Companies that are conservative generally classify software as available for sale once it reaches technological feasibility. Less conservative companies may allocate most costs to the stage where the software is technologically feasible but not yet available for sale.
Similarly, the decision to classify internally used software as in the development stage vs. AthenaHealth capitalizes a significant amount of development costs for internally used software. In their 10K , they explain that it is for internal use software called AthenaNet:. We capitalize certain costs related to the development of athenaNet services and other internal-use software.
Costs incurred during the application development phase are capitalized only when we believe it is probable the development will result in new or additional functionality. The types of costs capitalized during the application development phase include employee compensation, as well as consulting fees for third-party developers working on these projects.
Costs related to the preliminary project stage and post-implementation activities are expensed as incurred. Internal-use software is amortized on a straight-line basis over the estimated useful life of the asset, which ranges from two to five years.
When internal-use software that was previously capitalized is abandoned, the cost less the accumulated amortization, if any, is recorded as amortization expense. Fully amortized capitalized internal-use software costs are removed from their respective accounts.
In their footnotes, you can see that these costs are amortized, exactly like other intangible assets:. We expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Technological feasibility is typically reached shortly before the release of such products and as a result, development costs that meet the criteria for capitalization were not material for the periods presented.
Software development costs also include costs to develop software to be used solely to meet internal needs and cloud based applications used to deliver our services. We capitalize development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed and the software will be used to perform the function intended.
Expenses are capitalized if their occurrence helps produce revenues in more than the period in which they are incurred. For example, since software developed for sale will be sold in more periods than the ones in which development costs were incurred, said costs should be capitalized and written off in those subsequent periods to better reflect reality.
Amortization of capitalized software development costs is done in much the same manner as depreciation. First, the amount to be amortized is the asset's total value minus its estimated residual value, which can be none in this case. The amortization expense for each period is the amount to be amortized divided over the number of periods in which the capitalized expenditure will continue to be of use.
Alan Li started writing in and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. It may be bundled with a computer processor hardware , sold on a disc as computer software, downloaded over the Internet, accessed but not downloaded over the Internet, or developed by the taxpayer. It may be acquired by itself, or as part of a business. Thus, the treatment of computer software can vary, depending on the circumstances.
In view of these variations, it is important to get proper advice as to the tax treatment of computer software. Computer software is treated as an intangible under Code Sec. In this situation, the software must be amortized over 15 years, a fairly long period. However, if the software is stated and sold separately, not as part of a business acquisition, it can be amortized on a straight-line basis over 36 months. Off-the-shelf computer software can also qualify for Code Sec.
Code Sec. Bundled software that is included in computer hardware must be capitalized and depreciated over the life of the hardware, generally five years for computers.
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