Before ASC , entities were not taking advantage of the capitalization rules for some types of software agreements because they were ambiguous. Companies were basing the decision to use on-premise software solutions vs. As a result, incorrect accounting caused companies to view hosting agreements as a bigger impact to earnings than they often were, negating the positive technological aspects of moving to cloud-based computing.
Now ASC has a consistent and clear approach that entities can apply to account for hosting agreement fees. For agreements with no software license, the arrangement is considered a service contract and the updated guidance clarifies which implementation costs may be capitalized. In terms of the impact of the service contract to the financial statements , a prepaid asset is recognized on the balance sheet for the portion of the contract that can be capitalized.
Any expenses incurred upfront are recognized in the period incurred. The portion of the contract for future payments is recorded as a liability if future payments are due. Capitalization depends on the phase of the project in which the costs are incurred as well as the nature of the costs. Below is a description of the various phases of software development and implementation as well as the appropriate capitalization vs.
The preliminary project phase is the period in which an entity determines the system requirements for the internal use software. Activities during this phase are similar to research and development expenses, and therefore, all costs during this stage should be expensed as incurred. An entity enters the application development phase after it makes the decision to move forward with a software project and has express approval of management. During this stage, the entity will capitalize internal and external costs to develop or purchase internal-use software.
Generally, for internally developed software, only costs that relate to the actual development of the software are capitalizable.
Capitalization of data conversion costs depends on the method in which the data is converted. If the data is converted using software, the cost to develop or purchase that specific software is capitalized as software development costs. However, manual data conversion processes should be expensed as incurred. Training costs and overhead costs, even if incurred during this phase, are also expensed as incurred. Once the software is ready to be used by the entity, the post-implementation phase begins.
Costs incurred during this stage, such as training and maintenance, must also be expensed as incurred. Certain upgrade and enhancement costs incurred during this stage may be eligible for capitalization, if the costs meet the capitalization criteria of the application development stage.
Costs incurred in this phase include changes to the software that go beyond routine maintenance. If the improvements result in additional functionality, they fall into the upgrades and enhancements category and the costs incurred can be capitalized. Work on the software that does not result in additional functionality is looked at as routine maintenance costs and must be expensed as incurred. The capitalizable costs for a software agreement are the payments attributable to the purchase and installation of the software license.
Generally, the fees that fall into this category are part of the implementation costs. This includes, but is not limited to:. On the other hand, costs that cannot be capitalized are, in general terms, ongoing software costs after implementation.
Specifically, fees related to the usage or maintenance of the software are non-capitalizable. These costs should be expensed as they are incurred. For a cloud computing arrangement, a prepaid asset is recognized for the total amount of costs determined to be capitalizable. Then, to the extent there are payments still attributable to the implementation and other capitalizable costs, a liability is also recognized.
The liability is recorded for future payments owed under the agreement and the asset is recorded at total applicable contractual cost, with any difference representing payments made at the inception of the contract. The intangible asset is amortized over the life of the cloud computing arrangement. Most commonly, straight-line amortization of the intangible asset is used. However, instances could exist where a different method is more appropriate. Example 13 see paragraph illustrates these disclosure requirements.
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Your go-to resource for timely and relevant accounting, auditing, reporting and business insights. Follow along as we demonstrate how to use the site. My favorites. You haven't set any favorites so far. View all favorites. Add to favorites. Favorited Content. The presentation and disclosure requirements discussed in this section are applicable to the acquisition and postacquisition periods for intangible assets under ASC Business segment or unit to which the software relates is unprofitable or has been or will be discontinued.
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My favorites. You haven't set any favorites so far. View all favorites. Add to favorites. Favorited Content. ASC provides the guidance for software developed or obtained for internal use.
The cost guidance in ASC is similar to the cost guidance for other long-lived assets with respect to what costs are capitalized and how the costs are subsequently amortized and tested for impairment.
A software license purchased for internal use should be accounted for as an asset for the acquisition of an intangible and a liability, to the extent any or all of the software licensing fees are still outstanding on the acquisition date of the license.
See BCG 8. If a reporting entity is developing, modifying, or implementing software for internal use, the assessment of whether costs should be expensed or capitalized depends on the project stage during which the costs are incurred. The guidance describes the development of internal-use software as having three stages:. Only costs incurred during the application development stage are eligible for capitalization. When the software development process does not follow the same order as outlined above, reporting entities should apply the guidance in ASC based on the nature of the costs incurred.
For example, an agile or iterative software development approach may not have the distinct project stages contemplated in ASC In that case, the reporting entity should apply judgment to categorize costs based on the activities being performed e. See PPE 7. For guidance on the presentation and disclosure of software developed or obtained for internal use, see FSP 8.
The first stage of development described in ASC is the preliminary project stage. Definition from ASC Master Glossary Preliminary Project Stage: When a computer software project is in the preliminary project stage, entities will likely do the following:.
These costs are generally incurred in the early stages of a project, when the reporting entity is exploring its technological needs and exploring various alternatives. Internal and external costs incurred during the preliminary project stage should be expensed as incurred. Once the preliminary project phase has been completed, the next stage of development described in ASC is the application development stage. This stage is the period between when the preliminary project phase ends once the specifics of the software have been decided and the software is being developed and prior to the software being completed and ready for its intended use.
The following activities are considered to be within the application development stage:. During this stage, some costs should be capitalized while other costs should be expensed as incurred. ASC specifies the types of costs that can be capitalized. ASC Costs of computer software developed or obtained for internal-use that shall be capitalized include only the following:. Examples of those costs include but are not limited to the following:.
Fees paid to third parties for services provided to develop the software during the application development stage. Costs incurred to obtain computer software from third parties. The following types of costs are expensed as incurred, even during the application development stage:. If the reporting entity suspends substantially all of the software development activities, interest capitalization should cease until activities are resumed.
In summary, costs that are directly correlated to the actual development of the software application should be capitalized, while indirect costs related to the software development e. Capitalization of qualifying costs during the application development stage should begin when both of the following occur:. Capitalization should cease no later than the point at which a software project is substantially completed and ready for its intended use.
Software is ready for its intended use after all substantial testing is completed. This may occur before the software is placed in service. If it is no longer probable that a software project will be completed and placed into service, costs should no longer be capitalized. At that point, the software should be assessed for impairment. Refer to PPE 7. During this stage, all internal and external training and routine maintenance costs should be expensed as incurred.
Additional functionality means that the software modifications enable the software to perform tasks that it previously was not capable of performing. Software enhancement costs incurred that extend the useful life of the software product may qualify for capitalization. ASC indicates that if reporting entities cannot separate costs on a reasonable basis between maintenance and relatively minor upgrades and enhancements, the costs should be expensed as incurred.
The consideration paid to the third party should be allocated to each element based on its relative standalone price. After allocation, the accounting for each element e. ASC provides guidance on allocating costs to multiple elements in an arrangement. ASC Entities may purchase internal-use computer software from a third party or may enter into a hosting arrangement.
It represents the price at which a reporting entity would purchase an element of a contract separately.
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