FASB proposes update on accounting for internal software development

The Financial Accounting Standards Board issued a proposed accounting standards update Tuesday to update the guidance on accounting for software, specifically when it comes to developing software for a company’s internal use. 

The changes come in response to changes in how software is developed. When FASB originally issued its software accounting guidance, companies developing software generally followed a prescriptive and sequential development method. Since that time, many companies have adopted a more incremental and iterative development method (such as agile development). As a result, many stakeholders pointed to the challenges of applying the current internal-use software accounting requirements that don’t specifically address software developed using an incremental and iterative method, which has led to diversity in practice in determining when to begin capitalizing software costs.

“During our 2021 agenda consultation, stakeholders expressed the desire for updated accounting guidance that better aligns with how software is developed,” said FASB chair Richard Jones in a statement. “The FASB’s proposed changes are intended to improve the operability of the recognition guidance considering different methods of software development.”

Based on the feedback, the proposed ASU would remove all references to a prescriptive and sequential software development method (referred to as “project stages”) throughout Subtopic 350-40, Intangibles—Goodwill and Other—Internal-Use Software. The proposed amendments would specify that a company would be required to start capitalizing software costs when both of the following occur:

• Management has authorized and committed to funding the software project.
• It is probable that the project will be completed and the software will be used to perform the function intended (referred to as the “probable-to-complete recognition threshold”).

In evaluating the probable-to-complete recognition threshold, a company may need to consider whether there’s significant uncertainty associated with the development activities of the software.

The proposed amendments also would require a company to separately present cash paid for capitalized internal-use software costs as investing cash outflows in the statement of cash flows.

The proposed ASU, includes information on how to submit comments. FASB is asking its stakeholders to review and provide comments on the proposed ASU by Jan. 27, 2025.