Internal-Use Computer Software

Internal-Use Computer Software:
The Fixed Asset of the Information Age

By   Philip D. Ameen and Daniel J. Noll

Philip D. Ameen is chairman of the internal-use software costs task force .
Daniel J. Noll is technical manager, AICPA accounting standards .

H ow should an entity account for the costs of computer software used internally? Don't look for any financial accounting standards on the topic-they aren't there. That situation is on the verge of change, however. The American Institute of CPAs accounting standards executive committee has issued an exposure draft of a Statement of Position, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The ED applies to all entities except governmental.

Accounting practices for internal-use software are diverse as a result of a lack of authoritative guidance and escalating costs totaling billions of dollars annually. Some entities expense all costs as incurred, some capitalize most costs and some capitalize the costs of purchased internal-use software but expense costs of internally developed internal-use software. None of these entities is necessarily violating any standards.

In 1994, the staff of the Securities and Exchange Commission asked the Financial Accounting Standards board emerging issues task force (EITF) to develop financial reporting guidance for internal-use software. The EITF, FASB and AcSEC concluded that AcSEC should handle the project because it was able to provide the necessary due process, including exposure for public comment, that such a broad project warrants.

Relationship to existing standards

The ED basically follows a fixed asset accounting model with what may become an exception for some entities: The ED does not allow entities to capitalize indirect costs such as overhead. The draft recognizes that certain costs incurred for software developed internally are research and development costs and that such costs must be expensed as incurred in accordance with FASB Statement no. 2, Accounting for Research and Development Costs. Similarly, certain costs incurred for fixed assets constructed internally might be R&D costs.

Like FASB Statement no. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed , the ED strives to help entities determine when a project is in an R&D phase. However, the SOP would require capitalization of non-R&D costs at an earlier stage of the software development cycle than Statement no. 86 does.

Software as an asset
AcSEC concluded that certain non-R&D costs of internal-use software should be recorded as assets. Entities use software often for the same purposes they use other long-lived assets: to reduce costs, operate more efficiently, improve internal controls, service customers better and gain competitive advantages. In fact, some would argue that as society moves farther away from the industrial age and into the information age, computer software is a more important asset to many entities than a fixed asset.However, reporting internal-use software costs as assets would have its price. For example, an entity would have to devote resources to tracking and monitoring capitalizable costs. These costs might be especially high in the telecommunications industry, for instance, where internal-use software is common. As a result, the ED asks respondents to comment on whether the benefits of recording internal-use software as assets exceed the costs of such reporting.

AcSEC recognizes a widespread belief that entities need to do a better job of reporting intangible assets. Recent studies show the market values of some entities exceed their book values several times over, possibly because the market values reflect intangibles that are not reported on the balance sheet. We believe internal-use software is one such asset that deserves balance sheet recognition, and AcSEC wants to know what CPAs and other interested parties think.

Main provisions
The ED has the following provisions:

  • Software meeting the characteristics specified in the SOP is internal-use software.
  • Except as stated in the sentence following, these items should be capitalized as long-lived assets: external direct costs of materials and services consumed in developing or obtaining internal-use software; payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal-use software project (to the extent of the time spent directly on the project); and interest costs incurred in developing software for internal use. R&D computer software costs should be expensed as they are incurred in accordance with the provisions of FASB Statement no. 2.
  • Training costs included in the purchase price of software should be expensed as incurred. Maintenance fees included in the purchase price should be recognized as an expense over the maintenance period.
  • Impairment should be recognized and measured in accordance with the provisions of FASB Statement no. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of .
  • The costs of computer software developed or obtained for internal use that are capitalized should be amortized over the software's estimated useful life in a systematic and rational manner.
  • Proceeds received from the sale of software developed or obtained for internal use should be applied against the carrying amount of that software. No profit should be recognized until aggregate proceeds from sales exceed the carrying amount of the software.

One free copy of the ED (product no. 800108JA) may be ordered from the AICPA order department at 800-862-4272. It is also on the Accountants Forum in the accounting library and on the AICPA Web site in the accounting standards area. Comments are due by April 17.


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