Capitalized software, explained

Normally what you pay engineers is an expense in the month you pay it. ASC 350-40 makes an exception for software you build to run your business, which includes a SaaS platform customers use over the internet. Part of the cost of building it is recorded as an asset, called capitalized software, and spread over the years it's used.

Think of a delivery van. You don't expense the whole van in the month you buy it; you spread its cost over the years it does the work. For software, that spreading is called amortization.

Under the current rules a project moves through stages. Planning and weighing options is expensed. Once development starts, the qualifying costs of building the software are capitalized, mostly payroll for the engineers doing the work. Maintenance, training and bug fixes after launch are expensed. Amortization starts when the software is ready for its intended use.

ASU 2025-06 removes the stages. Capitalization starts once management has authorized and committed to funding the project and it's probable the software will be completed and used as intended. That threshold isn't met while significant development uncertainty remains, such as unresolved novel features or performance requirements still being revised. It's effective for annual periods beginning after December 15, 2027, and early adoption is allowed.

In March, Acme's engineers spend $30,000 of payroll building a new billing platform, and the work qualifies. Payroll booked it to engineering salaries, so the accountant moves $30,000 to capitalized software on the balance sheet, and March's operating expenses fall by the same amount. If Acme picks a three-year useful life, the asset is amortized at about $833 a month once the platform goes live.

Auditors ask for time records showing who worked on what. Sections 174 and 174A are separate tax rules for similar costs, so the books and the tax return can treat the same payroll differently, and the income tax provision tracks the gap.