At a minimum, the entity shall have performed the activities in either a or b as evidence that technological feasibility has been established:. If the process of creating the computer software product includes a detail program design, all of the following:.
If the process of creating the computer software product does not include a detail program design with the features identified in a , both of the following:. See PPE 7. As ASC indicates, technological feasibility is established through completion of a detailed program design or a working model.
This is not an accounting policy election. In practice, the process of establishing when technological feasibility occurs is varied. Many software companies do not have significant capitalized software because they define technological feasibility as the creation of a working model, which often occurs late in the development cycle. ASC addresses how to determine technological feasibility when a product comprises various modules. ASC When a product comprises various modules that are not separately saleable, technological feasibility is established for the product as a whole, not on a module-by-module basis.
In the unusual case when a high-risk development issue arises after management has established technological feasibility, the provisions of ASC for changes in accounting estimates would apply to the previously capitalized costs, as well as the costs to resolve any high-risk development issue. Any previously capitalized costs for that product, as well as any additional costs incurred to re-establish technological feasibility, should be charged to expense as research and development costs.
Detailed program design requirements are generally not met simply by a chart outlining work plan tasks or an overview flowchart or diagram of the product. Conceptually, a detailed program design is analogous to an engineering blueprint.
In each development environment, the form of a detailed program design will vary; however, it should typically include:. Once technological feasibility has been attained by development of an appropriately detailed program design, capitalization of software costs should begin.
In other words, reporting entities cannot elect to delay capitalization until a working model has been completed. Refer to PPE 7. A working model is not the same as a prototype; a working model is typically available only near the end of the development process and is generally the beta testing version of the software. Definition from ASC Master Glossary Working Model: An operative version of the computer software product that is completed in the same software language as the product to be ultimately marketed, performs all the major functions planned for the product, and is ready for initial customer testing usually identified as beta testing.
ASC states that all costs incurred to establish technological feasibility of a software product must be charged to expense. Once technological feasibility is established, subsequent costs that directly relate to the project should be capitalized until the product is available for general release to customers.
This is when the externally marketed software or the product which contains the externally marketed software is available for purchase.
ASC through ASC discusses the types of costs that should be capitalized once technological feasibility is established.
These costs include costs to perform coding and testing activities, including employee costs directly associated with those tasks. Both direct and indirect costs, such as overhead related to programmers and the dedicated computer hardware and systems they utilize, would qualify for capitalization.
However, an allocation of general and administrative expenses would not be appropriate because those costs are not directly related to the project. Question PPE addresses whether a reporting entity could elect to expense all software development costs incurred.
Question PPE May a reporting entity elect to expense all software development costs? A reporting entity should capitalize those costs that meet the criteria of ASC for capitalization or ASC for internal-use software.
However, in practice, many reporting entities utilize the working model to establish technological feasibility for software, which generally results in technological feasibility being established later than under the detailed program design approach.
As a result, the working model approach usually results in a shorter capitalization window and the costs to be capitalized during this period may be immaterial. The cost of purchased software to be sold, leased, or otherwise marketed that has no alternative future use is accounted for in the same manner as costs incurred to develop such software internally unless it is acquired in a business combination.
See BCG 4 for information on in-process research and development assets acquired in a business combination. If the purchased software, acquired before technological feasibility was established, has an alternative future use, the cost should be capitalized when acquired and accounted for in accordance with its alternative use. However, the amount capitalized would be limited to the amount realizable from the alternative future use.
This scenario is described in ASC ASC An entity may purchase software before technological feasibility has been established. Amortization of software should commence when the product is available for general release to customers. The method of amortizing costs capitalized for software to be sold, leased, or otherwise marketed to others is discussed in ASC through ASC ASC Capitalized software costs shall be amortized on a product-by-product basis.
The annual amortization shall be the greater of the amounts computed using the following:. ASC Because a net realizable value test, which considers future revenues and costs, must be applied to capitalized costs see paragraph ASC , amortization shall be based on estimated future revenues. The straight-line computation is the minimum annual amortization. Because the requirement is to use the greater of the amortization calculated using the ratio method or the straight-line amount, changing between the methods to meet this requirement is not considered a change in accounting principle.
However, if comparability is materially impacted, disclosure may be appropriate. PPE Corp expects the revenue to be recorded as follows:. ASC indicates that amortization should be the greater of 1 the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or 2 the straight-line method over the remaining estimated economic life of the product including the period being reported on.
Additionally, PPE Corp revises its future revenue projections as follows:. PPE Corp would determine amortization expense in 20X2 as follows. However, PPE Corp estimates that revision of its anticipated future revenue is not required, which are as follows:.
Year 4. Year 5. PPE Corp would determine amortization expense in 20X3 as follows. The impairment test for software to be sold, leased, or otherwise marketed follows the net realizable value NRV test described in ASC ASC At each balance sheet date, the unamortized capitalized costs of a computer software product shall be compared to the net realizable value of that product. The NRV test is required to be performed at each balance sheet date. ASC indicates that the unamortized capitalized costs to be used for subsequent accounting purposes i.
Thus, capitalized costs that are written down to NRV during an interim period may be written back up during that same fiscal year to an amount not to exceed the current year write-down. Any adjustments to subsequently restore write-downs should be recorded in the interim period in which the revised estimates of future gross revenues are made; previously reported interim amounts should not be restated.
If it is no longer probable the software will be completed, the asset should be written down to the lower of cost or fair value less cost to sell. If the software will be completed but will not include all of the features included in the original product design, the lower of cost or fair value model does not need to be applied as long as the product will continue to be saleable without the omitted features.
However, the capitalized costs would still be subject to a net realizable value test, which may require write-down based on changes in projected revenue as a result of the modified features. ASC states that the future gross revenues from the product should be used in applying the NRV test. The product's future revenues should be reduced by the estimated future costs of completing and disposing of the product, including maintenance and other PCS.
PCS revenues are often intended to recover not only capitalized costs, but also to fund the future development of upgrades and enhancements covered by the PCS arrangement. In applying the NRV test, it would be appropriate to include PCS revenues that have a capitalized cost recovery element.
However, if PCS revenues are included in the test, then those revenues should be reduced by the expected future costs of completing the upgrades or enhancements covered by the PCS arrangement. Future costs should include all costs that will be incurred to support the PCS arrangement and the costs of any upgrades that will be provided to the customer. ASC does not discuss the discounting of gross revenues unlike Step 2 in the impairment test for long-lived assets under ASC , Property, Plant, and Equipment—Overall which requires discounting.
Conceptually, costs of software to be sold, leased, or otherwise marketed are similar to inventory costs for non-software products.
ASC , Inventory—Overall does not discuss the discounting of inventory when performing the net realizable value test. As such, the NRV test for software to be sold, leased, or otherwise marketed should be performed on an undiscounted basis. Judgment will be required to determine whether additional costs incurred after general release to customers relate to product enhancements or maintenance and customer support. Product enhancements are explicitly included in the scope of ASC and may qualify for cost capitalization; maintenance and customer support are generally charged to expense when those costs are incurred.
The evaluations of whether costs are incurred relate to maintenance or enhancements is similar to that used for capital improvements. In general, costs for elements that can be marketed separately or create a new revenue stream can be capitalized as a product enhancement. For example, if a reporting entity commits to maintaining compatibility between its systems software and the related hardware, the costs of doing so would generally meet the definition of maintenance.
However, if an existing product is modified to run on a different type of hardware, thereby expanding the market for the product, this activity would generally be classified as product enhancement. Costs relating to product enhancement should be charged to expense until the technological feasibility of the enhancement is established.
Once established, capitalization and amortization of the product enhancement costs over the estimated life of the enhancement would be required. Software or data modifications are minor changes in either the software or data. The changes are not considered product enhancements, since they do not extend the life or improve the marketability of the product.
They usually relate to a specific customer's application of the product and would not require a product design. Technological feasibility may be more easily established for a product enhancement than for a new product, and capitalization of costs may, therefore, begin relatively earlier in the software development process.
For example, an enhancement that adds one function to an already successful product may require only minor modifications to the original product's detailed program design to establish technological feasibility. Similarly, in some cases, software that is ported made available for a different piece of hardware or operating system may not require a new detailed program design; thus, capitalization of the enhancement costs may begin once any high-risk development issues have been resolved.
Once a product enhancement has been completed, if the original product will no longer be separately marketed, any unamortized cost of the original product should be included with the cost of the enhancement for purposes of applying the NRV test and amortization provisions. If the original product will remain on the market along with the enhancement, an allocation of the unamortized cost of the original product between the original product and the enhancement will be necessary.
In other words, depending on whether the original product will remain on the market, two methods are commonly used in practice for the amortization of product enhancement costs. In this method, the costs of the initial product and the product enhancement are amortized separately. The initial software would continue to be amortized over its remaining useful life while the enhancement would be separately tracked and amortized over its own remaining useful life.
This method of amortization cannot be applied to other types of assets. Under the carryover method, the costs of the enhancement are added to the unamortized costs of the previous version and the combined amount is amortized over the remaining useful life of the new product. The estimated useful life of a product enhancement should be determined without reference to the estimated future revenue or economic life of the original product. Amortization of the costs of an enhancement that will be separately marketed follows the same model used for the original product.
ASC establishes technological feasibility as the threshold before software costs can begin to be capitalized. However, when the software is sold as firmware i. The accounting for software that is integral to the product is addressed in ASC ASC Software production costs for computer software that is to be used as an integral part of a product or process shall not be capitalized until both of the following conditions have been met:.
For an integrated product, even if technological feasibility has been established, software development costs should be expensed as incurred until all research and development for the integrated product are complete. For example, software may be developed that will be embedded in a semiconductor that in turn will be incorporated into a specific piece of hardware. If the semiconductor is not marketable as a stand-alone product, even though the technological feasibility of the software is evident, further software costs would continue to be subject to accounting under ASC , Research and Development , until the related hardware in which it will be sold is no longer in the development stage.
That may occur well after the point at which the software reached technological feasibility. This same notion is embodied in ASC , which addresses a software product that comprises various modules that are not sold separately as discussed in PPE 7.
Consistent with ASC , the detail program design or the working model of the entire product all modules linked together must be completed before software costs can be capitalized. Table of contents 7. Link copied. Related content 1 of. Examples 1 of. Effective date 1 of. Frequently asked questions 1 of. Industry insights 1 of. Subject matter experts 1 of. Table of contents.
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