Accounting for the Development Costs of Internal-Use Software

ABSTRACT:

In this paper, we evaluate accounting practices for internal-use software expenditures. Statement of Position 98-1 (SOP 98-1) requires that certain costs be expensed, while others are capitalized. We argue that current accounting practice does not go far enough with regard to capitalization, in that costs incurred during the systems analysis stage of model-based systems development are expensed, regardless of whether they create estimable future benefits through model and object reuse. This quest for uniformity in accounting treatment in the form of a single rule for multiple economic phenomena (i.e., treating all systems acquisition and development methods in the same manner) results in reduced flexibility to reflect genuine economic differences between various systems acquisition and development methods. To illustrate this, we provide an example of the differential effects of adopting SOP 98-1 for firms using different development approaches. Under the SOP, “Analysis” costs are expensed. Under model-based approaches, especially those with downstream effects, these Analysis costs are inherently assets, since the raison d'etre of these approaches is the ability to re-use models and objects developed in Analysis. Furthermore, since these costs tend to be relatively higher for companies leveraging these models and objects, the SOP has the effect of ignoring the future value associated with these models and objects. We propose a solution that is both principles-based and sets forth a framework specifying the conditions under which capitalization or expensing should occur for internally developed software.

Keywords: intangible assets; internal-use software; principles-based standards; Statement of Position 98-1; SOP 98-1; software capitalization; systems development life cycle