The Financial Accounting Standards Board is considering implementing a new rule for reporting business software costs, which some say would be a welcome change.
The current method for reporting software costs is based on the intended use for the finished product, whether for sale or internal use. Now, the FASB is considering eliminating the need for businesses to decide early on the ultimate plans for the software by instituting a single reporting rule for all use cases. The FASB is a not-for-profit organization that creates financial accounting and reporting standards for businesses that follow the U.S. Generally Accepted Accounting Principles (GAAP). All publicly traded companies and private companies that report to investors or other outside parties must submit GAAP financial statements.
The FASB has yet to issue a draft rule on a single reporting model. However, this change would make financial reporting on software costs easier, said Steve Soter, vice president and senior industry principal at Workiva, a financial reporting platform.
“While there are still many unanswered questions about a new FASB rule, a single model will likely provide welcome simplification for what has historically been a difficult and subjective accounting exercise for many companies,” he said.
Benefits of a single reporting rule
A new single reporting rule would likely more closely resemble the internal use reporting model, which could result in more development costs being capitalized, Soter said. Capitalizing a development cost is typically more beneficial for businesses than expensing a cost, because the cost is recorded on a financial statement as an asset, which demonstrates more profitability.
If a company today is developing software for internal use, costs are expensed until the company has completed initial planning and has committed to funding the project to completion, Soter said. After reaching that milestone, development costs are capitalized.
On the other hand, if a company determines that it’s developing software to be sold externally, the cost is expensed until it reaches the point of “technological feasibility,” meaning the company has a detailed design of the program or a working model. After reaching that point, costs are capitalized.
“Because planning for a project and committing to fund it are relatively easier criteria to meet than reaching technological feasibility, the majority of costs for internal use software are usually capitalized,” Soter said.
Steve SoterVice president and senior industry principal, Workiva
Indeed, the starting threshold for capitalization of software costs would begin when the software project is probable of being completed, said Kelly Brown, CPA and solution consultant for Softrax, a revenue management system provider.
Companies would need to consider past experiences for similar types of software, management commitment, core capabilities and development issues as part of this evaluation, Brown said.
“For the ending threshold for capitalization of software costs, companies will use the date that both the software project is substantially complete and the software is placed into service,” she said.
An added benefit of a single reporting rule would be helping companies that develop software to sell externally and use internally avoid financial reporting challenges, Soter said.
“A single model will prevent any potential accounting adjustments that would otherwise have been required if, for example, a software was initially developed to be sold but was later changed to be solely for internal use,” he said.
FASB considers new rule at stakeholder request
The accounting definition for selling software externally typically refers to a transaction where a company physically provides software, such as a disk or digital file, to customers, Soter said.
However, he noted that SaaS companies provide software access through the internet instead of physical disks or files, and generally account for development costs using the internal use model, which has prompted businesses to ask for a new rule.
“Physical possession of software is usually irrelevant in modern software transactions, which is why stakeholders have asked the FASB to update these rules,” Soter said.
The FASB is currently seeking investor feedback on a single reporting rule.
Makenzie Holland is a news writer covering big tech and federal regulation. Prior to joining TechTarget Editorial, she was a general reporter for the Wilmington StarNews and a crime and education reporter at the Wabash Plain Dealer.