Accounting for Software Costs
Accounting for software costs can be complex. Make sure you get it right using BDO's "Blueprint".
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Overview
Software is a set of codes or programs that tells hardware, for example, computer servers, laptops, phones and other devices, what to do. Entities across various industries develop or acquire software for internal use including supporting internal operations and enabling the provision of goods or services to end users such as online banking, online shopping, and online games. Entities in the technology industry generally sell software to their end users through either:
- On-premise licenses allowing an end user to use the software offline
- Arrangements where an end user can only access and use the software through the internet, for example, in a software-as-a-service (SaaS) arrangement.
Additionally, entities often embed software into tangible items, for example, network equipment, cars, electronic appliances, and industrial robots. As a result, every entity uses software to some extent and therefore incurs software costs and is affected by the accounting guidance for software costs.
U.S. GAAP includes multiple models to account for the costs of developing, acquiring, and implementing software. The applicability of a particular model depends on how an entity acquires or develops software and how the entity intends to use that software. Because of the judgments inherent in the guidance, entities may face challenges in determining which guidance applies to their software costs and applying that guidance.
Additionally, continuous evolution of the software industry and technological advancement affect how software products are developed and sold, creating complexities in applying the guidance on software costs. Also, as artificial intelligence (AI) training and data conversion costs become more prevalent, new practice issues may arise that are not directly addressed by the guidance.
This publication discusses the framework in U.S. GAAP for accounting for software costs and related practice issues, including accounting for costs incurred to develop or acquire software for external use as well as internal use.
This publication incorporates the guidance in Accounting Standards Update (ASU 2025-06), Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Targeted Improvements to The Accounting For Internal-Use Software, which was issued in September 2025 to modernize the internal-use software guidance to accommodate the evolution in software development method from a linear development method (for example, waterfall) to a nonlinear development method (for example, agile).
Chapter 1: Accounting for Software Costs - Scope
Accounting for software costs depends on how an entity intends to use the resulting software. ASC 350-40, Intangibles — Goodwill and Other — Internal-Use Software, provides a model for internal-use software while ASC 985-20, Software — Costs of Software to Be Sold, Leased, or Marketed, provides a model for software intended for sale, lease, or marketing. The internal-use software guidance in ASC 350-40 also addresses situations when an entity provides access to the software through a hosting arrangement or cloud computing arrangements (CCA), for example, SaaS. For software outside the scope of ASC 350-40 or ASC 985-20, other U.S. GAAP may apply.
There are significant differences between the guidance on accounting for software costs under ASC 350-40, ASC 985-20, and other U.S. GAAP. Further, the guidance in ASC 350-40 that applies to software licensing arrangements differs in important respects from the guidance in ASC 350-40 that applies to CCAs. It is important to correctly identify the applicable guidance to appropriately account for the costs of developing or acquiring software because of the significant differences therein.
Chapter 2: Software to be Sold, Leased, or Marketed
ASC 985-20 provides guidance for accounting and reporting for the costs of computer software to be sold, leased, or otherwise marketed as a separate product or as part of a product or process (externally marketed software), whether internally developed and produced or purchased. ASC 985-20 specifies whether an entity must expense or capitalize the software development costs based on whether the costs are incurred before or after the product reaches technological feasibility:
- Costs incurred before reaching technological feasibility are considered research and development costs and are expensed when incurred.
- Costs to develop, produce or purchase externally marketed software are capitalized after technological feasibility is reached. Capitalization of eligible costs ceases once the product is available for general release.
Additionally, ASC 985-20 provides guidance on subsequent accounting for capitalized costs and accounting for costs incurred after the product is available for general release and product enhancements.
Chapter 3: Internal-Use Software and Implementation Costs of CCA
ASC 350-40 provides guidance for accounting and reporting for the costs of internal-use software, including examples that illustrate whether computer software is in scope or not. ASC 350-40 requires an entity to begin capitalizing internal-use software development costs when both of the following occur:
- Management, with the relevant authority, implicitly or explicitly authorizes and commits funding for the software project.
- It is probable the project will be completed, and the software will be used to perform the function intended (referred to as “probable-to-complete recognition threshold”).
If the capitalization criteria are no longer met for software being developed, an entity cannot capitalize further costs and must apply the guidance in Section 3.3.1 on impairment to existing asset balances.
An entity must cease capitalizing internal-use software costs no later than the point at which a software project is substantially complete and ready for its intended use, that is, after all substantial testing is complete.
Subsequently, an entity amortizes the costs of software developed or obtained for internal use on a straight-line basis unless another systematic and rational basis is more representative of the software's use. Amortization begins when the software is ready for its intended use (that is, after all substantial testing is complete), regardless of when the software is placed in service. An entity must also assess internal-use software for impairment in accordance with ASC 360-10-35, which applies to property, plant, and equipment.
This guidance also applies to website development costs, as well as to costs to implement a hosting arrangement or CCA that is a service contract (for example, SaaS).
Chapter 4: Presentation and Disclosure
ASC 350-40 and ASC 985-20 provide limited guidance on presentation and disclosure requirements for software costs related to software to be sold, leased, or marketed, internal-use software, and cloud computing arrangements.
Presentation guidance addresses the classification of capitalized software costs on the balance sheet, the presentation of amortization in the income statement, and the categorization of related cash flows, with additional considerations for purchased software and implementation costs in cloud computing arrangements (see Sections 4.2, 4.2.1, and 4.2.2).
Disclosure requirements include unamortized software costs and amounts expensed. Recent amendments under ASU 2025-06 require entities to align their internal-use software disclosures with those for property, plant, and equipment (see Sections 4.3, 4.3.1, and 4.3.2).
If ASC 350-40 or ASC 985-20 does not provide specific presentation or disclosure requirements, an entity applies the general financial statement presentation principles and other U.S. GAAP, as appropriate.
Chapter 5: Transition
This chapter discusses transition guidance including effective date for ASU 2025-06, transition approaches and related disclosures.