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Business Guidance Note 10 - Software Capitalisation

This document provides guidance on developing a software capitalization policy. It discusses key Australian Accounting Standards related to capitalizing software costs. The document outlines considerations for determining what costs can be capitalized versus expensed. It emphasizes the importance of strong governance and tracking costs to ensure integrity in financial reporting regarding software capitalization. Specific examples are provided to illustrate accounting treatments for research versus development costs. Responsibilities for finance teams and policies are suggested.

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63 views2 pages

Business Guidance Note 10 - Software Capitalisation

This document provides guidance on developing a software capitalization policy. It discusses key Australian Accounting Standards related to capitalizing software costs. The document outlines considerations for determining what costs can be capitalized versus expensed. It emphasizes the importance of strong governance and tracking costs to ensure integrity in financial reporting regarding software capitalization. Specific examples are provided to illustrate accounting treatments for research versus development costs. Responsibilities for finance teams and policies are suggested.

Uploaded by

ImranShaikh
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Business Guidance Note

Guidance Note 10
As part of the Institutes ongoing
efforts to provide members with
guidance and information on key
issues, the Institute has developed
a Business Guidance Notes series
which presents guidance for
members written by members.

The Australian Accounting Standards


that provide guidance when considering
software capitalisation policy are:
>> AASB138 Intangible Assets
>> AASB116 Property Plant & Equipment
>> AASB136 Impairment of Assets

Key points
>> Levels of approval should be determined
in the policy
>> The cut off for capitalisation will vary
by company
>> The company should adopt a project
charging mentality move expense
from business as usual to project
>> The rolling effect of capitalisation /
amortisation over time should balance
out to underlying annual level of
investment required by the company
>> Maintenance costs should be included
in the budget going forward.

Software Capitalisation
This guidance note looks at the key points to consider when developing a software
capitalisation policy. Policy specifics will vary depending on the size of the organisation and
type of software development activity undertaken.
Software capitalisation occurs when some of the costs of internal software developments
are recognised as having economic value that will extend into the future (i.e. will have future
economic benefit). Where certain criteria are met, the cost of software development can be
taken up as an asset to be amortised over its useful life.

Impairment testing
At the end of each reporting period, the net carrying value of unamortised software costs
is subject to trigger testing. If the triggers are present, an impairment test is performed.
Impairment testing is a review of the value to be produced by the software during its
remaining useful life in order to confirm existence of any impairment (which would lead
to the write down of the carrying value).
Australian Accounting Standards specify that an intangible asset shall be recognised if,
and only if:
(a) It is probable that the expected future economic benefits that are attributable to the
asset will flow to the entity
(b) The cost of the asset can be measured reliably.1
Consideration should be given to the design of the impairment trigger testing that will be
applied. This should be sought to leverage existing reporting mechanisms wherever possible,
which may include a robust project status reporting mechanism.

Application of software capitalisation


Application of software capitalisation often depends on the judgement of the individual
and organisation applying it, and will vary depending on the policies of each company. For
example, internal limits may be set so projects with budgets below the limit are expensed,
with such limits often aligned with financial delegations and governance structures.
For practical purposes small developments are often regarded as part of infrastructure
maintenance that is necessary for the ongoing effective operation of systems, and are
expensed as incurred. Any immaterial software items are usually expensed immediately.
The overarching principle is that software capitalisation is subject to criteria within
the Accounting Standards, the interpretation of which will guide internal policy. The
Accounting Standards specify which costs of an internally generated intangible asset can
be capitalised. There are examples included of what are normally considered components
of the intangible asset.2

This Business Guidance Note is an initiative


of the Institutes NSW Corporate Advisory
Panel and has been prepared by the
following contributors.

Governance
Strong governance is critical to retain integrity in financial reporting, including systems
for tracking of costs and benefits. Decisions must be made in determining what can
be capitalised, the time period for amortisation, (the longer the useful life the higher
the risk of impairment given the rapid development of software), and the process and
value for impairment purposes.

Diane Green CA ANZ Wealth


David Southwell FCA
Insurance Australia Group

charteredaccountants.com.au

1. AASB 138 paragraph 21


2. AASB 138 paragraph 65-67

Continued overleaf >

Business Guidance Note

(continued)

Guidance Note 10

Important items to consider:


>> Timeliness of capture recording detail
on an ongoing basis is very important
>> The approach to capturing expenses for
capitalisation consider the process to
identify expenses at the first processing
of costs, rather than after the event
>> The importance of having ledger systems
set up to record expenses by project
this will make data easy to extract
>> The coding of the account this will
ensure Project Accounting and Expense
reporting needs are met
>> The capitalisation of backfill staff
business as usual staff are seconded
to development
>> The timing of the projects start
measuring the total project costs is
different to the amount capitalised
>> The interrelationship with tax effects
deferred tax impact
>> Any opportunities for Research and
Development (R&D) grants
>> The tax treatment of software vs.
accounting treatment
>> Whether the project meets requirement
for additional tax R&D benefits.

There will usually be differing views as to how those decisions should be applied. This
may arise when considering whether judgement should be exercised to maximise the
costs capitalised and so defer expenses (subject to impairment), or to minimise the costs
capitalised, thereby minimising the risk of impairment. This highlights the importance of
a clear software capitalisation policy.
When there is a group corporate structure in place and there are recharges between
companies comprising the development costs, care must be taken to ensure that any
profit margins built in are not capitalised, as these are not part of the costs to the group.
Broadly, only costs related to the development stage are able to be capitalised.
The following table illustrates some examples of research and development costs:
Research Phase

Development Phase

Expense

Capitalise

Activities aimed at obtaining new knowledge

The design, construction and testing of preproduction/pre-use prototypes and models

The search for, evaluation and final selection


of, applications of research findings

The design of tools/framework involved


in the new technology

The search for alternatives for materials,


devices, products, processes, systems
or services

The design, construction and operation of


a pilot that is not of a scale economically
feasible for commercial production

The formulation, design, evaluation and final


selection of possible alternatives for new
or improved materials, devices, products,
processes, systems or services

The design, construction and testing of a


chosen alternative for new or improved
materials, devices, products, processes,
systems or services

In breaking out the responsibilities in relation to software capitalisation, the following


table provides a suggested split:
Finance Team

Finance Policy

Gathering data supporting proposed


accounting treatment

Setting the accounting policy and


organisations thresholds for software
capitalisation

Developing a detailed understanding of the


project to support both capital investment and
accounting treatment

Supporting the accounting policy as


it requires it

Assessing software capitalisation


requirements and preparing submission
on accounting treatment

Approving individual software capitalisation


project applications

Published December 2010

Ongoing monitoring of development


costs to confirm satisfaction of capitalisation
requirements

Obtaining Audit Committee approval


and reporting

Disclaimer

Conducting annual testing for


impairment assessment

Providing an overview of the


impairment process

The Institute does not expect nor invite any person to act
or rely on any statement, opinion or advice contained in
this guidance note and readers must make and rely on
their own enquiries in making any decisions or giving
any advice. Neither the Institute nor any employee or
agent of the Institute nor any contributor to this guidance
note will be liable for any loss or damage caused by any
inaccurate statement, opinion, advice or information
contained in this guidance note. Information contained
in this guidance note might have been changed since it
was published.

For further information on this Business Guidance Note, please contact Karen McWilliams
on telephone +61 2 9290 5754 or email [email protected]
Continued overleaf >

ABN 50 084 642 571. The Institute of Chartered Accountants in Australia Incorporated in Australia Members Liability Limited. 1110-35

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