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FASB unveils new rules streamlining internal software accounting for modern development methods

Sept. 29, 2025

U.S. accounting rule makers have updated the rules for how companies track and report their spending on software they build for their own use.

The Financial Accounting Standards Board (FASB) on Sept.18, 2025, released Accounting Standards Update ( ASU) No. 2025-06, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software, aimed at making it simpler and more consistent for businesses to track and disclose expenses related to software they build for their own operations.

The guidance moves away from strict, phase-by-phase cost tracking, opting instead for a more flexible, modern approach that better reflects today's software development.

The narrowly drawn changes primarily focus on how companies decide when to count software development costs as an asset (capitalize them), especially when there's uncertainty during development. The rules also simplify how companies share this information with the public, bringing them more in line with how they report physical assets like buildings and equipment. This applies to all types of companies, from large corporations to small private businesses.

"Modernizing software accounting guidance was a top priority identified by stakeholders during our last agenda consultation," said FASB Chair Richard Jones in a statement. "The new ASU addresses changes in software development methods, increasing the operability of the recognition guidance for improved financial reporting."

Previously, companies had to capitalize software development costs based on specific project stages. However, many found it hard to tell the difference between these stages, particularly with modern, iterative development methods like agile.

The new rules remove these confusing "project stages." Instead, a company can capitalize software costs once two conditions are met: the company's leadership has approved and committed to funding the project, and it's likely the project will be finished and the software will work as intended. When making this decision, companies must consider any significant uncertainties in the software's development.

The most direct impact of these changes will be on companies that create or buy software for their own internal operations, affecting how they recognize, capitalize, and disclose these costs. Even website development costs, which had separate rules, will now fall under this unified guidance.

Addressing industry needs

Industry experts largely welcome the updates, noting that previous rules for internal-use software were considered out-of-date. Some are already looking ahead to future challenges. Ben Wempe, a partner at accounting firm Armanino, pointed to the rise of artificial intelligence (AI). "A lot of AI development involves trainers, not just engineers, and much of that isn't currently recognized as an asset because refining an AI model is often like fixing bugs," Wempe explained.

Allison Henry, a vice president at the Pennsylvania Institute of CPAs, praised the focused scope of the new rules. "Everyone generally agrees with the FASB's objective," she said. However, she also highlighted a concern for auditors: assessing management's judgment on whether a project is "probable" to be completed.

"While moving from rigid stages to a more flexible, probability-based approach is a positive step, auditors will face a challenge in evaluating management's judgment calls," Henry noted. "Many of the comments received indicated that preparers supported the standard, but auditors expressed some hesitation about how to interpret and audit this probability threshold. It will require significant effort from auditors."

Key changes:

• No more project stages: The concept of distinct "project stages" for software development costs is gone. All internal-use software will now follow the same clear rules for when to capitalize costs.
• Clarifies "significant development uncertainty": This is a central change. Companies must now use their best judgment to decide when to recognize software costs, especially if there's significant uncertainty during development. The term "probable" now officially means "likely to occur." If there's major uncertainty, costs can't be recognized until that uncertainty is resolved. All software projects will now need to be checked for significant development uncertainty.

Two specific situations now signal "significant development uncertainty":

• New or unproven software: This applies to software with unique features or technologies that haven't been tested or proven yet. This uncertainty should be cleared up through coding and testing.
• Major performance requirements still unclear: This covers situations where the software's main functions haven't been identified or are still undergoing significant changes.

These are now the only two factors indicating significant development uncertainty, according to the ASU. "Performance requirements" refer to what the software needs to do. Companies will need to use their own judgment to determine what "significant" means in these contexts.

Simpler reporting and disclosure

Under the changes, companies no longer need to provide specific separate disclosures for software costs. Instead, they are required to follow the existing disclosure rules for property, plant, and equipment (PP&E) for all capitalized internal-use software costs, regardless of how they appear on the balance sheet. Also, there are no new requirements to separately show cash outflows for capitalized software costs in financial statements.

The guidance merged the separate rules for website development costs into the general internal-use software guidance, making accounting for these costs more consistent.

Further, the way companies determine how to group software components with physical assets remains the same. Also, the new rules do not address accounting for software sold through cloud computing, the general definition of an "asset unit" for internal-use software, upgrades and enhancements, or costs related to artificial intelligence training and data conversion.

When the new rules take effect

These changes apply to annual reporting periods, including interim periods within those years, that begin after Dec. 15, 2027. Companies can choose to adopt the rules earlier if their financial statements haven't been issued yet. If adopted in an interim period, it must be applied from the beginning of the annual reporting period that includes that interim period.

Companies have the following options for implementing the new guidance:

• Prospective application: Apply the new rules only to new transactions going forward.
• Retroactive application: Apply the new rules to all past financial periods presented.
• Modified approach: For new projects and projects already underway where capitalization hasn't started by the adoption date, companies can apply the new rules going forward. For projects already underway where capitalization has begun, companies can use a modified approach. This means they can reverse any previously capitalized costs that no longer meet the new criteria, adjusting their retained earnings accordingly, but only if the new guidance determines that it is no longer probable the project will be completed and the software used as intended.

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