Computer Software Capitalization
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This document establishes standards for capitalizing expenses related to computer software developed or obtained for internal use. It defines key terms like capital assets and development stages. Costs are generally capitalized during the application development stage and expensed during preliminary and post-implementation stages. It provides guidance on capitalizing costs of upgrades, enhancements, and disposals. Internally generated assets do not require retroactive reporting.
![9) For internally generated intangible capital assets currently in development, how are capitalized labor
costs during the Application Development Stage to be determined?
Straight labor, develop a set rate or predetermined rate based on average salary? Would you include
benefits and/or direct or indirect costs, overhead, etc.?
Answer: No guidance has been established to address how to determine the capitalized labor costs
during the Application Development Stage for internally developed intangible capital assets. No guidance
exists for tangible CIP projects either. GASB recommends using the same method your agency uses to
determine labor rates for tangible CIP projects in determining the appropriate capitalized labor cost for
internally generated intangible assets.
10) Do we need to record construction-in-progress (CIP) for internally generated intangible capital assets
(i.e. software, patents, trademarks, and copyrights)?
Answer: Please refer to GASBS 51, ? 45. The Board compared the nature of internally generated
intangible assets in development to be the counterpart of construction-in-process capital assets. The
Board concluded that it may be more difficult to determine when outlays should begin to be capitalized in
the case of an internally generated intangible asset in development than for tangible construction-in-
process capital assets. As a result, the Board decided that the specified-conditions approach should be
used. Please refer to the intangible asset Components of Computer Software Development. Knowing
when and when not to capitalize, is the key.
11) Should you capitalize software licenses?
Answer: Yes. According to GASB 51, ? 65: ¡°The Board believes that outlays to acquire a license to use
commercially available software that is not considered internally generated computer software will meet
the description of an intangible [capital] asset and should be reported accordingly. (If the licensed
software is considered internally generated computer software and, therefore, reporting of related
outlays is based on the development stage approach, the Board believes that the criteria to begin
capitalization of outlays related to software development are met when the government makes the
decision to license the specific software. Accordingly, the licensing of the software would be an
application development stage activity, and the related outlays would be capitalized.)¡± Given that
licensed software, (or all software for that matter), is an intangible capital asset and it does not have an
indefinite useful life, the proper treatment is to capitalize software licenses that meet the $5,000
threshold and $100,000 for software.
12) Would monthly (quarterly, biannual, annual, etc.) modifications to software be considered
maintenance? Should they be expensed, or treated as an upgrade/ improvement and capitalized?
Answer: It depends. Per GASB 51, ? 69, outlays of the asset modification should be capitalized if any of
the following variables apply:
¡¤ increase the capacity [or functionality] (i.e. the computer software is able to perform tasks that it
was previously incapable of performing, ?15a)
¡¤ efficiency (i.e., an increase in the level of service provided by the computer software without the
ability to perform additional tasks, ?15b)
¡¤ extend the useful life of the asset beyond its previously established useful life (modifications that
defer obsolescence)
If none of these apply, then you would expense the outlays as maintenance. These are the 3 variables
that need to be analyzed while using professional judgment.
13) Since we are not required to retroactively report internally generated intangible capital assets, does
that also mean we do not need to capitalize and report any modifications to the same assets that extend
its useful life, efficiency, etc. that take place on or after the effective date of this statement (July 1,
2009)?
Answer: No, capitalization of modifications on existing internally generated intangible capital assets (or
intangible capital assets) as of the effective date would be reportable. Depending on the particular](https://image.slidesharecdn.com/19048b09-aa97-4fd1-a6fe-c0c573d74432-150310162641-conversion-gate01/85/Computer-Software-Capitalization-4-320.jpg)
![facts, some modifications can result in the creation of a new asset rather than the extension of an
existing asset.
14) How do you calculate the useful life of an intangible capital asset?
Answer: The useful life of an intangible capital asset should not exceed the economic life of the asset. If
the period to which the service capacity of the asset is limited by contractual or legal provisions the
useful life should be approximated accordingly. Otherwise, an intangible capital asset should be
considered to have an indefinite useful life.
15) Tangible capital assets physically deteriorate with time and cease providing service, however, what
would decrease the service capacity of (intangible) software?
Answer: Per GASB ? 70, ¡°because computer software is intangible, it does not deteriorate physically;
rather, obsolescence is what decreases the service capacity of computer software. [Therefore, only
modifications that defer obsolescence should be considered to extend the useful life of software.]¡±
16) Do we need to report obsolete software if purchased after 1980?
Answer: If the software is no longer being used (or is being used but considered internally generated)
then you don¡¯t need to retroactively report it.
17) Would a website be considered an intangible capital asset?
Answer: YES, however, the intangible capital asset must still meet the $100,000 threshold to be
reportable.
18) Since we¡¯re going to capitalize cost that used to be expensed are there any prior period adjustments?
Answer: According to GASBS 51, ? 20, ¡°this Statement should be applied retroactively (except for
internally generated intangible capital assets and intangible capital assets with indefinite useful lives) by
restating financial statements, if practical, for all prior periods presented. If restatement is not practical,
the cumulative effect of applying this Statement, if any, should be reported as a restatement of beginning
net assets, fund balances, or fund net assets as appropriate, for the earliest period restated. In the
period this Statement is first applied, the financial statements should disclose the nature of any
restatement and its effect.¡±
19) When you buy new computer(s) with software already installed, should you break out software costs
vs. hardware costs, to differentiate between intangible capital assets and tangible capital assets? In the
City of Mesa we have set a capital asset reporting threshold of $5,000 for tangible and $100,000 for
software and websites for intangible.
Answer: In general, it is NOT required to break out software vs. hardware costs, especially if the useful
lives of both are the same.
20) Should agencies value software individually or group them together? For example, our larger
agencies will buy 100+ computers together, already equipped with software.
Individually the computers and/or software are valued less than our reporting threshold.
But grouped together they would definitely be above our reporting threshold.
Answer: If all items were ordered at the same time and were part of the same transaction then they
should be grouped together and reported, (if their total value is equal to or greater than the $100,000
threshold). Invoices should not be split to avoid reporting. According to GASB Implementation Guide
7.9.8, ¡°capitalization policies adopted by a government should find an appropriate balance between
ensuring that all material capital assets, collectively, are capitalized and minimizing the cost of
recordkeeping for capital assets. It may be appropriate for a government to establish a capitalization
policy that would require capitalization of certain types of assets whose individual acquisition costs are
less than the threshold for an individual asset. Computers, classroom furniture, and library books are
assets that may not meet the capitalization policy on an individual basis, yet might be considered material
collectively.](https://image.slidesharecdn.com/19048b09-aa97-4fd1-a6fe-c0c573d74432-150310162641-conversion-gate01/85/Computer-Software-Capitalization-5-320.jpg)
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Computer Software Capitalization
- 1. CAPITALIZATION OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE Purpose The purpose of this administrative rule is to establish minimum standards for the capitalization of expenses incurred for the purchase or development of computer software for internal use. Definitions "Capital Assets" means tangible or intangible assets having significant value that are used in operations and that have initial useful lives extending beyond a fiscal year. Capital assets include land, improvements to land, buildings, equipment, infrastructure and work in progress. See the Capital Asset Policy (currently under development) for more detailed information regarding capital assets and the capitalization threshold. "Computer Software Developed or Obtained for Internal Use" means computer software purchased from a commercial vendor, internally developed, or contractor-developed to meet the City¡¯s internal needs. This administrative rule does not cover proper accounting for the costs of computer software developed to be sold, leased or otherwise marketed. "Preliminary Project Stage" means the earliest stage of a software development or selection project, during which the alternatives are being evaluated but no decision has been made as to which strategy or vendor to use. Typical activities during this phase include assembling the evaluation team, evaluating proposals from vendors and the final selection of alternatives. "Application Development Stage" means the stage of a software development or selection project during which the design, coding, installation and testing of new software occurs. The stage begins once management has authorized and committed to funding the project, and it is considered probable that the project will be completed and put to its intended use. The application development stage concludes when the software is complete and ready for use. "Post-Implementation/Operation Stage" means the stage that begins once the software is put into use. It includes training and subsequent maintenance of the software. Treatment of Project Costs 1. The decision to capitalize or expense the costs of obtaining computer software is based on the stage of computer software acquisition or development and the nature of the costs incurred. 2. Costs of projects during the application development stage shall be capitalized. Typical costs include direct materials or services contributing to the project, payroll and payroll-related costs for employees directly associated with the project, testing costs and installation costs. General and administrative costs, training costs, data conversion costs with the exception of data conversion software, maintenance costs and overhead shall not be capitalized but shall be expensed as incurred. 3. Interest costs incurred by proprietary funds during the development process shall be capitalized. Interest costs incurred by governmental funds during the development process shall not be capitalized. 4. Costs of projects in the preliminary project stage or the post-implementation/ operation stage shall be expensed as incurred. 5. The cost of upgrades and enhancements to capitalized computer software shall be capitalized only if the upgrades or enhancements provide additional functionality. 6. Capitalized software is included in the capital assets of individual proprietary funds, and in the government-wide statement of net assets for software held in a bureau in a governmental fund. Disposal of Software - If existing software is retired from use, the original cost ¨C less depreciation = shall be retired from the Capital Assets.
- 2. COMPONENTS OF COMPUTER SOFTWARE DEVELOPMENT ACTIVITIES EXPENSED CAPITALIZED Business Process Reengineering & Information Technology Transformation ? Preparation of request for proposals X ? Documenting the entity¡¯s current business process X ? Reengineering of the entity¡¯s business process to increase efficiency and effectiveness X ? Restructuring the work force to determine appropriate staffing requirements to operate the reengineering process X Preliminary Project Stage ? Making strategic decisions to allocate resources between projects X ? Determining the software performance and systems requirements for the proposed software project X ? Exploring alternate means of achieving specified performance requirements X ? Determining the computer hardware necessary to achieve the software performance requirements X ? Issuing solicitation to award a contract for a third-party software vendor X ? Selecting a consultant to assist in development or installation of software X Application Development Stage ? Design cost of chosen path, including software configuration and interface X ? External costs of materials and services consumed in developing or procuring internal use software: cost to purchase software; fees paid to third parties for software development; travel expenses of city employees directly associated with developing the software X ? Payroll and payroll related cost for time spent directly on the project X ? Interest cost incurred by proprietary or enterprise funds while developing the software according to Financial Accounting Standards Board Statement No. 34 X ? Installation to hardware X ? Cost to develop or acquire software to convert data to new system X ? System testing, including parallel processing phase X ? Computer software license fees or patents X ? Training costs (only at initial implementation of software) X ? General and administrative cost and overhead expenditures X ? Data conversion process: creating new data; converting data to the new system; reconciling of converted data; cleansing of existing data X X Post-Implementation / Operation Phase ? Training costs (new employees & staff) X ? Application maintenance costs X ? Ongoing support costs X Maintenance Agreements ? Increases the capacity or functionality X ? Efficiency - Increases the level of service without the ability to perform additional tasks X ? Extends the useful life of the asset beyond its previously established useful life (modifications that defer obsolescence) X ? Standard user maintenance agreements which include support services X
- 3. Intangible Capital Assets FAQ 1) What was GASB¡¯s motivation for making intangible capital assets a reportable item? Answer: GASB¡¯s objective is to reduce inconsistencies while establishing comparability in accounting and financial reporting requirements among state and local governments. Inconsistencies noted in the reporting of intangible capital assets include recognition, initial measurement, and amortization. 2) What will be the reporting threshold for intangible capital assets for the City of Mesa? Answer: Equal to or greater than $5,000, except for software & websites which is $100,000. 3) Do we need to report software purchased a long time ago if we are still using it? Answer: Yes, all intangible capital assets (that are still being used), meeting the $5,000 threshold and $100,000 threshold for software and websites, and acquired after June 30, 1980 will need to be reported as intangible capital assets unless it is considered internally generated (developed), then you don¡¯t have to retroactively report it. However, you may retroactively report an internally generated (developed) intangible asset if the amount is based on sound cost accounting principles that can be supported for our auditors? 4) Will agencies have to start tagging software with a property or identification number? Answer: While physically tagging software won¡¯t be necessary (or possible), there must be a way to identify each intangible asset. If the software was purchased ¡°off-the-shelf¡± a serial number or user identification number from the software product would be an acceptable identification number. For software developed in-house, a property or identification number will need to be assigned once the software has been completed and is operational. 5) If I purchase off-the-shelf software and then install it onto my agency¡¯s system AS IS (without modifying it), would this be considered an intangible capital asset? Answer: YES! ALL computer software is to be classified as an intangible capital asset, regardless of whether or not it is modified. However, if off-the-shelf software IS modified for your own application in order to make it operational, the software is then considered an internally generated intangible capital asset. GASB 51, ? 7, states that if more than a ¡°minimal incremental effort¡± is required to make the software operational then it will be classified as an internally generated intangible capital asset. You will need to use professional judgment as to what is considered ¡°minimal incremental effort¡±. As a general rule, if you have to modify or change any part of the original makeup/coding of the off-the-shelf software, then you have satisfied the requirement of applying more than a ¡°minimal incremental effort¡±. 6) If I purchase off-the-shelf software and then install it onto my agency¡¯s system AS IS (without modifying it), am I required to retroactively report it? Answer: YES! But remember the $5,000 reporting threshold and $100,000 for software and websites. 7) Since we are required to retroactively report intangible capital assets, what if I am unable to determine an actual historical cost; can I use an estimated historical cost? Answer: Yes, it is acceptable to use an estimated historical cost for intangible capital assets if you are unable to determine an actual historical cost; however, it is not acceptable to estimated historical cost for internally generated (developed) intangible capital assets. 8) Do we have to retroactively report internally generated intangible capital assets? Answer: No, if an intangible asset is internally generated (developed) you do not need to retroactively report it. It is permitted though, but only if you can determine the actual historical cost using accepted cost accounting principles that can be supported for your auditors. As mentioned in the disclaimer above, it is inappropriate to estimate the historical cost of an internally generated (developed) intangible capital asset.
- 4. 9) For internally generated intangible capital assets currently in development, how are capitalized labor costs during the Application Development Stage to be determined? Straight labor, develop a set rate or predetermined rate based on average salary? Would you include benefits and/or direct or indirect costs, overhead, etc.? Answer: No guidance has been established to address how to determine the capitalized labor costs during the Application Development Stage for internally developed intangible capital assets. No guidance exists for tangible CIP projects either. GASB recommends using the same method your agency uses to determine labor rates for tangible CIP projects in determining the appropriate capitalized labor cost for internally generated intangible assets. 10) Do we need to record construction-in-progress (CIP) for internally generated intangible capital assets (i.e. software, patents, trademarks, and copyrights)? Answer: Please refer to GASBS 51, ? 45. The Board compared the nature of internally generated intangible assets in development to be the counterpart of construction-in-process capital assets. The Board concluded that it may be more difficult to determine when outlays should begin to be capitalized in the case of an internally generated intangible asset in development than for tangible construction-in- process capital assets. As a result, the Board decided that the specified-conditions approach should be used. Please refer to the intangible asset Components of Computer Software Development. Knowing when and when not to capitalize, is the key. 11) Should you capitalize software licenses? Answer: Yes. According to GASB 51, ? 65: ¡°The Board believes that outlays to acquire a license to use commercially available software that is not considered internally generated computer software will meet the description of an intangible [capital] asset and should be reported accordingly. (If the licensed software is considered internally generated computer software and, therefore, reporting of related outlays is based on the development stage approach, the Board believes that the criteria to begin capitalization of outlays related to software development are met when the government makes the decision to license the specific software. Accordingly, the licensing of the software would be an application development stage activity, and the related outlays would be capitalized.)¡± Given that licensed software, (or all software for that matter), is an intangible capital asset and it does not have an indefinite useful life, the proper treatment is to capitalize software licenses that meet the $5,000 threshold and $100,000 for software. 12) Would monthly (quarterly, biannual, annual, etc.) modifications to software be considered maintenance? Should they be expensed, or treated as an upgrade/ improvement and capitalized? Answer: It depends. Per GASB 51, ? 69, outlays of the asset modification should be capitalized if any of the following variables apply: ¡¤ increase the capacity [or functionality] (i.e. the computer software is able to perform tasks that it was previously incapable of performing, ?15a) ¡¤ efficiency (i.e., an increase in the level of service provided by the computer software without the ability to perform additional tasks, ?15b) ¡¤ extend the useful life of the asset beyond its previously established useful life (modifications that defer obsolescence) If none of these apply, then you would expense the outlays as maintenance. These are the 3 variables that need to be analyzed while using professional judgment. 13) Since we are not required to retroactively report internally generated intangible capital assets, does that also mean we do not need to capitalize and report any modifications to the same assets that extend its useful life, efficiency, etc. that take place on or after the effective date of this statement (July 1, 2009)? Answer: No, capitalization of modifications on existing internally generated intangible capital assets (or intangible capital assets) as of the effective date would be reportable. Depending on the particular
- 5. facts, some modifications can result in the creation of a new asset rather than the extension of an existing asset. 14) How do you calculate the useful life of an intangible capital asset? Answer: The useful life of an intangible capital asset should not exceed the economic life of the asset. If the period to which the service capacity of the asset is limited by contractual or legal provisions the useful life should be approximated accordingly. Otherwise, an intangible capital asset should be considered to have an indefinite useful life. 15) Tangible capital assets physically deteriorate with time and cease providing service, however, what would decrease the service capacity of (intangible) software? Answer: Per GASB ? 70, ¡°because computer software is intangible, it does not deteriorate physically; rather, obsolescence is what decreases the service capacity of computer software. [Therefore, only modifications that defer obsolescence should be considered to extend the useful life of software.]¡± 16) Do we need to report obsolete software if purchased after 1980? Answer: If the software is no longer being used (or is being used but considered internally generated) then you don¡¯t need to retroactively report it. 17) Would a website be considered an intangible capital asset? Answer: YES, however, the intangible capital asset must still meet the $100,000 threshold to be reportable. 18) Since we¡¯re going to capitalize cost that used to be expensed are there any prior period adjustments? Answer: According to GASBS 51, ? 20, ¡°this Statement should be applied retroactively (except for internally generated intangible capital assets and intangible capital assets with indefinite useful lives) by restating financial statements, if practical, for all prior periods presented. If restatement is not practical, the cumulative effect of applying this Statement, if any, should be reported as a restatement of beginning net assets, fund balances, or fund net assets as appropriate, for the earliest period restated. In the period this Statement is first applied, the financial statements should disclose the nature of any restatement and its effect.¡± 19) When you buy new computer(s) with software already installed, should you break out software costs vs. hardware costs, to differentiate between intangible capital assets and tangible capital assets? In the City of Mesa we have set a capital asset reporting threshold of $5,000 for tangible and $100,000 for software and websites for intangible. Answer: In general, it is NOT required to break out software vs. hardware costs, especially if the useful lives of both are the same. 20) Should agencies value software individually or group them together? For example, our larger agencies will buy 100+ computers together, already equipped with software. Individually the computers and/or software are valued less than our reporting threshold. But grouped together they would definitely be above our reporting threshold. Answer: If all items were ordered at the same time and were part of the same transaction then they should be grouped together and reported, (if their total value is equal to or greater than the $100,000 threshold). Invoices should not be split to avoid reporting. According to GASB Implementation Guide 7.9.8, ¡°capitalization policies adopted by a government should find an appropriate balance between ensuring that all material capital assets, collectively, are capitalized and minimizing the cost of recordkeeping for capital assets. It may be appropriate for a government to establish a capitalization policy that would require capitalization of certain types of assets whose individual acquisition costs are less than the threshold for an individual asset. Computers, classroom furniture, and library books are assets that may not meet the capitalization policy on an individual basis, yet might be considered material collectively.