Insights on Developing Internal-Use Software

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As companies become increasingly dependent on technology and consider developing their own software for financial systems, lease documentation and fixed asset management, it’s important to keep Accounting Standards Codification Topic 350-40, Intangibles—Goodwill and Other—Internal-Use Software, in mind for capitalizing software. Being aware of common factors that can cause pain points when capitalizing internally developed software helps companies properly state their bottom line.  

This article focuses on computer software that’s developed or obtained for internal use and should not be used as guidance for any software developed to be sold, leased or marketed externally. This determination should be made by the company as soon as possible to ensure the appropriate guidance is used. There is additional guidance available for companies wishing to develop their own software to be marketed externally.

Preliminary Development – Time & Expenses
Determining when to start capitalizing time and expenses can cause headaches. To properly capture expenses, your company should keep track of when the project crosses over from the preliminary development phase to the application development phase. Preliminary development can include overall concept formulation, evaluation of alternatives and determination of technology needs, among others. These expenses should be expensed as they’re incurred.

Application Development – Time & Expenses
Once the company determines the preliminary phase is completed and management commits to the continuation of the project (whether implicitly or explicitly), the project enters the application development stage. At this time, capitalization can begin. The application development stage includes any costs (internal or external) incurred to develop new internal-use software or software that allows new systems to access old data.  

Upgrades & Enhancements vs. Maintenance
Upgrades, enhancements and maintenance to internally developed software can fall into a gray area when it comes to determining whether a company should capitalize or expense the associated costs. Per FASB ASC 350-40-25-7, upgrades and enhancements are defined as improvements that allow the software to perform tasks it was previously incapable of performing. These costs can be capitalized by the company if they add functionality or additional modules for internal users. Maintenance costs must be expensed as incurred and could include costs to fix bugs, enhance the user interface or update integration capabilities.

Payroll & External Costs to Be Capitalized
For any internal costs incurred by your company, there could be some confusion about what salaries should be capitalized into the project. Salaries and payroll-related costs for any employees directly involved with the project should be capitalized. Companies also need to track employee time closely, whether it’s spent on multiple projects or projects that ultimately will not be capitalized by the company. If an employee spends time on a project that will not be capitalized, the salary related to this time should be expensed as incurred. 

In addition, it’s important to note that any payroll-related costs (such as vacation, employee benefits, payroll taxes, etc.) incurred during the application development phase should be included in the costs to be capitalized. Companies should watch expenses to appropriately classify internal and external costs in each stage (pre-development, maintenance and upgrades).  Also, any external costs (including travel reimbursements, purchase of software, fees paid to third parties, etc.) should be broken out between maintenance and modifications and expensed or capitalized accordingly. On the other side, there are expenses that shouldn’t be capitalized into the software regardless of when they’re incurred. These costs include, but aren’t limited to, overhead costs, data conversion costs and training costs.

End of Project
Many companies use a release calendar to track when each release is completed and activated in their system. It’s a good idea to schedule releases in a formalized calendar or policy to identify the correct date that costs should stop being capitalized to the project. When a project has been formally released, external expenses and employee salaries should no longer be capitalized and instead a new project and evaluation should begin.

In conclusion, there are several concepts within FASB guidance that could cause large dollar amounts related to a company’s internally developed software projects to be expensed rather than capitalized or vice versa.

Contact BKD or your local trusted advisor if you have specific questions related to this guidance.


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