Depreciation is an accounting method used to allocate the cost of an asset over its useful life. When it comes to computer software, determining how long to depreciate it can be a bit tricky. In this article, we will explore the factors that determine software depreciation and how long you should depreciate computer software.
What is Software Depreciation?
Software depreciation is the method of allocating the cost of computer software over its useful life. The purpose of depreciation is to match the cost of the asset with the revenue it generates. The concept of depreciation applies to physical assets like machinery and equipment as well as intangible assets like patents and copyrights.
Factors That Determine Software Depreciation
Several factors are considered when calculating software depreciation. These factors include:
- Useful Life: The useful life of a software application refers to how long it will remain relevant and useful to the business.
- Technological Obsolescence: Technological changes can make some software applications obsolete within a short period.
- Market Changes: Changes in market demand or competition can make some software applications irrelevant.
- Licensing Terms: Licensing terms may dictate when and how you can depreciate the cost of software.
How Long Should You Depreciate Computer Software?
The useful life of computer software depends on several factors, as mentioned earlier. However, in general, most businesses depreciate their software over three years. This time frame aligns with most licensing agreements for commercial off-the-shelf (COTS) software.
If you develop custom software for your business, you may be able to depreciate it over a longer period if it has a longer useful life. Additionally, the IRS allows businesses to accelerate the depreciation of software if it is placed in service during the first three quarters of a tax year.
Computer software is a valuable asset that requires careful consideration when it comes to depreciation. Factors such as useful life, technological obsolescence, licensing terms, and market changes all affect how long you should depreciate your software.
In general, most businesses depreciate their software over three years. However, if you develop custom software or have specific licensing terms, you may need to adjust your depreciation schedule accordingly.