Accounting for Costs in Agile Software Development

In the ever-evolving landscape of software development, Agile methodology has taken center stage. Agile software development is an adaptive approach that emphasizes flexibility, integrated customer involvement, and speed. It’s a paradigm shift from the traditional waterfall model, which involved extensive upfront planning. In this article, we’ll explore the nuances of accounting for costs incurred in the application of Agile software development and its impact on finance and accounting functions.

Understanding Agile Software Development

Agile methods are based on iterative and incremental development, where requirements and solutions evolve through collaboration between self-organizing, cross-functional teams. Unlike the traditional waterfall method, Agile doesn’t require an extensive project plan before commencing work. Instead, it uses time-bound increments known as “sprints.”

During these sprints, teams plan smaller-scale development goals, work for two to three weeks, evaluate progress, recalibrate, and repeat. The product is delivered at the end of each sprint, making it more adaptable to change. Agile focuses on identifying and addressing issues promptly, ensuring the project aligns with the overall goal.

Impact on Finance and Accounting

One of the primary challenges when transitioning to Agile development is the impact on finance and accounting. Traditional finance funding models rely on annual budgeting, which is incompatible with the iterative and incremental nature of Agile.

In Agile, development activities may rapidly move through different phases, making it challenging to identify costs specific to application development. Under U.S. GAAP, technology development costs should be capitalized only during the application development phase. Failing to do so may lead to incorrect accounting for these costs.

Determining Capitalizable Costs

To ensure appropriate accounting, users of Agile software development should be familiar with key Codification topics:

1. ASC 985-20, Software: Costs of Software to Be Sold, Leased, or Marketed

   • For software developed for external use (e.g., software to be sold), all costs incurred to establish technological feasibility must be expensed as research and development expenses. Costs after the establishment of technological feasibility should be capitalized.

2. ASC 350-40, Intangibles — Goodwill and Other: Internal-Use Software

   • Internal-use software development involves distinguishing costs incurred during different project stages. Some costs, like payroll-related costs and applicable interest, should be capitalized.

3. ASC 350-50, Intangibles — Goodwill and Other: Website Development Costs

   • Costs associated with website development should be accounted for according to the project stage at which they are incurred.

Identifying the costs to be capitalized and the technology development phase they belong to is essential for accurate accounting.

Key Accounting and Reporting Challenges

The Agile environment presents unique challenges for accounting and reporting:

1. Cost Tracking

   • All costs incurred in Agile software development need to be meticulously tracked. This includes payroll-related costs, third-party service fees, costs for inputs from third parties, and travel expenses.

2. Amortization

   • Assets established upon capitalization must be amortized once the developed technology is ready for use. Agile’s iterative nature and various units of account can complicate amortization.

3. Impairment and Abandonment

   • Identifying the appropriate unit of account is crucial for assessing impairment and abandonment of capitalized costs. Agile’s real-time development and testing may lead to more frequent impairment or abandonment events.

Internal Controls Over Financial Reporting

Entities using Agile development should evaluate their internal controls:

1. Cost Tracking and Capitalization

   • These processes should be carried out by knowledgeable personnel, and training is essential for accurate time tracking and cost classification.

2. Evidence Maintenance

   • Keeping all evidence to prove the accuracy and completeness of time tracking is vital.

3. Oversight and Accountability

   • Implementing appropriate oversight and accountability measures ensures that internal controls are in place to identify and mitigate risks.

Conclusion

The transition to Agile software development brings about significant changes in the way we account for costs. Adapting to this new landscape is crucial for accurate financial reporting and efficient project management. Agile’s flexibility and adaptability can be harnessed effectively with a sound understanding of the associated accounting challenges.