FASB to propose simplified guidance on software costs

The Financial Accounting Standards Board agreed to release a draft proposal to simplify accounting for internal use software costs by, among other things, no longer considering the development stage and removing the distinction between linear and nonlinear development methods.

The proposed amendments would make targeted improvements to Subtopic 350-40, Intangibles—Goodwill and Other—Internal-Use Software.

The proposed guidance, agreed to at the board's June 18 meeting, would remove all references to "stages" throughout the current literature, which requires companies to identify and differentiate between costs incurred during the preliminary and application development stages for internal-use software projects (in contrast to those intended to be sold to customers, which is governed by a different standard). According to KPMG, this is in recognition that companies now predominantly develop software using non-linear (e.g. agile) development methods. 

The proposed guidance would, instead, require the same recognition guidance for all software within the scope of Subtopic 350-40, which would result in no distinction between linear and nonlinear software development methods. Instead, all entities would be required to evaluate the probable to complete recognition threshold and include significant development uncertainties and performance requirements as factors to consider in the evaluation. 

Consequently, the proposed changes would move the evaluation of whether the software being developed has unresolved high-risk development issues (novel, unique, unproven functions and features or technological innovations) from the scope guidance to the recognition guidance as a factor to consider in evaluating the probable to complete recognition threshold. 

Further, as a way to streamline this evaluation, entities would specify that if it's unclear that it is probable that the project will be completed and the software will be used to perform the function intended, and overall consider whether there is significant uncertainty associated with the development activities of the software. This specification would include factors indicating significant development uncertainty, such as the software being developed having novel, unique, unproven functions and features or technological innovations; or significant performance requirements have not been selected or the significant performance requirements continue to be revised. 

The proposed changes would clarify that entities should determine the unit of account for an asset that incorporates both software and tangible components, and whether the software component should be accounted for separately under 350-40 or combined with the tangible component in accordance with other GAAP rules, like those that govern property, plant and equipment. 

It would also define the term "probable" in the "probable to complete recognition threshold" consistently with the definition in the Master Glossary. "Probable" is defined in the Master Glossary as the future event or events are likely to occur. FASB decided to supersede Subtopic 350-50, Intangibles—Goodwill and Other—Website Development Costs, and incorporate website-specific development costs guidance into Subtopic 350-40. It also decided to require cash outflows for software costs capitalized under Subtopic 350-40, other than implementation costs of a hosting arrangement that is a service contract, to be presented separately as investing cash flows in the statement of cash flows.

During an earlier meeting in March, FASB decided to scale back the original proposal. FASB had originally intended to develop a much more expansive standard for software that covered both internal- and external use, which currently operates under a dual model (external use is governed under Subtopic 985-20, Software—Costs of Software to Be Sold, Leased, or Marketed), according to KPMG. Later investor outreach, though, indicated there was not a significant appetite for changes to companies' software development cost capitalization. As a result, the FASB decided to re-focus its software cost project principally on targeted improvements to modernize ASC 350-40 for agile software development as well as enhancing software cost disclosures.

Allison Henry, vice president of professional and technical standards with the Pennsylvania Institute of CPAs, welcomed the proposal, saying it creates a truly unified framework for all software covered by ASC 350-40. 

"Currently, practitioners must determine distinct stages in projects, such as preliminary project stage, application development stage, and post implementation-operational stage," she said. "Given that software development has moved away from traditional models to more iterative or agile methods since the guidance was first issued, updating these guidelines to reflect present practices is likely to simplify financial reporting and decrease variations in practice. Furthermore, the FASB suggests that companies evaluate if significant uncertainties exist in their development activities, a proposition for which specific application examples will be crucial," she said. 

Scott Muir, partner for the department of professional practice at KPMG, felt the proposed changes, which were much narrower than FASB originally intended, was unlikely to lead to significant change for most entities. 

"However, software-as-a-service entities may capitalize less of their software development costs, more consistent with their software licensing entity peers, if these updates become GAAP," he said. 

FASB directed the staff to draft a proposed Accounting Standards Update for vote by written ballot. It also decided on a 90-day comment period for the proposed update.