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UNDERSTANDING CAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS UNDERSTANDING CAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS

APPLICATION WATERFALL VS. AGILE
2.
DEVELOPMENT STAGE: METHODOLOGIES
Eligible costs during this stage include The choice of development methodology—
coding, testing, and customization required to whether waterfall or agile—affects how SaaS
meet external customer specifications. Costs providers manage and capitalize software
can be capitalized during the application development costs. BENEFITS AND CHALLENGES OF CHALLENGES:
development stage under certain conditions, ► SOFTWARE CAPITALIZATION FOR
particularly for SaaS providers developing Waterfall Methodology: Traditionally SAAS PROVIDERS ► Complexity in Amortization: Determining
used in software development, the
software for external sale or use. waterfall approach follows a linear BENEFITS: the appropriate useful life and amortization
► Writing and testing source code to ensure progression from requirements gathering method for SaaS software can be complex
functionality meets external customer through to deployment and maintenance. ► Enhanced Financial Metrics: Capitalizing due to evolving customer preferences and
requirements. Costs incurred during each phase software costs defers their impact on the technological advancements.
► Customizing features or integrating third- (e.g., design, coding, testing) can be income statement, potentially boosting ► Compliance and Reporting: Adhering
party services to enhance the software’s categorized more straightforwardly as reported profitability metrics over time. to GAAP guidelines and accurately
value proposition in the market. either capitalizable or expensable based documenting capitalizable costs require
on achieving specific milestones. ► Investor Appeal: Reporting higher meticulous record-keeping and internal
POST-IMPLEMENTATION ► net income through capitalization controls.
3. Agile Methodology: Agile’s iterative may enhance investor confidence and
STAGE: approach emphasizes flexibility and valuation of the SaaS provider and the ► Capitalization Thresholds: The application
responsiveness to customer needs carrying value of the asset may indicate development stages can be blurry, especially
Costs related to customer onboarding, through short development cycles or given how software is developed now as
support, and ongoing enhancements after sprints. Development costs under agile the technological prowess of the company opposed to 40 years ago. Distinguishing
software deployment are expensed as may be more challenging to capitalize, on a very surface-level review. between costs and efforts that meet the
incurred. as costs are incurred incrementally based ► Strategic Resource Allocation: Deferred capitalization thresholds will be tricky, at
► Providing customer training and support on ongoing improvements and customer expenses can be reinvested in marketing, best, if not seemingly impossible at times.
to ensure successful adoption and usage feedback rather than completing distinct customer acquisition, or further product
of the SaaS platform. project phases. innovation to drive growth.
► Iteratively improving the software based EXAMPLES OF CAPITALIZED
on customer feedback and market trends SOFTWARE COSTS FOR TO SUMMARIZE…
to maintain competitiveness. SAAS PROVIDERS
Examples include costs directly attributable For SaaS providers, proper capitalization of software development costs is essential
for financial transparency, investor confidence, and strategic decision-making. By
AMORTIZATION METHODOLOGY to external-use software development navigating the complexities of software capitalization with clarity and adherence to
and enhancement, which may qualify for regulatory guidelines, SaaS providers can optimize financial reporting, enhance market
Amortization of capitalized software costs capitalization: competitiveness, and sustain long-term growth in the dynamic tech industry landscape.
for SaaS providers is based on the software’s ► Licensing fees for third-party software None of this will be accomplished easily though. With nearly-obsolete accounting
expected revenue-generating life. Factors components integrated into the SaaS regulation definitions, an out of touch FASB, and so much data to review and assess
influencing useful life include technological platform. before forming conclusions, this is an extremely challenging area of GAAP to apply.
obsolescence, customer retention rates, Turn to professionals like us who can help educate and advise you as you try to properly
and market demand shifts impacting the ► Compensation for development teams implement these accounting rules. We can help.
software’s utility and value. This is an involved in coding, testing, and
estimate that just needs to be reasonable and customizing software features for external
based on something realistic and appropriate. customer needs. These developers
can be salaried or paid on a contract
basis. For salaried employees, related MATTHEW BURKE, CPA
payroll-related overhead should also be PARTNER
capitalized.
► Costs associated with securing intellectual
property rights or patents related to
proprietary software functionalities.
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