Reporting Software Costs

On June 22, the Financial Accounting Standards Board (FASB) unanimously voted to add a project to its rulemaking agenda to modernize the accounting and disclosure rules for reporting software costs. Here’s an overview of the current accounting models for external and internal-use software and why the FASB wants to move to a single model for all software.

Existing Rules

There are two main areas of U.S. Generally Accepted Accounting Principles (GAAP) that provide accounting guidance for software costs. To determine how to account for software costs, a company first must evaluate what area of GAAP applies. The guidance that a company must follow is largely dependent on how a company plans to use the software.

Specifically, when a company determines that it has a substantive plan to sell, lease or otherwise market the software externally (including licensing), it’s required to account for the software costs as external use. In this situation, Accounting Standards Codification Subtopic 985-20, Software — Costs of Software to Be Sold, Leased, or Marketed, would be applied.

Conversely, if a company doesn’t have such a substantive plan in place when the software is under development, it’s required to account for the software costs incurred to develop or purchase software as internal use. In this situation Subtopic 350-40, Intangibles — Goodwill and Other — Internal-Use Software, would be applied.

The guidance for internal-use software is generally applied to hosting arrangements by both the vendor that’s incurring costs to develop the hosting arrangement for customers (such as software-as-a-service) and the customer incurring costs to implement the hosting arrangement. However, Subtopic 985-20 applies to hosting arrangements in which 1) a customer has a contractual right to take possession of the software at any time during the hosting period without significant penalty, and 2) it’s feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

Need for Change

The project to revamp the rules for reporting software costs would address recognition, measurement, presentation and disclosure guidance. The ultimate goal is to align the differing accounting models for external and internal-use software.

“I do think it’s time to develop a single model. I think the differentiation in the models, interestingly enough, are more about cost apportionment versus the incurrence of cost,” said FASB Chair Richard Jones. He wants the FASB’s new model “to be more reflective of how software is developed.”

The project is based on feedback from companies that find the current rules complex and costly. The complexity stems from the outdated nature of today’s rules, which complicates the evaluation of which guidance to apply and what amount should be capitalized. FASB member Gary Buesser noted, “Investors are generally unaware of this accounting, and, if they do know it, they don’t view it as informative.” He believes that investors want informative disclosures about software costs.

Stay Tuned

This project is currently in the deliberation phase. No proposals have yet been issued, but the FASB plans to discuss this topic in the coming months.

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