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Capitalization of internally developed software

My company develops software for internal use (although it could also be sold to other similar companies). It almost always replaces the software we purchased at earlier time, so it generates visible economic benefits by reducing costs. Can we capitalize our internally developed software?

Unfortunately, unlike US GAAP (ASC 350-40). IFRS does not specifically deal with software. IAS 38 does, however, deal with internally generated intangible assets (which include software).

IAS 38 outlines 6 criteria that must be met if development costs are to be capitalized. Of these, demonstrating (IAS 38.57.d) “how the intangible asset will generate probable future economic benefits…” is the most onerous.

In my opinion, if the entity plans to use the asset internally, it would have no problem demonstrating “the usefulness of the intangible asset”, so it could capitalize.

Unfortunately, this is not the only view. For example Epstein thinks it is not possible to demonstrate how the SW will generate economic benefits and that (even although IFRS recognizes both legal and separable intangible assets) the absence of a purchased license precludes capitalization.

I personally think Barry’s an idiot but, but that does not change the fact that his options do carry a lot of weight (a lot more than mine).

Fortunately, they are not definitive.

IAS 8.12 states “In making the judgement described in paragraph 10, management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, …” which means that (since IFRS does not explicitly deal with the issue) it is acceptable to consider the pertinent US GAAP.

That US GAAP (ASC 350-40-25) is quite explicit: “-1 Internal and external costs incurred during the preliminary project stage shall be expensed as they are incurred. -2 Internal and external costs incurred to develop internal-use computer software during the application development stage shall be capitalized. -3 Costs to develop or obtain software that allows for access to or conversion of old data by new systems shall also be capitalized. -4 Training costs are not internal-use software development costs and, if incurred during this stage, shall be expensed as incurred. -5Data conversion costs, except as noted in paragraph 350-40-25-3, shall be expensed as incurred. -6 Internal and external training costs and maintenance costs during the postimplementation-operation stage shall be expensed as incurred.”

So, as far as I’m concerned, costs of internally developed SW are suitable for capitalization under IFRS and, if I do run into resistance, I can always fall back on US GAAP.

However, I also must point out one more little thing.

US GAAP (350-40-35) also states: “-7 If, after the development of internal-use software is completed, an entity decides to market the software, proceeds received from the license of the computer software … shall be applied against the carrying amount of that software. -8 No profit shall be recognized until aggregate net proceeds from licenses and amortization have reduced the carrying amount of the software to zero. … ”

Thus, if one does use US GAAP to justify oen’s judgment as per IFRS, and one’s company does decide to sell the software, it won’t be able to record any revenue until the capitalized asset is fully derecognized.

This makes US GAAP a two edged sword. On the one hand, it makes justifying the judgment to capitalize easy; on the other, it precludes recognizing a lot of revenue. But that’s just the way it goes.

I agree that IAS 38 permits you to capitalize development costs as long as the criteria are met. According to paragraph 57 in IAS 28, you must be able to demonstrate ALL of following BEFORE you can START capitalizing costs:

(1) technical feasibility of completing the intangible asset so that it will be available for use or sale
(2)its intention to complete the intangible asset and use or sell it.
(3)its ability to use or sell the intangible asset
(4) how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.

So certainly, this permits you to capitalize some of the costs associated with developing internal use software. You won’t be able to capitalize any costs you’ve expensed prior to meeting these criteria. You won’t be capitalizing all of your expenditures.

Astra Zeneca is one company that discloses “Software development costs” as a separate asset class in Note 9, Intangible Assets”.

I’ve seen others as well.

Hope this helps.

I meant to add.

There is no reason to go to US GAAP requirements or constraints.

IFRS does deal with capitalization of development costs for intangible assets to be used internally. The fact that the standard doesn't say: “Oh, by the way, software is an intangible that you may develop internally”, isn’t relevant.

Software is an intangible that can be (and often is) developed internally and the capitalization decision is covered by IAS 38.

US GAAP is irrelevant. In my view, it would be inappropriate to look to US GAAP for guidance because IAS 38 explains clearly what the criteria for capitalization are.

While I agree (as I stated in my first post) that IAS 38 does not preclude capitalizing internally developed SW, applying paragraph 57 (in practice) is anything but clear-cut and simple.

If it were, widely read publications (such as WILEY Interpretation and Application of International Financial Reporting … By Barry J. Epstein, Eva K. Jermakowicz) would not come to the opposite conclusion.

If it were, auditors would sign off on companies capitalizing everything, including the kitchen sink.

If it were, I would not have bothered citing US GAAP.

In any event, I’m not saying that it is impossible to convince a skeptical auditor that one has fulfilled all the criteria as outlined in paragraph 57. What I am saying is that it may not be a slam-dunk.

This is especially the case in continental Europe, where one does run into auditors that, while expert in applying their own “national GAAPs”, have little first hand experience interpreting and applying IFRS (or systems, such as US GAAP or UK GAAP, developed by standard-setting bodies using similar conceptual frameworks).

As to US GAAP being irrelevant, it would be, if IFRS did not explicitly state the opposite.

IAS 8.12: “In making the judgement described in paragraph 10, management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11″,

Paragraph 10 states “In the absence of an IFRS that specifically applies to a transaction, other event or condition, management shall use its judgement in developing and applying an accounting policy …”.

Now, correct me if I’m wrong, but I have never noticed an IFRS that (like ASC 350-40) specifically applies to Internal-Use Software.

This implies that, if anyone were to question my judgment that Internal-Use Software is capitalizable, in addition to IAS 38.57, I could also point to a standard (set by a standard-setting body that use a similar conceptual framework to develop accounting standards) that states that my judgment is GAAP.

Also, as an added benefit, US GAAP provides explicit, clear and easy to follow instructions on how to set up an accounting procedure to accomplish this task.

The only reasons that I can see why anyone would not want to avail oneself of such an opportunity:

1. one is not aware that US GAAP exists

2. one is not aware of its content

3. one does not realize that it can be used to supplement IFRS (especially in situations where IFRS’s sometimes vague, abstract and theoretical guidance is difficult to translate into day-to-day practice).

I never said making these decisions was easy. Hardly any financial reporting decision these days is easy. As I tell my students, if these decisions were easy and there was always a clear answer, they wouldn’t be looking to make the “big bucks” on graduation.

However, the philosophy behind IFRS’ principles approach to financial reporting is that the standard doesn’t provide a list of every specific item that standard applies to or doesn’t apply to.

Software is an intangible asset. Hence, IAS 38 applies.
IAS 38 covers intangibles developed internally for own use. Hence, development costs associated with internally-developed software can be capitalized under IAS 38 if the criteria for capitalization are met.

Some companies may not need to look to guidance beyond what’s available in IAS 38 to determine whether these criteria are met and there is no requirement to do so.

In fact, there is a danger in immediately leaping to guidance provided by other standard-setters (US GAAP) or developing a habit of doing so. Such guidance is not always consistent with IFRSs or its conceptual framework and preparers need to be vigilant in using the very detailed guidance provided by US GAAP that it will produce results in accordance with IFRS.

Finally, currently available written materials such as the book you cite are not authoritative guidance on either IFRS or US GAAP. Anything written in that book, no matter how well-respected the authors, is purely their considered opinion. They are men (and women), not gods or the IASB or IFRIC. Hence, I feel free to disagree with authors of such books. And, often do. Just as we are disagreeing here.

If you believe that additional guidance is needed regarding how to judge whether a particular criterion in IFRSs is inadequate and needs clarification, the place to go for that additional guidance is either IFRIC or the IASB. Not US GAAP.

Otherwise, you are basically telling people to learn a minimum of two sets of accounting standards, rather than the one they are expected to apply. What is the point of that recommendation?


I do agree with you.

Principles based means being allowed to reach one’s own professional judgment. But that judgment does not live in a vacuum. Judgment has to be justified (to one’s superiors, one’s auditors, possibly one’s regulator and, if worse comes to worse, at court).

As to people having to “learn a minimum of two sets of accounting standards, rather than the one they are expected to apply.”

At what point exactly does less knowledge become superior to more knowledge?

Also, I am not recommending anything. This is an open discussion. I am not being paid for my services. I an not being asked to take responsibility for my judgment. People can read what I wrote, use the information provided, or not. I really couldn’t care less which way they decide.

I am simply pointing out that, while IFRS does not clearly address the topic at hand, US GAAP does.

I am also pointing out that, while IFRS companies are not obligated to follow this guidance, it is not (since IFRS does not provide conflicting guidance) disallowed.

Oh, BTW, it wasn’t me who opened the door to either US GAAP or non-authoritative literature. The IASB managed to do that all by itself by stating “In making the judgement described in paragraph 10, management may also consider … other accounting literature and accepted industry practices, to the extent that these do not conflict …″.

This also means, authoritative or not, such literature does have an influence on practice. Simply wishing it were not so, will not make not so.

As to advice like: “If you believe that additional guidance is needed regarding how to judge whether a particular criterion in IFRSs is inadequate and needs clarification, the place to go for that additional guidance is either IFRIC or the IASB”.

This advice is spot on, but (quite obviously) pertinent only in those situations where the IASB or IFRIC has decided to provide such guidance.

As far as I know, the only “authoritative” guidance provided on the topic at hand are these three words (bold): “IAS 38.62 An entity’s costing systems can often measure reliably the cost of generating an intangible asset internally, such as salary and other expenditure incurred in securing copyrights or licences or developing computer software. ”

Pretty scant pickings.

Sure the old SIC published SIC 32, but analogizing from an interpretation dealing with web site costs to software in general is a pretty far stretch (if it’s allowed at all).

Hmmm, maybe I should try writing the IASB / IFRIC a letter? Maybe they’ll even write back. Or, better yet, maybe they’ll add an internally developed software project to their agenda. Wouldn’t that be nifty.

Sure, if all I had to deal with were students, such advice would be sufficient. If I gave such advice to a paying client, he’d want his money back (if he didn’t sue me for professional incompetence that is).

Though I also (time o time) deal with students, my real world clients need to solve real world problems. And, in the real world, things get messy. And when things do get messy, having more than three words comes in handy.

True, no one has an obligation to know US GAAP in order to apply IFRS (or vice versa). But it doesn’t hurt (especially since the IASB and FASB are working away so diligently at their convergence) .

When that guidance also corresponds to my own professional judgment. Hey, I call that accounting nirvana in my book.

And the knife cuts both ways.

My clients include US GAAP companies (primary listing in the US), EU-IFRS companies (using IFRS due to EC 1606/2002) and IASB-IFRS companies (mostly foreign private issuers with a secondary listening in the US taking advantage of the SEC’s relaxed IFRS requirements).

They find that when it comes to dealing with particular auditors or regulators (surprise, surprise), these tend to let themselves be influenced by their home standards.

And then there are the prosaic reasons.

If, for example, a US company with significant operations in the EU wants to staff its accounting department with European nationals (rather than pricey US ex-pats), it better have some IFRS knowledge. And if it doesn’t have it, it better get it (otherwise, it’s pretty much screwed).

But, I digress.

Oh well.

I guess it’s because its raining outside and I’m stuck here with nothing better to do than listen to myself talk (err, … write).

Your responses are exactly what make answering questions on this list worthwhile. I wish more questioners would get involved in a discussion or debate on the issues, especially the ones where there are differences in views.

The IASB opened the door to using the pronouncements of other like-minded standard-setters in IAS 8 with respect to the hierarchy. My point is not to go there first. After all, some people are coming to this list for advice and we’re not authoritative, by any means.

If you enjoy debating accounting issues, you should join the AECM listserv at Lots of vigorous discussion there.

So, please don’t take my comments personally. I love an aggressive debate, even when I am soundly trounced. I hope to fence with you again on another issue and maybe we’ll agree.

And, I do more than just teach….

What about other intangibles like \'CAD\' drawings and so on, can these intangibles also be included in the valuation?

If the entity can demonstrate the future economic benefits associated with the drawings, in other words to demonstrate its ability to sell them or use them in a productive way, they can be capitalized.
Care must, however, be taken if the drawings are associated with new and untried devices, products, processes, systems or services.
In this case, they would be most likely fall into research, rather than development, category in which case they would have to be expensed. 

Thanks for the comments ihave been following the whole discussion

Suppose one uses the revaluation model say after the software has been raunched the entity hires a competent valuer to give an independant value of the soft whare

Unlike many national GAAP's, IFRS does not, as a rule, allow valuation/revaluation on the basis of opinions from competent valuers. 

With intangible assets in particular, IAS 38.75 states: For the purpose of revaluations under this Standard, fair value shall be measured by reference to an active market.

This implies, even if a company did decide to use the services of a valuer, this valuer would need to prove that his/her valuation was made on the basis of an active market.

This would be difficult if not impossible.

IAS 38.78 states: It is uncommon for an active market to exist for an intangible asset, although this may happen. For example, in some jurisdictions, an active market may exist for freely transferable taxi licences, fishing licences or production quotas. However, an active market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or trademarks, because each such asset is unique.

Due to the cost and complexity involved, when a company does develop software in house, the only reason it does so is that there is no commercially available alternative.  This implies that the resulting software will be unique just like brands, newspaper mastheads, music and film publishing rights, patents or trademarks.

This being the case, it is not possible to measure fair value shall be by reference to an active market, which makes the revaluation model unacceptable.

Assets to be capitalized:
Value $$
1 - Fair value can be determined by seeking any quotation to three software development companies , asking them to do the same in house developed software the same facilitates, same features
Future benefits $$
2 - Amortization of above which already came in fact from the actual needs pushed company to spend in house to developing that intangible assets.
3- Expenses paid for 12 moth use not for 5-10-15 years.


Must admit, I do not really understand what you are trying to say, but if I understand it correctly, you are suggesting that you can measure the fair value of internally developed software on the basis of third party offers.

If you are testing the asset for impairment, third party offers would be an acceptable way to determine that fair value for the fair value portion of the recoverable amount test.

However, as I stated in a previous post, revaluation (above historical cost) needs to be measured on the basis of an active market. If the software was developed in house, it is unique and so no active market can exist. This implies that one cannot revalue internally developed software on the basis of third party offers (assuming one even wants to use the fair value model for intangible assets, which isn't common practice).

As to determining the historical, acquisition cost of the software, assuming the company can demonstrate that it will be able to use the SW to generate economic benefits (IAS 38.52 c and d), I do not see any problems in capitalizing actual development costs including salaries.

IFRS is more general with the rules compared to us gaap having specific rules for software costs. I took several college classes from Mrs Jermakovic twenty plus years ago. Kind cool that she has some

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