ASC 985-20
Costs of Software to Be Sold, Leased, or Marketed
985 Software
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ASC 985-20 governs the accounting for costs of computer software to be sold, leased, or otherwise marketed, whether internally developed or purchased. All costs incurred to establish technological feasibility are research and development expensed as incurred (985-20-25-1); costs of producing product masters after technological feasibility is established are capitalized (985-20-25-3) and capitalization ceases when the product is available for general release (985-20-25-6). Capitalized amounts are amortized product-by-product at the greater of the revenue-ratio or straight-line amount (985-20-35-1) and are written down to net realizable value at each balance sheet date (985-20-35-4).
Key points (7)
- Technological feasibility is the dividing line: all costs before it are R&D expensed under Subtopic 730-10, and it is established only when the entity completes either the detail program design criteria in 985-20-25-2(a) or a completed, tested working model under 985-20-25-2(b); a working model must be operative, in the marketed language, complete with all major planned functions, and ready for initial customer testing (985-20-55-9).
- For software that is an integral part of a product or process, capitalization cannot begin until technological feasibility is established AND all R&D for the other components is complete (985-20-25-4); allocated indirect costs such as programmer overhead may be capitalized, but general and administrative expenses may not (985-20-25-5).
- Capitalization stops when the product is available for general release, and maintenance and customer support costs are expensed when the related revenue is recognized or when incurred, whichever is first (985-20-25-6).
- Purchased software with no alternative future use is capitalized only if the 985-20-25-2 criteria are met at the time of purchase; otherwise it is expensed as R&D, while purchased software with an alternative future use is capitalized on acquisition (985-20-25-8 through 25-10).
- Annual amortization begins when the product is available for general release and equals the greater of the current-to-total-anticipated gross revenue ratio or straight-line over remaining estimated economic life including the current period (985-20-35-1 through 35-3).
- At each balance sheet date unamortized capitalized costs are compared to net realizable value (estimated future gross revenues less estimated future costs of completing, disposing, maintaining, and supporting), the excess is written off, and the write-down is never restored (985-20-35-4).
- Amortization is charged to cost of sales, capitalized costs are presented as an other asset (an amortizable intangible), and disclosure must include unamortized software costs on each balance sheet and amortization plus write-downs charged to expense (985-20-45-1 through 45-2; 985-20-50-1); Topic 350's recognition rules do not apply but its presentation and disclosure rules do (985-20-45-3).
For students. Exam questions almost always turn on identifying the exact moment technological feasibility is reached — everything before is R&D expense, everything after (until general release) is capitalized. Common misunderstandings: thinking Topic 350's intangible impairment model applies (it does not; use the NRV test, and write-downs can never be reversed), assuming amortization is simply straight-line (it is the greater of straight-line or the revenue ratio), and confusing this Subtopic with 350-40 internal-use software.
technological feasibilitydetail program designworking modelproduct masternet realizable value testproduct enhancementhosting arrangementresearch and development costs
Machine-generated study aid for ASC 985-20. Check the source paragraphs below.
985-20-00Status
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985-20-00-1
The following table identifies the changes made to this Subtopic.
985-20-05Overview and Background
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985-20-05-1
This Subtopic specifies standards of financial accounting and reporting for the costs of computer software to be sold, leased, or otherwise marketed as a separate product or as part of a product or process, whether internally developed and produced or purchased.
985-20-05-2
This Subtopic identifies the costs incurred in the process of creating a software product that are research and development costs and those that are production costs to be capitalized, and it specifies amortization, disclosure, and other requirements.
985-20-15Scope and Scope Exceptions
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Overall Guidance
985-20-15-1
This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Section 985-10-15, with specific transaction qualifications and exceptions noted below.
Transactions
985-20-15-2
The guidance in this Subtopic applies to the costs, including costs incurred after the date of a business combination or a combination accounted for by a not-for-profit entity, of computer software to be sold, leased, or otherwise marketed as a separate product or as part of a product or process, whether internally developed and produced or purchased.
985-20-15-3
The guidance in this Subtopic does not apply to the following transactions and activities:
- aSoftware developed or obtained for internal use (see Subtopic 350-40).
- bResearch and development assets acquired in a business combination, acquired in an acquisition by a not-for-profit entity, or recognized by a joint venture upon formation. If tangible and intangible assets acquired in those combinations are used in research and development activities, they are recognized and measured at fair value in accordance with Subtopic 805-20.
- cArrangements to deliver software or a software system, either alone or together with other products or services, requiring significant production, modification, or customization of software (see the guidance on costs to fulfill a contract in Subtopic 340-40).
Other Considerations
985-20-15-4
As used in this Subtopic, the terms computer software product, software product, and product encompass a computer software program, a group of programs, and a product enhancement.
Software Subject to a Hosting Arrangement
985-20-15-5
The software subject to a hosting arrangement is within the scope of this Subtopic only if both of the following criteria are met:
- aThe customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.
- bIt is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.
985-20-15-6
For purposes of criterion (a) in paragraph 985-20-15-5, the term significant penalty contains two distinct concepts:
- aThe ability to take delivery of the software without incurring significant cost
- bThe ability to use the software separately without a significant diminution in utility or value.
985-20-15-7
If the software subject to a hosting arrangement never meets the criteria in paragraph 985-20-15-5, then the software is utilized in providing services and is not within the scope of this Subtopic and, therefore, the development costs of the software should be accounted for in accordance with Subtopic 350-40 on internal-use software (see also paragraph 985-20-55-2).
985-20-25Recognition
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Research and Development Costs of Computer Software
985-20-25-1
All costs incurred to establish the technological feasibility of a computer software product to be sold, leased, or otherwise marketed are research and development costs. Those costs shall be charged to expense when incurred as required by Subtopic 730-10.
985-20-25-2
For purposes of this Subtopic, the technological feasibility of a computer software product is established when the entity has completed all planning, designing, coding, and testing activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. At a minimum, the entity shall have performed the activities in either (a) or (b) as evidence that technological feasibility has been established:
- a If the process of creating the computer software product includes a detail program design, all of the following:
- 1 The product design and the detail program design have been completed, and the entity has established that the necessary skills, hardware, and software technology are available to the entity to produce the product.
- 2 The completeness of the detail program design and its consistency with the product design have been confirmed by documenting and tracing the detail program design to product specifications.
- 3 The detail program design has been reviewed for high-risk development issues (for example, novel, unique, unproven functions and features or technological innovations), and any uncertainties related to identified high-risk development issues have been resolved through coding and testing.
- 1
- b If the process of creating the computer software product does not include a detail program design with the features identified in (a), both of the following:
- 1 A product design and a working model of the software product have been completed.
- 2 The completeness of the working model and its consistency with the product design have been confirmed by testing.
- 1
Production Costs of Computer Software
985-20-25-3
Costs of producing product masters incurred subsequent to establishing technological feasibility shall be capitalized. Those costs include coding and testing performed subsequent to establishing technological feasibility.
985-20-25-4
Software production costs for computer software that is to be used as an integral part of a product or process shall not be capitalized until both of the following conditions have been met:
- a Technological feasibility has been established for the software.
- b All research and development activities for the other components of the product or process have been completed.
985-20-25-5
An entity may capitalize an allocated amount of indirect costs, such as overhead related to programmers and the facilities they occupy. However, an allocation of general and administrative expenses is not appropriate because those costs relate to the period in which they are incurred.
985-20-25-6
Capitalization of computer software costs shall cease when the product is available for general release to customers. Costs of maintenance and customer support shall be charged to expense when related revenue is recognized or when those costs are incurred, whichever occurs first.
Purchased Computer Software
985-20-25-7
Some entities purchase software as an alternative to developing it internally. Purchased computer software may be modified or integrated with another product or process.
985-20-25-8
The cost of purchased computer software to be sold, leased, or otherwise marketed that has no alternative future use shall be accounted for the same as the costs incurred to develop such software internally, as specified in paragraphs .
985-20-25-9
An entity shall capitalize the total cost of purchased software that has no alternative future use if the criteria specified in paragraph 985-20-25-2 are met at the time of purchase. Otherwise, the cost will be charged to expense as research and development. For example, if the technological feasibility of a software product as a whole (that is, the product that will be ultimately marketed) has been established at the time software is purchased, the cost of the purchased software shall be capitalized and further accounted for in accordance with the other provisions of this Subtopic. The cost of software purchased to be integrated with another product or process shall be capitalized only if technological feasibility is established for the software component and if all research and development activities for the other components of the product or process are completed at the time of purchase.
985-20-25-10
If purchased software has an alternative future use, the cost shall be capitalized when the software is acquired and accounted for in accordance with its use. The alternative future use test also applies to purchased software that will be integrated with a product or process in which the research and development activities for the other components are not complete.
Inventory Costs
985-20-25-11
For guidance on costs incurred for duplicating the computer software, documentation, and training materials from product masters and for physically packaging the product for distribution, see Subtopic 985-330.
Funded Software-Development Arrangements
985-20-25-12
A funded software-development arrangement within the scope of Subtopic 730-20 shall be accounted for in conformity with that Subtopic. If the technological feasibility of the computer software product pursuant to the provisions of this Subtopic has been established before the arrangement has been entered into, Subtopic 730-20 does not apply because the arrangement is not a research and development arrangement. If capitalization of the software-development costs commences pursuant to this Subtopic and the funding party is a collaborator or a partner, any income from the funding party under a funded software-development arrangement shall be credited first to the amount of the development costs capitalized. If the income from the funding party exceeds the amount of development costs capitalized, the excess shall be deferred and credited against future amounts that subsequently qualify for capitalization. Any deferred amount remaining after the project is completed (that is, when the software is available for general release to customers and capitalization has ceased) shall be credited to income. If the counterparty is a customer, the entity shall apply the guidance of Topic 606 on revenue from contracts with customers.
985-20-35Subsequent Measurement
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Amortization of Capitalized Software Costs
985-20-35-1
Capitalized software costs shall be amortized on a product-by-product basis. The annual amortization shall be the greater of the amounts computed using the following:
- aThe ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product
- bThe straight-line method over the remaining estimated economic life of the product including the period being reported on.
985-20-35-2
Because a net realizable value test, which considers future revenues and costs, must be applied to capitalized costs (see paragraph 985-20-35-4), amortization shall be based on estimated future revenues. In recognition of the uncertainties involved in estimating revenue, amortization shall not be less than straight-line amortization over the product's remaining estimated economic life.
985-20-35-3
Amortization shall start when the product is available for general release to customers.
Net Realizable Value of Capitalized Software Costs
985-20-35-4
At each balance sheet date, the unamortized capitalized costs of a computer software product shall be compared to the net realizable value of that product. The amount by which the unamortized capitalized costs of a computer software product exceed the net realizable value of that asset shall be written off. The net realizable value is the estimated future gross revenues from that product reduced by the estimated future costs of completing and disposing of that product, including the costs of performing maintenance and customer support required to satisfy the entity's responsibility set forth at the time of sale. The reduced amount of capitalized computer software costs that have been written down to net realizable value at the close of an annual fiscal period shall be considered to be the cost for subsequent accounting purposes, and the amount of the write-down shall not be subsequently restored.
985-20-45Other Presentation Matters
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985-20-45-1
Because amortization expense of capitalized software costs relates to a software product that is marketed to others, the expense shall be charged to cost of sales or a similar expense category.
985-20-45-2
In an entity's balance sheet, capitalized software costs having a life of more than one year or one operating cycle shall be presented as an other asset because the costs are an amortizable intangible asset.
985-20-45-3
The accounting requirements of Topic 350 do not apply to capitalized software costs. However, the presentation and disclosure requirements of that Topic do apply to capitalized software costs.
985-20-50Disclosure
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985-20-50-1
Both of the following shall be disclosed in the financial statements:
- aUnamortized computer software costs included in each balance sheet presented.
- bThe total amount charged to expense in each income statement presented for both of the following:
- 1Amortization of capitalized computer software costs
- 2Amounts written down to net realizable value.
- 1
985-20-50-2
Paragraph 350-30-15-3 requires that an entity apply the disclosure requirements of paragraphs to capitalized software costs. Paragraph 730-10-50-1 requires that disclosure be made in the financial statements of the total research and development costs charged to expense in each period for which an income statement is presented and states that such disclosure shall include research and development costs incurred for a computer software product to be sold, leased, or otherwise marketed.
985-20-55Implementation Guidance and Illustrations
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Implementation Guidance
985-20-55-1
A software product is most easily defined by describing its necessary qualities. As a product, it is complete and has exchange value. As software, it is a set of programs that interact with each other. A program is further defined as a series of instructions or statements that cause a computer to do work.
985-20-55-2
If the entity never sells, leases, or licenses the software (that is, the software meets the criteria in paragraph 985-20-15-5), then the software is used in providing services and the development costs of the software should be accounted for in accordance with Subtopic 350-40. However, if during such software's development or modification (accounted for in accordance with Subtopic 350-40), the entity develops a substantive plan to sell, lease, or otherwise market the software externally, the development costs of the software should be accounted for in accordance with this Subtopic (985-20). Paragraph 350-40-35-7 provides guidance if, after the development of internal-use software is completed, an entity decides to market the software.
985-20-55-3
The costs of software that is marketed as part of a product or process are included in the scope of this Subtopic. Software is sometimes embedded in a product and sold as part of the product as a whole. Examples are calculators and robots. This type of software is sometimes known as firmware. Also, some services provided to customers would not be possible without software. Time-sharing and service bureaus are two straightforward examples.
985-20-55-4
Paragraph 985-20-25-2 specifies the minimum activities an entity should have performed as evidence that technological feasibility has been established, by either inclusion of a detail program design or completion of a working model. However, an entity may need to defer capitalization until after meeting the working model criteria in paragraph 985-20-25-2(b), even though technological feasibility had previously been established by meeting the detail program design criteria in paragraph 985-20-25-2(a).
985-20-55-5
Paragraph 985-20-25-2(a) specifies three criteria relating to the detail program design to be satisfied before capitalization begins. Entities whose software product process fits the description in that paragraph should look to that paragraph for the applicable technological feasibility criteria. However, if the three criteria in that paragraph are not met until a working model is completed, this Subtopic requires capitalization to begin upon completion of the working model and satisfaction of the other criteria in paragraph 985-20-25-2(b).
985-20-55-6
Management shall not require more stringent criteria than specified in paragraph 985-20-25-2 to begin capitalizing software production costs. One of the purposes of this Subtopic is to identify an objective point in the software product process at which research and development activities end and production activities begin. If management were to modify the Subtopic's criteria or impose additional criteria of its own, this objective would be thwarted.
985-20-55-7
When a product comprises various modules that are not separately saleable, technological feasibility is established for the product as a whole, not on a module-by-module basis. The detail program design or the working model of the entire product (all modules linked together) must be completed before capitalization.
985-20-55-8
Some entities in the software industry use the term working model to mean a prototype in which critical parts of the product have been coded or written in pseudocode. This definition of working model does not meet the criteria in paragraph 985-20-25-2(b). This Subtopic defines a working model as having several key characteristics not found in that description of a prototype.
985-20-55-9
To meet this Subtopic's criteria, the working model must meet all of the following conditions:
- aIt must be operative.
- bIt must be in the same language as the product that will be marketed.
- cIt must be complete with all the major functions that were planned for the product.
- d
985-20-55-10
A high-risk development issue may arise after an entity has established technological feasibility by meeting the criteria in paragraph 985-20-25-2. The previously capitalized costs and the costs to resolve the high-risk development issue should be accounted for as a change in accounting estimate in accordance with paragraph 250-10-45-17. That paragraph states that changes in accounting estimates result from new information. The discovery of a high-risk development issue after the entity's personnel thought technological feasibility was established meets this definition. Any previously capitalized costs for that product, as well as any additional costs incurred to establish technological feasibility, should be charged to expense as research and development until the criteria in paragraph 985-20-25-2 are met.
985-20-55-11
When selling systems software, an entity may promise to keep the software current with revisions in the hardware, and incur costs in connection with this service.
985-20-55-12
This activity appears to meet the definition of maintenance because it keeps the product updated with current information. The cost of maintenance is charged to expense when related revenue is recognized or when those costs are incurred, whichever occurs first. The distinctions among maintenance, customer support, and product enhancements are sometimes very fine lines; in each case, the particular circumstances and intentions of the entity should be evaluated in light of the definitions in this Subtopic for each activity.
985-20-55-13
An entity may purchase software that will be integrated into another software or hardware product. Assuming that purchased computer software has no alternative future use, its costs can be capitalized only if the technological feasibility of the product to be ultimately marketed has been established at the time of purchase. Such factors as the timing of receipt or the status of hardware and internal software development may be crucial in determining whether technological feasibility is established at the time of purchase.
985-20-55-14
An entity may purchase software before technological feasibility has been established. For example, an entity purchases software for $100,000 that can be resold for $75,000. The amount of $25,000 would be charged to research and development, and $75,000 would be capitalized. If the software product reached technological feasibility, the $75,000 would be included in the cost of the software product. If the technological feasibility of the software was never established, the $75,000 would be classified as inventory.
985-20-55-15
Estimates of future revenues or the remaining economic life for a product may change over the period in which the software product is being amortized. Amortization for any asset is based on estimates of future events, and software is no exception. The most recent information should be used to determine if changes to estimates should be made.
985-20-55-16
Paragraph 985-20-35-1 indicates that straight-line amortization of a software product is computed over the remaining estimated economic life of the product. As such, the unamortized cost of the product should be divided by its remaining life, including the current year.
985-20-55-17
If the completed software product does not include all features that had originally been planned, the accounting depends on an evaluation of the modified product. If the product is saleable without the features that were dropped, no specific accounting is required. The net realizable value test controls the amount of capitalized costs. Application of the net realizable value test may result in a writeoff of some or all of the product's capitalized costs. If the product is not saleable without the dropped features, the technological feasibility of the product is not established.
985-20-55-18
Costs incurred for product enhancements should be charged to expense as research and development until the technological feasibility of the enhancement has been established. If the original product will no longer be marketed, any unamortized cost of the original product should be included with the cost of the enhancement for purposes of applying the net realizable value test and amortization provisions. If the original product will remain on the market along with the enhancement, the unamortized cost of the original product should be allocated between the original product and the enhancement.
985-20-55-19
The estimated useful life of a product enhancement is the estimated life of the enhancement. It is not the remaining life of the original product nor is it the remaining life of the original product for any costs of the original product included in the enhancement and the estimated life of the enhancement for all other costs. All costs of a product enhancement, including any costs carried over or allocated from the original product, should be amortized over the enhancement's estimated useful life.
985-20-55-20
The technological feasibility criteria in paragraph 985-20-25-2 must be met for a product enhancement if the criteria had been met for the original product.
985-20-55-21
Product enhancements are specifically included in the scope of this Subtopic and, as such, are subject to the same requirements as any other software product. However, technological feasibility may be more easily established for a product enhancement than for a new product, and capitalization of costs may, therefore, begin relatively earlier in the software process. For example, an enhancement that adds one function to an already successful product may require only minor modifications to the original product's detail program design to establish technological feasibility.
985-20-55-22
Similarly, in some cases, software that is ported (made available for a different piece of hardware) may not require a new detail program design, and capitalization of the enhancement costs may begin once any high-risk development issues have been resolved.
Illustrations
985-20-55-23
This Example illustrates the application of the disclosure requirements of Topic 275 to risks and uncertainties related to capitalized software costs. This Example has the following assumptions.
985-20-55-24
Software, Inc. develops and markets computer programs. In 20X3, it acquired a software entity. A significant portion of the purchase price was allocated to (capitalized) Product A (present net book value of $5 million), the most significant and profitable software program currently being marketed by the acquired entity. Only nominal amounts of other software costs have been capitalized. Software, Inc. expects Product A and its derivatives to be among its most significant products over the next several years. However, a competitor has recently released a new product designed to compete directly with Product A. Software, Inc. amortizes the capitalized software costs of Product A by the greater of the following:
- aThe ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product
- bThe straight-line method over the remaining estimated economic life of the product including the period being reported on, pursuant to this Subtopic.
985-20-55-25
The amount of the amortization computed for the year 20X4 was equal to 20% of the beginning-of-the-year capitalized amount and was a significant component of cost of sales.
985-20-55-26
The segment of the computer software industry in which Software, Inc. operates is characterized by sales of products occurring primarily on the basis of customers' perceptions of the relative technical merits of competing products. Those perceptions are greatly influenced by product reviews in technical journals and advertising, and they can change rapidly. Innovative products have been introduced in recent years that have reduced quickly and significantly the volume of sales of preexisting products in the same market niche. While management of Software, Inc. believes its estimates of future gross revenues and the estimated economic life of Product A used in the determination of the amortization of capitalized software costs are reasonable, new products introduced by its competitors, such as the one discussed in paragraph 985-20-55-24, could have a significant near-term negative effect on such estimates. As a result, the amount of periodic amortization could increase in the near term in amounts that could be material to the entity's financial statements.
985-20-55-27
Software, Inc. would make the following disclosure.
- Software, Inc.'s policy is to amortize capitalized software costs by the greater of the following:
- aThe ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product
- bThe straight-line method over the remaining estimated economic life of the product including the period being reported on.
- a
- It is reasonably possible that those estimates of anticipated future gross revenues, the remaining estimated economic life of the product, or both will be reduced significantly in the near term [due to competitive pressures]. As a result, the carrying amount of the capitalized software costs for Product A ($5 million) may be reduced materially in the near term.
985-20-55-28
In this Example, the entity acknowledges that the carrying amount of its capitalized software costs is subject to significant uncertainty. The uncertainty relates to estimates of future years' revenues and useful lives that are made at the date of the financial statements, and the entity is aware that circumstances exist that could cause such estimates to change in the near term. The entity's disclosure makes clear that it is at least reasonably possible that the carrying amount could be reduced in the near term.
985-20-55-29
If the amortization policy in the preceding illustrative disclosure is already disclosed elsewhere in the notes, it need not be repeated. The reference in brackets to competitive pressures in the preceding illustrative disclosure is an example of voluntary disclosure of factors that cause the estimate to be sensitive to change that is encouraged by paragraph 275-10-50-9.
985-20-60Relationships
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Intangibles—Goodwill and Other
985-20-60-1
For guidance to help determine whether software is developed for internal use or is subject to a plan to be marketed externally, see paragraphs 350-40-15-2 through 15-2C and 350-40-15-5.
Research and Development
985-20-60-2
For the application of Subtopic 730-10 to costs incurred to purchase or lease computer software developed by others, see paragraph 730-10-25-3.
Software
985-20-60-3
For software-development arrangements that are fully or partially funded by a party other than the vendor that is developing the software and for which technological feasibility of the computer software product has not been established before entering into the arrangement, see Subtopic 730-20 on research and development arrangements.