FASB proposes updates to modernize accounting for internal-use software

The Financial Accounting Standards Board (FASB) issued Proposed Accounting Standards Update (ASU), Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software.

The proposed ASU would remove all references to software development project stages in Subtopic 350-40, Intangibles — Goodwill and Other — Internal-Use Software and would clarify the capitalization threshold for internal-use software costs.

The proposed amendments would apply to all entities subject to the internal-use software guidance in Subtopic 350-40 and to entities that account for website development costs in accordance Subtopic 350-50, Intangibles — Goodwill and Other — Website Development Costs.

The proposed amendments wouldn’t affect the accounting for external-use software in the scope of Subtopic 985-20, Software — Costs of Software to Be Sold, Leased, or Marketed.

Comments are due Jan. 27, 2025.

Key provisions

Under current GAAP, entities are required to capitalize development costs incurred for internal-use software depending on the nature of the costs and the project stage during which they occur.

Feedback received during the 2021 FASB Invitation to Comment noted that the current guidance is outdated and lacks relevance given the evolution of software development — in particular, the transition from using a prescriptive and sequential method to using an incremental and iterative method to develop software.

The proposed amendments are intended to better align the accounting for internal-use software costs with how software is developed as well as improve operability of the recognition guidance and reduce diversity in practice.

Internal-use software costs

The proposed amendments would remove all references to project stages in Subtopic 350-40 and would require entities to capitalize internal-use software costs when both of the following occur:

• Management has authorized and committed to funding the software project.
• It’s probable that the project will be completed, and the software will be used to perform the function intended — referred to as the probable-to-complete recognition threshold.

If there’s significant uncertainty associated with the development activities of the software, the probable-to-complete recognition threshold wouldn’t be met. The proposed ASU includes the following factors that may indicate there’s significant development uncertainty:

• The software being developed has novel, unique, unproven functions and features or technological innovations.
• The significant performance requirements — for example, functions or features — of the computer software haven’t been identified.
• The significant performance requirements continue to be substantially revised.

Once the significant development uncertainty has been resolved, entities would begin capitalizing internal-use software costs if the other criterion has been met.

Statement of cash flows

The proposed amendments would require entities to separately present cash paid for capitalized internal-use software costs, other than implementation costs of a hosting arrangement that’s a service contract, as investing cash outflows in the statement of cash flows.

Website development costs

Subtopic 350-50 currently provides accounting guidance for website development costs and whether such costs should be expensed or capitalized.

As certain areas of Subtopic 350-50 directly reference guidance in Subtopic 350-40, the proposed amendments would supersede Subtopic 350-50 and incorporate the recognition requirements for website-specific development costs into Subtopic 350-40.