When it comes to accounting for computer software, the question often arises – should it be amortized or depreciated? The answer is not as straightforward as one might think and depends on various factors. In this article, we will discuss the differences between amortization and depreciation and explore which method is more suitable for computer software.
What is Amortization?
Amortization is a method of spreading out the cost of an intangible asset over its useful life. Intangible assets are those that do not have a physical existence but still hold value, such as patents, copyrights, and trademarks. Amortization is calculated based on the asset’s purchase price, estimated useful life, and any residual value.
What is Depreciation?
Depreciation, on the other hand, is a method of allocating the cost of a tangible asset over its useful life. Tangible assets are those that have a physical existence such as buildings, machinery, and vehicles. Depreciation is calculated based on factors such as the asset’s purchase price, estimated useful life, salvage value, and depreciation method used.
How Does this Apply to Computer Software?
Computer software can be classified as either tangible or intangible depending on how it was acquired. If the software was purchased outright from a vendor or developed in-house by a company without any external funding or grants, it can be considered tangible property subject to depreciation. In this case, the company may choose to depreciate the software over its useful life using methods such as straight-line or accelerated depreciation.
If the software was acquired through licensing agreements or with external funding or grants that restrict ownership rights to intellectual property (IP), it would be considered an intangible asset subject to amortization. In this case, companies may choose to use methods such as straight-line or accelerated amortization to spread out its cost over its estimated useful life.
Which Method is Better for Computer Software?
It ultimately depends on the circumstances surrounding the acquisition of the software. If the software was purchased outright or developed in-house, it is more appropriate to use depreciation. However, if the software was acquired through licensing agreements or with external funding, amortization is more suitable.
- For Tangible Software – Depreciation
- For Intangible Software – Amortization
In conclusion, whether computer software should be amortized or depreciated depends on its classification as either tangible or intangible property. If it was purchased outright or developed in-house without any external funding, depreciation is more appropriate.
However, if it was acquired through licensing agreements or with external funding that restrict ownership rights to IP, amortization is more suitable. As always, it’s important to consult a financial professional for guidance on which method to use for your specific situation.