FASB proposes guidance to improve accounting for internal-use software

The Financial Accounting Standards Board (FASB) recently issued a proposed Accounting Standards Update (ASU), Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software, to modify the accounting for internal-use software costs and enhance transparency of entities’ related cash flows.

During the FASB's 2021 agenda consultation project and other outreach, stakeholders noted that the existing guidance on accounting for internal-use software cost is outdated and does not consider current software development practices. Specifically, the guidance was developed when most entities used a sequential development method, as opposed to using more iterative methods (e.g., agile) that are common today. This results in challenges in applying the current internal-use software guidance and has led to diversity in practice when determining when to begin capitalizing costs.

The proposed ASU removes all references to project stages throughout Subtopic 350-40 and instead requires that entities begin capitalizing software costs when:

• Management has authorized and committed to funding the software project, and
• It is probable that the project will be completed and the software will be used to perform the function intended.

When evaluating whether the latter probable-to-complete recognition threshold is met, the proposed ASU requires entities to consider whether there is significant uncertainty associated with the development activities. The following factors may indicate that there is significant development uncertainty:

• The software has novel, unique, unproven functions and features or technological innovations.
• The entity has not identified the significant performance requirements of the computer software or continues to substantially revise the requirements.

The proposed amendments would also require entities to separately present cash paid for capitalized internal-use software costs as investing cash outflows in the statement of cash flows.

Entities would be permitted to apply the proposed guidance either prospectively or retrospectively.

The FASB will determine the effective date for the proposed ASU, and whether early application should be permitted, after considering feedback from stakeholders.

Stakeholders are encouraged to review and provide input on the proposed ASU by January 27, 2025.