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Specific guidance exists to address accounting for costs related to software that is (1) sold, leased, or otherwise marketed, (2) developed or obtained for internal use, and (3) accessed through a cloud computing arrangement. Other specific types of software costs that could qualify for capitalization, such as website development costs, costs of business process reengineering activities, and costs to develop mobile applications, are described in PPE 7.6.   
The decision tree in Figure PPE 7-1 provides a summary for determining the relevant guidance for costs incurred to obtain or develop software.
Figure PPE 7-1
Costs incurred to obtain or develop software decision tree

7.2.1 Software to be sold, leased, or marketed—scope

ASC 985-20 establishes the accounting and reporting for the costs of software to be sold, leased, or otherwise marketed as a separate product or as part of a product or process, whether internally developed or purchased. An example of externally marketed software, described in ASC 350-40-15-5, is software embedded in a semiconductor chip that is used as a component of a product that is sold to a customer (e.g., automobile electronic systems). Another example is costs incurred to develop a mobile game to be sold through an app store, which should also be accounted in accordance with ASC 985-20.
Typically, costs related to software that is used by the vendor in the production of a good or for providing a service does not meet the criteria of software to be sold, leased, or otherwise marketed, unless that software is included or part of the actual good or service sold. Software that is not intended to be sold, leased, or otherwise marketed separately or as part of a product should be accounted for in accordance with the guidance for internal-use software in ASC 350-40. Refer to PPE 7.2.2 for further discussion of the distinction between software to be sold, leased, or otherwise marketed and software that is developed or obtained for internal use.
Refer to PPE 7.3 for discussion of the accounting for costs of software to be sold, leased, or otherwise marketed.

7.2.2 Software developed or obtained for internal use—scope

ASC 350-40 provides guidance on accounting for the costs of software developed or obtained for internal use.

ASC 350-40-15-2A

Internal-use software has both of the following characteristics:
a. The software is acquired, internally developed, or modified solely to meet the entity’s internal needs.
b. During the software’s development or modification, no substantive plan exists or is being developed to market the software externally.

A plan to market software externally would be considered substantive if its implementation is reasonably possible. A substantive plan could include the selection of marketing channels with identified promotional, delivery, billing, and support activities. Typically, reporting entities planning to sell or license software externally would have potential customers identified and resources contributed to a salesforce and marketing activities.
A reporting entity should also consider its past practices related to selling software. For example, if the reporting entity has a history of selling software to a third party that was originally being developed to use internally, there is a rebuttable presumption that any software developed by that reporting entity is intended for sale, lease, or other marketing.
ASC 350-40-55-1 provides a list of examples of software developed or obtained for internal use.

ASC 350-40-55-1

The following is a list of examples illustrating when computer software is for internal-use:
a. A manufacturing entity purchases robots and customizes the software that the robots use to function. The robots are used in a manufacturing process that results in finished goods.
b. An entity develops software that helps it improve its cash management, which may allow the entity to earn more revenue.
c. An entity purchases or develops software to process payroll, accounts payable, and accounts receivable.
d. An entity purchases software related to the installation of an online system used to keep membership data.
e. A travel agency purchases a software system to price vacation packages and obtain airfares.
f. A bank develops software that allows a customer to withdraw cash, inquire about balances, make loan payments, and execute wire transfers.
g. A mortgage loan servicing entity develops or purchases computer software to enhance the speed of services provided to customers.
h. A telecommunications entity develops software to run its switches that are necessary for various telephone services such as voice mail and call forwarding.
i. An entity is in the process of developing an accounts receivable system. The software specifications meet the entity's internal needs and the entity did not have a marketing plan before or during the development of the software. In addition, the entity has not sold any of its internal-use software in the past. Two years after completion of the project, the entity decided to market the product to recoup some or all of its costs.
j. A broker-dealer entity develops a software database and charges for financial information distributed through the database.
k. An entity develops software to be used to create components of music videos (for example, the software used to blend and change the faces of models in music videos). The entity then sells the final music videos, which do not contain the software, to another entity.
l. An entity purchases software to computerize a manual catalog and then sells the manual catalog to the public.
m. A law firm develops an intranet research tool that allows firm members to locate and search the firm’s databases for information relevant to their cases. The system provides users with the ability to print cases, search for related topics, and annotate their personal copies of the database.

ASC 350-40-55-2 helps clarify the determination by providing a list of examples of software that is not considered developed for internal use.

ASC 350-40-55-2

The following list provides examples of computer software that is not for internal-use:
a. An entity sells software required to operate its products, such as robots, electronic game systems, video cassette recorders, automobiles, voice-mail systems, satellites, and cash registers.
b. A pharmaceutical entity buys machines and writes all of the software that allows the machines to function. The pharmaceutical entity then sells the machines, which help control the dispensation of medication to patients and help control inventory, to hospitals.
c. A semiconductor entity develops software embedded in a microcomputer chip used in automobile electronic systems.
d. An entity purchases software to computerize a manual catalog and then sells the computer version and the related software to the public.
e. A software entity develops an operating system for sale and for internal-use. Though the specifications of the software meet the entity's internal needs, the entity had a marketing plan before the project was complete. In addition, the entity has a history of selling software that it also uses internally and the plan has a reasonable possibility of being implemented.
f. An entity is developing software for a point-of-sale system. The system is for internal-use; however, a marketing plan is being developed concurrently with the software development. The plan has a reasonable possibility of being implemented.
g. A telecommunications entity purchases computer software to be used in research and development activities.
h. An entity incurs costs to develop computer software for another entity under a contract with that other entity.

In practice, the primary consideration for determining whether software is developed or obtained for internal use is whether the software will ultimately be transferred and sold to a customer (either on its own or integrated as part of a product). If the software is transferred to a customer, it is generally not considered to have been developed solely to meet the reporting entity’s internal needs (and, therefore, is not internal-use software), unless the only purpose of the software is to connect to and receive a service from the vendor. Two contrasting examples of internal-use software and software to be sold, leased, or otherwise marketed in the context of mobile applications are included in PPE 7.6.3.
A reporting entity providing software-as-a-service (SaaS) or similar services to a customer that does not meet the conditions in ASC 350-40-15-4A (see PPE 7.2.3) is only providing a service and is not licensing software to its customers. Thus, the reporting entity should apply the guidance in ASC 350-40 to software costs.
Refer to PPE 7.4 for discussion of the accounting for costs of internal-use software.

7.2.3  Cloud computing arrangements–scope

A cloud computing arrangement (CCA) includes software-as-a-service and other SaaS-type services, including platform as a service, infrastructure as a service, and other hosting arrangements. “Hosting” refers to situations in which the end user does not take possession of the software; instead, the software resides on the vendor’s or a third party’s hardware, and the customer accesses the software remotely. Some CCAs include a traditional license to the software in addition to the remote service. It is important to determine whether the CCA includes a software license in addition to the service or if it is only a service. If the below criteria are not met (regardless of whether a CCA contains a contractual software license), the CCA is only a service.
ASC 350-40-15-4A states that a CCA includes a software license if the customer:
  • Has the contractual right to take possession of the software at any time during the hosting period without significant penalty (i.e., the penalty, monetary or nonmonetary, is sufficiently significant to disincentivize the customer from taking possession of the software), and
  • It is feasible for the customer to either run the software on its own hardware or contract with a third party unrelated to the vendor to host the software.
The phrase “without significant penalty” refers to the ability to (1) take delivery of the software without incurring significant cost and (2) use the software separately without a significant diminution in utility or value. “Diminution” generally refers to a reduction in the size, extent, or importance of the software, such as losses in feature, function, processing speed, or computing power. Determining whether the customer is taking possession of the software without significant penalty requires judgment. We believe that “at any time during the hosting period” is generally equivalent with “all the time or at every point during the hosting period.”
If the CCA meets both of the above criteria, it includes a software license in addition to the hosting service. Refer to PPE 7.4.4 for guidance on costs incurred for multi-element software arrangements. The software license costs could be in the scope of the internal-use software or software to be sold, leased, or otherwise marketed guidance, depending on the reporting entity’s use of the software. Refer to PPE 7.2.1 and PPE 7.2.2 for discussion of scoping consideration for software costs.
A CCA not meeting both of the above criteria should be accounted for solely as a service contract. The implementation costs of a CCA are subject to the internal-use software guidance, as discussed in PPE 7.5. The ongoing cost for the CCA services is expensed as the service is received similar to other service contracts.

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