FASB is making progress on a project to modernize software cost accounting to address long-standing concerns that the current guidance is unintuitive and costly to apply. Software development has evolved substantially since the first guidance was issued more than 35 years ago, and there is diversity in practice under the current guidance. For software companies, a move from a licensing model to software-as-a-service (SaaS) changes the accounting outcomes under the two existing software accounting models. See Appendix for a summary of current guidance. For non-software companies, the growing use of agile software development upends the standardized phased workflows built into current accounting guidance.
FASB Project History: Accounting for & Disclosure of Software Costs
FASB included software costs as a research agenda item in December 2021 but part of a bigger project on intangible assets. After reviewing stakeholder feedback, software costs were broken out as a standalone project in June 2022. Staff was directed to research two possible approaches:
- Initial development cost model. This would require an entity to capitalize all direct software costs from the point at which it is probable that the software project will be completed and the software will be used to perform the function intended.
- Dual model. This would require an entity to account for certain software costs as an expense as incurred model and other software costs under the initial development cost model.
Feedback to the dual model was mixed, and in April 2023, FASB decided to focus on a single model, the initial development cost model. The dual model received support from some preparers, including software companies that would prefer to expense all their software costs and non-software companies that would like to continue their current capitalization policies. At the meeting, staff highlighted feedback from preliminary outreach with practitioners, preparers, and analysts. Most practitioners and preparers strongly opposed a dual model, citing its potential cost and complexity. Due to the evolving nature of software development, it would be challenging for practitioners to determine which model to use. Preparers from non-software companies and most practitioners said a single model would be operable. However, software companies that participated in the outreach did not support the single model because too many research and development costs would be capitalized that are currently expensed as incurred.
Initial Cost Model
The single model would apply to costs that a company incurs to acquire, internally develop, or modify software. The single model would require an entity to capitalize all direct software development costs (a) from the point at which it is probable that the software project will be completed and the software will be used to perform the function intended (b) until the software is substantially complete and ready for its intended use. Amortization of the capitalized costs would begin when the software is substantially complete and ready for its intended use. Ongoing maintenance costs would be expensed while enhancements would be capitalized.
Significant details of a single model still need to be deliberated at future FASB meetings, including the threshold for capitalization, unit of account, distinguishing between maintenance costs and enhancements, cost eligible for capitalization, subsequent measurement, and substantially complete threshold.
An exposure draft is planned for the second half of 2023. All FASB decisions are subject to change until a final accounting standard update is issued. Not all proposals result in new accounting guidance. When comment letter feedback is mixed or negative and where potential implementation costs do not outweigh perceived benefits, FASB can drop proposed changes. This happened recently with the long-running goodwill project.
FORVIS will continue to follow this project. Contact our team to learn how we’re assisting software and technology companies with the accounting for their software development costs. For more information, reach out to a professional at FORVIS or submit the Contact Us form below.
Appendix – Current Accounting Guidance for Software Development Costs
|Software Development Costs – Current Accounting Guidance|
|ASC 350-40, Intangibles—Goodwill and Other—Internal-Use Software||ASC 985-20, Software—Costs of Software to Be Sold, Leased, or Marketed|
|Cost incurred to develop or purchase software that is solely for the entity’s internal use||Cost incurred to develop software to be sold or licensed to customers|
|Cost to develop a hosting arrangement platform||Cost incurred to develop software used in a SaaS / hosting arrangement in which the customer can take possession|
|Costs incurred by a customer to implement a cloud computing arrangement|
ASC 350-40, Intangibles – Goodwill & Other – Internal Use Software
ASC 985-20, Software – Cost of Software to Be Sold, Leased, or Marketed