When it comes to accounting for software development costs, the question often arises: can computer software be capitalized? The answer is not a simple yes or no, as it depends on various factors and guidelines set by accounting standards. In this article, we will explore the concept of capitalizing software and what criteria need to be met for it to be eligible.
What Does It Mean to Capitalize Software?
To understand whether software can be capitalized, we first need to define what it means to capitalize an asset. Capitalizing refers to the process of recording an expense as an asset on the balance sheet rather than as a current period expense on the income statement. This is done because the asset is expected to provide future economic benefits beyond the current period.
When we apply this concept to software development costs, capitalizing means recognizing those costs as an intangible asset on the balance sheet rather than expensing them immediately as incurred.
Criteria for Capitalizing Software
According to Generally Accepted Accounting Principles (GAAP), there are specific criteria that must be met in order to capitalize software development costs. These include:
- The software must be intended for sale or lease
- The cost of completing the software can be reliably estimated
- The software has technological feasibility
- The company has demonstrated its ability and intention to complete and use or sell the software
- The future economic benefits are expected to exceed the cost of developing and marketing the software
If all of these criteria are met, then a company can capitalize their software development costs.
Types of Software Costs That Can Be Capitalized
Not all costs related to developing computer software can be capitalized. GAAP specifies that only certain types of expenses can be recognized as an intangible asset on a company’s balance sheet. These include:
- External direct costs of materials and services used in creating or acquiring software
- Payroll and payroll-related costs for employees directly involved in developing or obtaining the software
- Interest costs incurred during the development period of software intended for external sale or lease
In conclusion, computer software can be capitalized if it meets specific criteria set by accounting standards. If a company intends to sell or lease the software, can estimate the cost of completing it, has demonstrated its ability to complete and use or sell the software, and expects future economic benefits to exceed the cost of development and marketing, then they are eligible to capitalize their software development costs.
It’s important for companies to understand these guidelines when accounting for their software development costs as it can have a significant impact on their financial statements. By properly capitalizing their eligible expenses, companies can more accurately reflect the value of their intangible assets on their balance sheet.