing arrangement costs under ASC Website development costs under ASC External-use software costs under ASC Report contents Executive summary Scope Initial recognition and measurement: Internal-use software and cloud computing implementation costs Initial recognition and measurement: Website development costs Initial recognition and measurement: Software to be sold, leased or marketed Subsequent measurement Presentation Disclosure ASU effective dates and transition.

Related content. Handbook: Impairment of nonfinancial assets. Handbook: Revenue for software and SaaS.