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2.7 Amortization of capitalized externally marketed software
Publication date: 31 Dec 2021
us Software costs
Amortization of capitalized development costs for externally marketed software should commence when the product is available for general release to customers. The amortization of those costs is discussed in ASC 985-20-35-1 through ASC 985-20-35-2.
Capitalized software costs shall be amortized on a product-by-product basis. The annual amortization shall be the greater of the amounts computed using the following:
- The ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product.
- The straight-line method over the remaining estimated economic life of the product including the period being reported on.
Because a net realizable value test, which considers future revenues and costs, must be applied to capitalized costs (see paragraph ASC 985-20-35-4), amortization shall be based on estimated future revenues. In recognition of the uncertainties involved in estimating revenue, amortization shall not be less than straight-line amortization over the product's remaining estimated economic life.
The straight-line computation of amortization is the minimum annual amortization expense. Because the guidance requires amortization of the greater of the amounts calculated using the ratio-of-revenues method or the straight-line method, changing between the methods from period to period to meet this requirement is not considered a change in accounting principle. However, if period-to-period comparability is materially impacted, disclosure of the amortization method may be appropriate.
Example SW 2-1 illustrates a scenario in which the reporting entity would conclude that straight-line amortization is appropriate in the first year that it begins amortization.
EXAMPLE SW 2-1
Software amortization example – year 1
Software amortization example – year 1
Software Corp has capitalized costs associated with software to be sold to customers in accordance with ASC 985-20. At the beginning of 20X1, Software Corp has capitalized $100 million of software costs for Product X. Product X was available for release to customers at the end of 20X0.
Software Corp estimates $625 million of revenue from Product X over its estimated 5-year economic life. Software Corp expects the revenue to be recognized as follows (in millions):
20X1 | $100 | |||
20X2 | $150 | |||
20X3 | $200 | |||
20X4 | $100 | |||
20X5 | $75 | |||
Total | $625 |
During 20X1, Software Corp recognizes revenue of $100 million from Product X (which is in line with its expectation). Software Corp’s future revenue projections are unchanged.
What is Software Corp’s amortization expense for 20X1 related to Product X?
Analysis
Amortization should be the greater of (1) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or (2) the straight-line method over the remaining estimated economic life of the product including the period being reported on.
Those amounts would be calculated as follows.
- Ratio-of revenues method:
View image
- Straight-line method: $100 million / 5 years = $20 million
As a result, during 20X1, Software Corp should record amortization of $20 million for Product X.
Example SW 2-2 illustrates a situation in which a reporting entity needs to adjust the amortization from the straight-line method in Year 1 to the ratio-of-revenues method in Year 2.
EXAMPLE SW 2-2
Software amortization example – year 2
Software amortization example – year 2
Assume the same facts as Example SW 2-1, including that Software Corp recognized $20 million of amortization for Product X in year 1.
During 20X2, Software Corp exceeds its revenue projections for Product X and records revenue of $325 million and revises its future revenue projections as follows (in millions):
20X1 (actual) | $100 | |||
20X2 (actual) | $325 | |||
20X3 (projected) | $350 | |||
20X4 (projected) | $200 | |||
20X5 (projected) | $125 | |||
Total | $1,100 |
What is Software Corp’s amortization expense for Product X in 20X2?
Analysis
At the beginning of 20X2, Software Corp had unamortized capitalized software of $80 million ($100 million cost less $20 million amortization in 20X1). Amortization should be the greater of (1) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or (2) the straight-line method over the remaining estimated economic life of the product including the period being reported on.
Software Corp would determine amortization expense in 20X2 as follows.
- Ratio-of-revenues method:
View image
- Straight-line method: $80 million / 4 years = $20 million
As a result, during 20X2, Software Corp would record amortization of $26 million for Product X.
Example SW 2-3 illustrates the calculation of software amortization when a change in expected customer demand results in a change in the software’s economic life.
EXAMPLE SW 2-3
Software amortization example – year 3
Software amortization example – year 3
Assume the same facts as Example SW 2-2, including that Software Corp recognized amortization for Project X of $20 million and $26 million in years 1 and 2, respectively.
During 20X3, sales of Product X fall below expectations and amount to only $125 million compared to the projection of $350 million. Software Corp also determines that, as a result of reduced customer demand, the software’s 5-year economic life should be reduced to 4 years (or only one additional remaining year beyond 20X3). Software Corp revises its future revenue projections as follows (in millions):
20X4 | $200 | |||
Total | $200 |
What is Software Corp’s amortization expense in 20X3 related to Product X?
Analysis
At the beginning of 20X3, Software Corp had unamortized software capitalized cost of $54 million ($100 million less cumulative amortization of $46 million in 20X1 and 20X2). Amortization should be the greater of (1) the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or (2) the straight-line method over the remaining estimated economic life of the product including the period being reported on.
Software Corp would determine amortization expense in 20X3 as follows.
- Ratio-of-revenues method:
View image
- Straight-line method: $54 million / 2-year adjusted remaining economic life = $27 million
As a result, during 20X3, Software Corp would record amortization of $27 million for Product X.
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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