Plan for new accounting rules on software costs moves forward

U.S. companies may need to report cash amounts tied to their software expenditures, more of which would be moved off corporate balance sheets under a forthcoming proposal to update decades-old accounting rules.

The Financial Accounting Standards Board voted Tuesday, 7-0, to propose requiring companies to report cash amounts tied to their software costs and help them determine when to expense or capitalize costs. The proposal is a scaled-back version of rule-making around these expenses.

Dissecting the proposal

The standard setter wants to require U.S. public and private companies to provide a line item in their cash-flow statement to account for cash spending on software. Rules around software costs have gone largely unchanged since the 1980s and 1990s.

The proposal would cover use of software ranging from enterprise resource planning systems to hosting services and mobile banking applications, meaning it applies to almost every company. It would exclude development of software licensed to customers.

Under the plan, companies would no longer have to evaluate the stage of their software project to determine whether to expense the costs on the income statement or to capitalize, or delay fully recognizing them, on the balance sheet. Companies are now required to expense their software costs as incurred on the income statement during the initial planning and post-implementation stages. When building the programs or applications, companies have to capitalize eligible costs. These current requirements involve significant judgment for companies, creating higher compliance costs.

Instead, companies would only have to determine when to begin capitalizing software costs based on executives’ signoff for a project and the likelihood that the project will be completed and the software will carry out its intended use.

“I’m supportive of moving forward by taking more software off the balance sheet, which I think is what we’re doing here,” FASB Chairman Rich Jones said.

If companies are unsure if they will complete the project, they would have to review any significant development uncertainties such as an unproven or unique software feature and hold off on capitalizing the related costs until those issues are resolved. When there are uncertainties, the development costs would be expensed on the income statement similar to research and development and not capitalized, resulting in less cost on the balance sheet. While this concept is already part of U.S. accounting rules, the proposal would specify that when uncertainties exist, the costs shouldn’t be reported as an asset.

Such changes would help companies account for a popular approach to software development known as agile development, in which they seek and incorporate user feedback early in the process to improve product features.

The FASB aims to issue a formal proposal by the end of the year and ask the public for feedback over a 90-day period, a spokeswoman said.

Why should companies care?

Despite the narrowing of the FASB’s focus, the proposal will still affect a swath of companies. “I have to imagine almost every preparer of U.S. financials is creating internal-use software in some way, shape or form,” said Scott Ehrlich, managing director at Mind the GAAP, an accounting training and consulting firm. “Today’s accounting standards don’t really do a great job of explaining how to account for that.”

Many companies have found it difficult to apply the existing model for internal use of software because they don’t have a tracking system in place to be able to gauge which stage they are in. The proposal could reduce companies’ efforts around tracking software costs.

The current rules lay out two different models depending on whether a company develops software or just uses it in its business, versus a single accounting model that was previously weighed.

Some tech companies were hoping for new accounting rules on licensing software. For example, design-software company Autodesk, in a 2021 letter to the FASB, said it experienced undue complexity in accounting for revenue-generating software development costs. “Existing guidance for software capitalization does not accurately reflect the reality of how software development occurs in practice today,” Chief Accounting Officer Stephen Hope said at the time. Autodesk didn’t immediately respond to a request for comment.

Scaling back

The proposed changes mark a significant walk-back from when the FASB added the project to its agenda in 2022. The accounting standard setter late last year was considering a single accounting model for all companies under which they would have had to expense over time all their direct software costs, starting when they deem a software project’s eventual completion to be probable and until they substantially have completed it.

The FASB in March decided not to change the accounting rules for companies that are developing software for license or sale. Its potential new rule would instead focus on specific improvements to the accounting for companies’ internal use of software, citing investor feedback indicating a lack of interest in significant increases in capitalization.

“It seems odd to me that the accounting that applies should depend on how the product is delivered to the customer. But, that said, I think we’ve back-doored a solution for those companies,” FASB board member Christine Botosan said Tuesday.