{"schema_version":2,"canonical_url":"https://asc.understandingaccounting.org/asc/985/20/#55-implementation-guidance-and-illustrations","source":"FASB Accounting Standards Codification, Basic View","usage":"Study and research edition. Verify current requirements with the official source. Summaries, enrichment, and tags are machine-generated study aids. Paragraph html preserves source markup; snippet is abbreviated. Pending content is not necessarily effective.","topic":"985","topic_title":"Software","subtopic":"985-20","subtopic_title":"Costs of Software to Be Sold, Leased, or Marketed","section":{"number":"55","label":"55 Implementation Guidance and Illustrations","anchor":"55-implementation-guidance-and-illustrations","is_sec":false,"groups":[{"block":null,"heading":"Implementation Guidance","paragraphs":[{"citation":"985-20-55-1","para":"55-1","html":"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.
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. 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.
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). 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). 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. 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.
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. To meet this Subtopic's criteria, the working model must meet all of the following conditions: - a
It must be operative.
- b
It must be in the same language as the product that will be marketed.
- c
It must be complete with all the major functions that were planned for the product.
- d
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. 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.
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. 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.
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.
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.
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. 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.
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. 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.
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. 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.
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.
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.
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: - a
The ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product
- b
The straight-line method over the remaining estimated economic life of the product including the period being reported on, pursuant to this Subtopic.
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.
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. Software, Inc. would make the following disclosure.
Software, Inc.'s policy is to amortize capitalized software costs by the greater of the following:
- a
The ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product
- b
The straight-line method over the remaining estimated economic life of the product including the period being reported on.
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.
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.
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.