In today’s digital sphere, software companies often deal with the problem of high software development costs. The one question that they always wonder about is whether to capitalize the costs or try to expense them. There are multiple factors that affect the internal and external costs of developing software. Software companies need to take all these factors into consideration.
One of the first things that software firms need to consider, is the type of software that they are required to develop. In general, software companies either develop software for internal use or for the purpose of selling, leasing or marketing. Here we have listed all the important points that you need to be mindful, prior to accounting cost.
A lot of software companies create software to use within the company. When it comes to deciding whether to capitalize or expense the cost, the accounting standards can be quite straightforward.
Stages of internal-use software
Ideally, they divide the process of internal-use software development into three different stages.
- The first stage is the preliminary project stage. During this stage, the software firm performs multiple tasks such as allocation of resources, determination of the system requirements and technology as well as weighing the pros and cons of building software or buying one from another company. These are the tasks that are covered during the preliminary project stage. As per the accounting norms all the costs, whether internal or external, that incur during this stage need to be expensed instead of capitalized.
- The second stage is the application development stage during which plenty of tasks like designing, coding, as well as testing are taken care of. Additionally, the installation of hardware is another important task that the software company needs to perform during this stage. Unlike the costs that incur during the preliminary project stage, the costs of the application development stage need to be capitalized. In order to make sure that the costs do not exceed the previously set amount, the costs of performing various tasks like converting data should be expensed instead of capitalized.
- The third stage is the post-implementation stage. This is the stage that occurs after the software has been developed. A wide array of tasks is performed during this stage including training and maintenance. Unlike the second stage, the costs of this stage need to be expensed to ensure the total costs do not exceed the budget.
Software firms need to be mindful of the costs that are expensed and capitalized. Typically, the only costs that qualify for capitalization are the ones that are incurred during the stage in which the application is developed. The higher management of the software firms is involved with the capitalization of the costs. Funds are allocated only to the costs that are authorized by the professionals holding higher management positions. Most firms do not capitalize on general expenses that incur during the software development stage.
Proper accounting treatment is essential for the exact fund allocation. Everything from the training costs to the general expenses that incur during the software development stage needs to be monitored. As it is critical to get the right type of costs expensed and capitalized.
Software developed for leasing, selling, and marketing
Software companies that develop software for the purpose of leasing, selling or marketing need to pay attention to the time when the project attained technological feasibility. As the term suggests, this is the time when the research has been completed and the software development stage has come to an end.
The costs that incur prior to the achievement of technological feasibility are expensed, while a lot of the costs that incur post the technological feasibility stage are to be capitalized. However, not all costs can qualify for capitalization. As per the accounting rules, few costs like programmers’ compensation, testing expenses, direct production costs qualify for capitalization.
Web development costs
As per the accounting rules, the cost of developing a website as well as the cost incurred for the purpose of maintaining the website should be capitalized. Whether you are developing software for internal use or for leasing, selling, and marketing purposes, the costs are divided as per the stages.
Stages of web development costs
As per the experts, the web development stage is divided into the planning stage, application and infrastructure development stage, and graphics development stage. Aside from these, there are two other stages for which the costs need to be either expensed or capitalized.
- During the first stage, which is the planning stage, all types of costs are expensed.
- The application stage involves a variety of tasks such as the creation of the website as well as designing its layout.
- The costs that occur during the application and infrastructure development stage need to be capitalized. This is quite like the process of dividing the costs during the second stage of developing internal-use software.
- The costs of the graphics development stage need to be accounted for as capitalized while the costs that occur during the content development stage are required to be entered as expensed.
- Lastly, the costs that occur during the operating stage of developing software for selling, leasing, and marketing should be entered as expensed.
Software companies that follow these accounting rules to divide the costs that incur during the various stages of developing software can take care of the price. It is critical to follow the accounting norms while deciding which costs to capitalize on.