Companies were basing the decision to use on-premise software solutions vs. As a result, incorrect accounting caused companies to view hosting agreements as a bigger impact to earnings than they often were, negating the positive technological aspects of moving to cloud-based computing. Now ASC has a consistent and clear approach that entities can apply to account for hosting agreement fees. For agreements with no software license, the arrangement is considered a service contract and the updated guidance clarifies which implementation costs may be capitalized.
In terms of the impact of the service contract to the financial statements , a prepaid asset is recognized on the balance sheet for the portion of the contract that can be capitalized. Any expenses incurred upfront are recognized in the period incurred. The portion of the contract for future payments is recorded as a liability if future payments are due. Capitalization depends on the phase of the project in which the costs are incurred as well as the nature of the costs.
Below is a description of the various phases of software development and implementation as well as the appropriate capitalization vs. The preliminary project phase is the period in which an entity determines the system requirements for the internal use software.
Activities during this phase are similar to research and development expenses, and therefore, all costs during this stage should be expensed as incurred. An entity enters the application development phase after it makes the decision to move forward with a software project and has express approval of management. During this stage, the entity will capitalize internal and external costs to develop or purchase internal-use software.
Generally, for internally developed software, only costs that relate to the actual development of the software are capitalizable.
Capitalization of data conversion costs depends on the method in which the data is converted. If the data is converted using software, the cost to develop or purchase that specific software is capitalized as software development costs.
However, manual data conversion processes should be expensed as incurred. Training costs and overhead costs, even if incurred during this phase, are also expensed as incurred. Once the software is ready to be used by the entity, the post-implementation phase begins.
Costs incurred during this stage, such as training and maintenance, must also be expensed as incurred. Certain upgrade and enhancement costs incurred during this stage may be eligible for capitalization, if the costs meet the capitalization criteria of the application development stage. Costs incurred in this phase include changes to the software that go beyond routine maintenance.
If the improvements result in additional functionality, they fall into the upgrades and enhancements category and the costs incurred can be capitalized.
Work on the software that does not result in additional functionality is looked at as routine maintenance costs and must be expensed as incurred. The capitalizable costs for a software agreement are the payments attributable to the purchase and installation of the software license. Generally, the fees that fall into this category are part of the implementation costs.
This includes, but is not limited to:. On the other hand, costs that cannot be capitalized are, in general terms, ongoing software costs after implementation. Specifically, fees related to the usage or maintenance of the software are non-capitalizable.
These costs should be expensed as they are incurred. For a cloud computing arrangement, a prepaid asset is recognized for the total amount of costs determined to be capitalizable. Then, to the extent there are payments still attributable to the implementation and other capitalizable costs, a liability is also recognized. The liability is recorded for future payments owed under the agreement and the asset is recorded at total applicable contractual cost, with any difference representing payments made at the inception of the contract.
The intangible asset is amortized over the life of the cloud computing arrangement. Most commonly, straight-line amortization of the intangible asset is used. However, instances could exist where a different method is more appropriate.
As long as the basis for amortization is systematic and rational and reflects the usage of the asset, it may be employed. The journal entry to amortize the prepaid asset is a debit to the cloud computing arrangement expense line item and a credit to the asset. The liability is relieved as payments are made. In our example below, we specify which costs are capitalized vs. This application will allow certain employees at Company XYZ to view employee contact information in one central online location.
The agreement does not include a license to use any software. The capitalization of costs depends on the nature of the costs and the phase of development in which the costs are incurred. Specific details of the work performed and the costs incurred in each phase of the project is described below. The explanation of each phase is followed by a determination of whether the fees are capitalizable. Company XYZ hires a consultant to assist with the preliminary selection of a software.
Also, the management team at Company XYZ creates a committee to help with determining the list of the requirements and functionality needed for the software solution.
To begin development of the new application, Company XYZ authorizes a team of internal software developers to create a software to convert old data from the existing system to the new system. Company XYZ also incurs costs to manually purge existing data from the current system i. Company XYZ implements the software and, after transition, incurs costs for additional training of employees.
After employees are trained and onboarded with the new application, Company XYZ continues to incur its ongoing software maintenance and customer support costs. However, after a few months of use the management team decides to allocate resources for the internal software development team to provide an upgraded user interface for the employees at Company XYZ. Please note this upgraded interface will enhance the functionality of the software.
This article provides a summary and example of accounting for cloud computing arrangements under ASC Specifically, the article covered in depth which costs are capitalized vs.
The issuance of updates to ASC in provided much needed clarity to entities in regard to the accounting treatment for cloud computing arrangements. It is the nature of the cost , not entirely timing of their occurrence, that matters. Now, the capitalization of software development costs can begin.
You can still use these within in an Agile format. Some things to consider before continuing down this path of using time cards or some other method of cost tracking include:. With all of these issues, you will need evaluate the pros and cons of maintaining the existing time tracking system.
As part of that evaluation you should consider several other alternative ways to track costs for capitalization. A second way is you could use story points and assign a dollar value to each point completed during the sprint. Note, there are considerations for this using this method, including:.
If there is a good amount of disparity among your development teams in using story points—which is not unusual or uncommon—a third way, and potentially the best for agile, is to capitalize costs based on the new functionality features completed in relation to all of the other work that each development team completes during a specified period of time such as a Release.
Because story point values within a team should be consistent and accurately reflect the amount of work completed during a particular Release or even an Epic, this should provide a defensible methodology for your internal accounting colleagues and external auditors. Of course, with the appropriate rigor, any of these methods can work. In Waterfall, the amortization begins once the project has been completed.
Some companies who practice Agile begin to amortize costs every month with the release of each sprint. You can expect to see a constant balancing act that the IT and Finance team members will have to work through together to ensure the appropriate level of investment is maintained. Creating the appropriate accounting policies and procedures will be necessary for your capitalization efforts. Otherwise, you may impact some of the benefits you are attempting to achieve within an Agile environment.
If your accounting policies become overly complicated or burdensome, any cost savings you may have gained from capitalizing will surely be lost to the adverse impacts to productivity, the decline in associate morale, or even associate turn-over. I wish you much success as you venture within the accounting element of the overall Agile equation. Paul, great post and great to see you working at a leader in our field that I definitely follow.
Great post man. This really helps a lot to get the best out of the organization. I would also want to share an article that helped me make the right decision when it came to deciding which accounting software would be best for my business. Hope it helps you all too. Your email address will not be published. Saved Posts. Reading: Accounting for Internal Use Software. Save for Later. For example: Accounting for internal-use software under ASC was originally predicated on Waterfall methodologies, so what happens when implementing these new software development processes?
Uncertainty created among internal accounting brethren on how to capitalize costs in an Agile environment. How do you manage that? As teams become more efficient and produce software more rapidly, tracking of their costs becomes even more important. What options exist? Solving for The Historical Approach In the past, the approach to software development—within an IT software project framework—can become a point of contention due to the following factors: Formal annual funding of projects Certain projects can involve duplicated efforts within organizations due to acquisitions, legacy systems not being retired, etc.
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