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‘Literally all’ software costs will be addressed under new FASB project to modernize rules

What do Tesla cars, Smart TVs and equipment used for making french fries have in common? Embedded software, according to FASB Vice Chair James Kroeker. And today’s accounting rules for booking software costs are outdated and thus will be modernized under one model.

The goal is to provide investors with more transparent, relevant and useful information, the FASB has said.

“When we talk about software costs, I think a lot of people’s minds go to the internal cost that you develop – your own [enterprise resource planning] or systems or hiring a third-party,” he said on Sept. 22, 2022. “But when we say, ‘all software costs’ I think the scope of this literally is all.”

His remarks were part of a Private Company Council (PCC) discussion to address potential models FASB staff have been researching to revamp recognition, measurement, presentation, and disclosure of costs to internally develop or acquire software. The 11-member PCC works with the board to amend or develop reporting rules for private companies.

The topic encompasses all software costs subject to the guidance in Subtopics 350-40, Intangibles—Goodwill and Other—Internal-Use Software, and 985-20, Software—Costs of Software to Be Sold, Leased, or Marketed, for all entities.

If the project takes shape as planned companies will no longer have to distinguish between two sets of guidance.

“Right now we have a mixed model and to create a new mixed model say ‘purchased versus developed’ and then dealing with ‘well I outsourced my development to this small consulting firm made up of the exact same people who used to be my employees so now I capitalize it versus –.’ So, you can certainly see drawing lines can create a lot of issues,” FASB Chair Richard Jones said. “We’ve gotten a lot of input that says, ‘our balance sheet under current GAAP standards doesn't reflect the evolving nature of business and that many of the most valuable assets aren’t reflected on that balance sheet,’” he said. “If you think about the large tech companies, a lot of that value ultimately goes into the algorithms and the software that they develop and that they have—so as you start thinking about that should the balance sheet really evolve?”

Shooting for a single model

Currently, FASB’s staff is researching a single model based on one of the following approaches: 1) require software costs to be capitalized based on a principle such as when there is a present right to the economic benefit as a result of incurring the software costs; 2) require software costs to be capitalized if they are undertaken during certain development activities; and 3) expense all software costs including cloud computing.

“This would mean if you purchased software as a license, or entered into a cloud computing arrangement, or if you developed internal software or develop licenses, or developed cloud solutions—everybody would be under the same model,” a staff member explained.

PCC members gave mixed views on which approach they favored, reflecting the difficulty the FASB could ultimately face on the topic. Some financial statement preparers liked a principles-based approach, while others said they grew to like the idea of expensing software costs as there is no true prediction of its future useful life.

“From my point of view, it is very difficult because the feasibility of software whether its external or internal may switch over night,” Yan Zhang, partner at EisnerAmper LLP in New York, said. “It really depends on the market, the regulators sometimes, the competition, the variability of other competitive software or any other product that's out there so I understand sometimes it’s hard to look into the future,” she said. “In this case the future is so dynamic and uncertain to be able to capitalize something on the books and really try to determine a useful life associated with this “asset” it’s just unpredictable,” she said.

The issue with intangibles broadly is that the U.S. economy is intangibles-based and investors want to get a sense of what that capital is, according to the discussions.

“As a user I’d like to have some better sense of when these expenses are going out the door what is going into development of something that’s a capitalized asset versus what is going into maintenance,” Michael Minnis, professor at the University of Chicago Booth School of Business, said. “I don’t know how best to do that.”

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