Software Cost Capitalization in Practice

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DEFINITIONS

Software Development Cost (Costs): all outflows of financial resources that were incurred in the current period, regardless of whether associated amounts were capitalized or expensed.

Software Development Expenses (Expenses): all outflows of financial resources that were both incurred and expensed in the current period.

Amortization of Capitalized Software Development Costs (Amortization): all outflows of financial resources that were incurred and capitalized in the prior periods, and subsequently expensed in the current period as a part of the amortization expense charge.

Introduction

Let’s summarize one practical way to approach capitalization of software development costs by startups.

APPROACH

Initial Costs

1. Identify the list of software development projects, and for each project, identify dates when costs should have started to be capitalized and (if the software is already in use) amortized.

2. Capitalize costs incurred before the launch of the software solution (prior to the date when the solution became available to use for its intended purpose):

   DEBIT Capitalized Software Costs

   CREDIT Software Development Expense

3. Subsequently, calculate and record amortization expense for capitalized software development costs every month:

   DEBIT Amortization Expense

   CREDIT Accumulated Amortization of Capitalized Software

Subsequent Costs

1. Classify subsequent costs between:

   1. Noncapitalizable costs related to ongoing maintenance, bug fixing, customer support, training, and the content of the software.

   2. Capitalizable costs related to the development of new substantial features or functionality.

2. Identify the approach to capitalization and amortization of costs in 2(a), for example, you can:

   1. Capitalize costs on a project-by-project basis and amortize each project once the feature is available to be used for its intended purpose through the minimum of the expected useful life of the feature or the upgraded software solution.

   2. Capitalize subsequent eligible costs in annual tranches and subsequently amortize each tranche through the standard useful life set by your accounting policy for capitalised software assets.

3. Capitalize and amortize subsequent costs eligible for capitalization consistent with #2 and #3 in the Initial Costs section above.

Conclusion

I hope this will be helpful for someone. Thank you!