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2.5 Purchased software to be externally marketed
Publication date: 31 Dec 2021
us Software costs
The cost of purchased software is generally accounted for in the same manner as costs incurred to develop such software internally unless it is acquired in a business combination. If technological feasibility of the software product to be ultimately marketed has been established, the cost of purchased software should be capitalized. If technological feasibility has not been established, the costs are expensed as R&D, unless the purchased software has an alternative use. See BCG 4 for information on in-process R&D assets acquired in a business combination.
Figure SW 2-2 provides a summary of accounting for purchased software.
Figure SW 2-2
Accounting for purchased software
Accounting for purchased software
The cost to purchase a completed software product that will undergo minimal changes before it is marketed to customers will generally be capitalized in its entirety. In that case, the software has already reached technological feasibility and the purchase cost is considered a cost incurred after technological feasibility is established. If the purchased software will become part of the ultimate software product to be marketed to customers, reporting entities may need to apply judgment to determine whether the purchased software is a cost incurred before or after technological feasibility has been established.
A reporting entity may contract with another entity to develop a custom software product. In this situation, the reporting entity may need to apply judgment to determine whether it is purchasing (a) a completed software product or (b) development services. If the reporting entity is purchasing a completed software product, it would apply the guidance on purchased software to determine the amount of cost to capitalize. If the reporting entity is effectively outsourcing development services, it will need to monitor the development progress to determine when technological feasibility is established. Only fees paid to the third party for development services after technological feasibility is established would qualify for capitalization.
2.5.1 Purchased software with alternative future use
If purchased software is acquired before technological feasibility of the software product to be ultimately marketed has been established, but the purchased software has an alternative future use (e.g., the company could alternatively resell the purchased software separately), the cost should be capitalized and accounted for in accordance with its alternative use. However, the amount capitalized would be limited to the amount realizable from the alternative future use. This scenario is described in ASC 985-20-55-14.
An entity may purchase software before technological feasibility has been established. For example, an entity purchases software for $100,000 that can be resold for $75,000. The amount of $25,000 would be charged to research and development, and $75,000 would be capitalized. If the software product reached technological feasibility, the $75,000 would be included in the cost of the software product. If the technological feasibility of the software was never established, the $75,000 would be classified as inventory.
Determining whether purchased software has an alternative future use may require judgment. Chapter 3 of the AICPA Accounting and Valuation Guide: Assets Acquired to Be Used in Research and Development Activities includes interpretive guidance to assist in determining whether assets acquired that will be used in R&D activities have an alternative future use.
Excerpt from AICPA Accounting and Valuation Guide
Paragraph 3.14
For an asset acquired in an asset acquisition for use in R&D activities to have an alternative future use, the task force believes that (a) it is reasonably expected that the reporting entity will use the asset acquired in the alternative manner and anticipates economic benefit from that alternative use, and (b) the reporting entity’s use of the asset acquired is not contingent on further development of the asset subsequent to the acquisition date (that is, the asset can be used in the alternative manner in the condition in which it existed at the acquisition date).
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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