Software Capitalization Accounting Services — ASC 350 & ASC 985 – XoraH PLLC

Software Capitalization Accounting Services — ASC 350 & ASC 985

Intro to Services

For technology companies, SaaS businesses, and any organization with significant software development activity, the question of how to account for software development costs is not a minor accounting detail — it is a decision that directly affects reported assets, expenses, and profitability. Capitalize too aggressively and you overstate assets and understate expenses. Expense everything and you potentially understate the value of the technology you are building and report lower earnings than GAAP actually requires.

The accounting for software development costs is governed by two distinct standards depending on the nature of the software — ASC 350-40 for internal-use software and cloud computing arrangements, and ASC 985-20 for software products sold or licensed to customers. The two standards have different capitalization criteria, different triggers for the capitalization period, and different subsequent accounting. Getting the right standard applied to the right activity requires careful analysis of what is being built and how it will be used.

Our software capitalization services help technology companies, SaaS businesses, and companies with significant internal software development programs apply the correct standard, establish practical and defensible capitalization policies, and maintain compliance as their software development activities evolve. We serve clients throughout Florida and nationwide.

The Two Software Capitalization Standards

ASC 350-40 — Internal-Use Software

ASC 350-40 governs the accounting for costs incurred to develop or obtain software for internal use — software that the company will use in its operations and will not sell, lease, or market to external customers. The standard divides the software development process into three stages, each with different accounting treatment:

• Preliminary project stage — all costs expensed as incurred. This stage encompasses conceptual formulation, evaluation of alternatives, and determination of the existence of the technology needed to achieve the desired performance.
• Application development stage — costs capitalized. This is the stage in which the company has completed the preliminary project stage and has authorized and committed to funding the project. Capitalized costs include external direct costs of services consumed in developing the software and payroll and payroll-related costs for employees directly associated with the development activities.
• Post-implementation/operation stage — all costs expensed as incurred. This stage begins when the software is ready for its intended use. Training costs and maintenance costs incurred in this stage are expensed.

The determination of when a project moves from one stage to another is a judgment call that has significant accounting consequences — and it is one of the areas most frequently questioned in audits of technology companies.

ASC 350-40 and Cloud Computing Arrangements

ASU 2018-15 extended the ASC 350-40 framework to implementation costs incurred in a hosting arrangement that is a service contract — such as software-as-a-service subscriptions that include implementation, configuration, and customization. Under this guidance, implementation costs for cloud computing arrangements are evaluated using the same three-stage framework as internal-use software, with capitalized costs amortized over the term of the hosting arrangement including renewal periods.

ASC 985-20 — Software Products Sold or Licensed to Customers

ASC 985-20 governs the accounting for costs incurred to develop software products that will be sold, leased, or otherwise marketed as a separate product or as part of a product or process. The capitalization trigger under ASC 985-20 is the establishment of technological feasibility — the point at which the company has completed all planning, designing, coding, and testing activities necessary to establish that the product can be produced to meet its design specifications.

For many SaaS companies, ASC 985-20 is not the applicable standard — because the software is hosted and not sold or licensed to the customer. Determining which standard applies requires an analysis of the delivery model and the rights conveyed to the customer, and it is an area where companies frequently apply the wrong standard.

Our Software Capitalization Services

Standard Determination and Scoping

The first step in any software capitalization engagement is determining which standard — ASC 350-40 or ASC 985-20 — applies to each of your software development programs. For companies with multiple products and revenue models, this analysis may yield different answers for different programs. We analyze each program, document the standard determination, and establish a clear framework for applying the correct accounting going forward.

Capitalization Policy Development

A well-designed software capitalization policy documents the three-stage framework (for ASC 350-40) or the technological feasibility threshold (for ASC 985-20), the types of costs eligible for capitalization, the process for identifying and tracking capitalizable costs, and the amortization method and useful life determinations. We draft software capitalization policies that are GAAP-compliant, practical for your development team to apply, and defensible under audit scrutiny.

Stage Determination and Cost Identification

We work with your engineering and product teams to establish a practical process for identifying when projects cross from the preliminary stage into the application development stage and from application development into post-implementation. This boundary determination drives the period during which costs are capitalized, and it must be supported by contemporaneous documentation. We design documentation processes that capture the necessary information without creating an undue administrative burden on the development team.

Capitalization Rate Analysis

For companies capitalizing employee payroll costs, the capitalization rate must reflect only the time spent on qualifying application development activities. We advise on time-tracking methodologies, assess the reasonableness of capitalization rates, and ensure the rate is documented consistently with the ASC 350-40 requirements.

Amortization and Impairment

Capitalized internal-use software is amortized on a straight-line basis over its estimated useful life, beginning when the software is ready for its intended use. We advise on useful life determinations, establish the amortization schedule, and advise on the impairment indicators that require evaluation of the carrying value of capitalized software. For software products under ASC 985-20, amortization is calculated as the greater of the straight-line amount and the ratio of current-period revenue to total projected revenue — an ongoing calculation that requires current revenue projections.

GAAP Compliance Review for Existing Capitalization Practices

Many technology companies have capitalization practices that were established informally and have never been formally evaluated against ASC 350-40 or ASC 985-20. We conduct GAAP compliance reviews of existing software capitalization practices — identifying costs that are being capitalized that should be expensed (or vice versa), assessing the reasonableness of useful life determinations, and identifying disclosure deficiencies. This review is particularly valuable before a first audit or when existing practices are questioned by auditors.

Who Needs Software Capitalization Advisory

• SaaS companies and technology businesses with significant ongoing software development investment
• Companies implementing enterprise software systems — ERP, CRM, or custom applications for internal use
• Businesses with cloud computing arrangements (SaaS subscriptions) that include material implementation costs
• Technology companies preparing for a first audit or a financing round where capitalized software is a significant balance sheet item
• Companies whose existing software capitalization practices have been questioned by auditors or have not been updated for the current standards