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Inception of Software Capitalization: Tracing Back to 1985
The Significance of FASB Statement No. 86 in Software Capitalization
The year 1985 marked a significant turning point in the world of accounting, particularly in the realm of software development costs. It was during this era that the Financial Accounting Standards Board (FASB) issued Statement No. 86, titled “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” This groundbreaking statement provided a clear direction for accountants, addressing a void that existed in accounting guidance related to internally developed software intended for sale. While general guidelines for accounting software were available, the specific intricacies associated with internally developed software were largely uncharted territory.
Transformative Growth in Accounting and Business Landscape
Fast forward over three decades to the present day, and the landscape of both accounting and business has undergone transformative growth. The acceleration of technological advancements has been paralleled by a rapid evolution in accounting standards to accommodate the changing dynamics of software. As the utilization of software has become more pervasive, an array of additional regulations and amendments has emerged to encompass the expanding range of software arrangements available in the market. Notably, the release of ASC 350, also known as “Intangibles – Goodwill and Others,” in 2015, marked a key milestone in the evolution of software accounting. This standard was introduced to address the intricacies of intangible assets and their treatment in financial reporting, slated for implementation beginning in 2016.
Refinement Driven by Stakeholder Engagement
Despite the issuance of new standards, the FASB remained committed to ensuring clarity in accounting practices. Stakeholders actively engaged in the accounting discourse, seeking further elucidation and guidance during the comment period and after the implementation of updated rules in 2016. Responding to these insights, the FASB took a proactive step by issuing an amendment to ASC 350-40 in 2018. This amendment, tailored specifically for internally used software, aimed to provide a comprehensive framework for its accounting treatment. The effective date for these updates was aligned with the fiscal years commencing after December 15, 2019, for public entities and subsequent interim periods. This implied that public entities adhering to the calendar year end adopted the revised ASC 350-40 as of January 1, 2020. Similarly, for non-public entities, the revised ASC 350-40 came into play for annual reporting periods commencing after December 15, 2020.
A Paralleled Journey: Software Capitalization for State and Local Governments
The journey of software capitalization for state and local governments bears semblance to that of the FASB. In June 2007, the Governmental Accounting Standards Board (GASB) introduced GASB 51, titled “Accounting and Financial Reporting for Intangible Assets.” This standard aimed to bring uniformity to the accounting treatment of software capitalization and provided a framework for organizations to account for intangible assets. However, the dynamic landscape of technology and the increasing reliance on software propelled the need for further standardization and clarity. Responding to this demand, GASB issued Statement No. 96 in 2020, addressing Subscription-based IT Arrangements. This statement, effective for fiscal years embarking after June 15, 2022, catered to the nuances of contracts pertaining to software services.
Diverse Facets of Software: A Holistic Perspective
The spectrum of software offerings has expanded remarkably, and concomitantly, the accounting treatment has evolved in tandem. When delving into the accounting treatment for software, it is crucial to consider three primary types:
In the nascent stages of software adoption, purchased software emerged as an intangible asset available for acquisition. Limited entities, such as HP and IBM, pioneered this domain, capitalizing on their expertise in computer technology. Software, initially distributed on floppy disks, held minimal intrinsic value, while the coded instructions it contained were considered intangible assets. Though the paradigm has shifted, and physical distribution is less prevalent, occasions arise when companies acquire off-the-shelf software. This nomenclature denotes instances where the software requires no customization for its utilization by the acquirer.
The treatment of purchased software within the realm of US Generally Accepted Accounting Principles (GAAP) entails its recognition on the balance sheet as an intangible asset at the acquisition cost. This asset is subsequently amortized over its economic or legal life, with the shorter of the two periods being selected. The economic life pertains to the duration over which the asset contributes to the organization’s cash flows, while the legal life corresponds to the contractual term. In cases where the asset exhibits an indefinite useful life, amortization is forgone, although periodic assessments of impairment are requisite.
Mirroring US GAAP, GASB designates computer software as an intangible asset owned by state and local governments. Under this directive, software is treated as a capital asset and reflected on the statement of financial position at its acquisition cost. Amortization occurs through a rational and systematic methodology, either over its useful life or, if deemed indefinite, the asset remains unamortized.
As technological familiarity grew and businesses relied increasingly on software, customization gained prominence. Organizations sought software tailored to their specific needs, whether by customizing purchased software or developing software in-house. To cater to these evolving needs, accounting guidelines were extended to encompass capitalization of development costs. Furthermore, with the proliferation of technology companies, standards emerged to address internally developed software intended for sale.
US GAAP’s Interpretation
In the annals of accounting history, the year 1985 stands as a significant milestone marking the inception of considerations surrounding the capitalization of software development costs. It was during this era that the Financial Accounting Standards Board (FASB) unleashed Statement No. 86, a groundbreaking directive titled “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” This seminal statement not only addressed an existing void in accounting standards but also laid the foundation for a structured approach to accounting for software development costs, particularly for internally developed software with commercial intent.
The passage of more than three decades has ushered in a period of dynamic transformation, not only in the technological realm but also in the intricate domain of accounting standards. The relentless march of technological advancement has been paralleled by the evolution of accounting regulations, adapting to the changing contours of the software landscape. As software’s pervasiveness has increased, the accounting profession has risen to the challenge, proactively releasing a series of regulations and amendments to embrace the burgeoning variety of software arrangements.
One of the significant milestones in this trajectory was the advent of ASC 350, titled “Intangibles – Goodwill and Others,” in early 201
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