Accounting for Internal-Use Software
Daniel J. Noll · Journal of accountancy online/Journal of accountancy · 1998
A reasonable way to report the benefits as assets. As with some other accounting standards, the conclusions in a recent AICPA AcSEC SOP may seem obvious. However, things are not always as they appear. In March 1998, AcSEC issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which re quires entities to capitalize certain internal-use software costs once certain criteria are met. The SOP applies to all nongovernment entities and must be adopted for fiscal years beginning after December 15, 1998, although earlier adoption is encouraged. The objective here is to focus not on the requirements of SOP 98-1 but, rather, on its intent in some of the tricky areas that will require management and auditor judgment. WHEN IS SOFTWARE FOR INTERNAL USE? For software to be considered for internal use, the SOP requires that during its development or modification no substantive plan exists or is being developed to market the software externally. If an entity has or is working on such a plan, it must account for the software costs in accordance with FASB Statement no. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (even if it also will use the software internally). Software costs capitalized under Statement no. 86 would almost certainly be less than costs capitalized under SOP 98-1. In fact, some have criticized this FASB statement for giving entities the ability to expense as incurred almost all costs of software to be marketed. SOP 98-1 emphasizes substance over form. An entity should not casually say it has or is developing a marketing plan simply to follow Statement no. 86. Rather, the entity must show it has or is working on a substantive plan to market the software. Because most well-managed companies look for ways to recoup internal-use software costs, routine studies and inquiries about recouping costs are not considered substantive marketing plans under the SOP. In those instances, entities should treat the software as internal use and follow the guidance in SOP 98-1. MARKETING INTERNAL-USE SOFTWARE During the development of internal-use software, an entity may decide to market the software to others. The SOP says the entity must apply Statement no. 86 to the existing balance of capitalized software costs and to future development costs to determine whether it can capitalize those future costs. An entity conceivably could follow SOP 98-1 in the early stages of development to capitalize more costs (and thus show less expense) and then, later in the development cycle, decide to sell the software. Such situations should be unusual occurrences. At the start of software development projects--which often cost millions of dollars--management normally has already determined whether it should market the resulting applications. Therefore, in most cases, an entity would apply SOP 98-1 or Statement no. 86 consistently from the start of the project. LEAVING THE PRELIMINARY PROJECT STAGE SOP 98-1 says an entity should expense costs it incurs during the preliminary project stage of software development as incurred. One typical activity an entity performs during this stage is determining whether the exists to develop the software. One might compare this to determining whether the and tools exist to build a state-of-the-art, high-tech manufacturing plant. If the does not exist to develop the internal-use software, a project would not leave the preliminary stage because it would be considered similar to a research and development effort. The existence of technology question is different from the issue of whether management believes it has the right talent to do the job or whether it will be able to fund the project in the event of cost overruns. Management rarely authorizes an internal-use software project without knowing whether the exists to develop the software. …