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The next stage of development described in ASC 350-40-25 is the application development stage. Capitalization of qualifying costs during the application development stage should begin when both of the following occur:
  • The preliminary project stage is completed, and
  • Management, with the relevant authority, implicitly or explicitly authorizes and commits to funding a project and it is probable that the project will be completed, and the software will be used to perform the function intended (e.g., execution of a contract with a third party, approval of expenditures related to internal development, or a commitment to obtain software from a third party).

The following activities are generally part of the application development stage:
  • Design of chosen path, including software configuration and interfaces
  • Coding
  • Installation of hardware
  • Testing, including parallel processing

Capitalization should cease no later than the point at which a software project is substantially completed and ready for its intended use. Software is ready for its intended use after all substantial testing is completed. This may occur before the software is placed in service.
If, prior to completion, it becomes not probable that a software project will be completed and placed into service, a reporting entity should cease capitalization of costs and assess the in-process software asset for impairment. Refer to SW 3.8 for additional discussion on the impairment of capitalized internal-use software.

3.3.1 Capitalizable costs for internal-use software

During the application development stage, some costs are capitalized while other costs are expensed as incurred. In general, costs that are directly attributable to the development of the software are capitalized, while indirect costs are expensed as incurred.
ASC 350-40-30-1 specifies the types of direct costs that should be capitalized.

ASC 350-40-30-1

Costs of computer software developed or obtained for internal use that shall be capitalized include only the following:
a. External direct costs of materials and services consumed in developing or obtaining internal-use computer software. Examples of those costs include but are not limited to the following:
1. Fees paid to third parties for services provided to develop the software during the application development stage
2. Costs incurred to obtain computer software from third parties
3. Travel expenses incurred by employees in their duties directly associated with developing software.
b. Payroll and payroll-related costs (for example, costs of employee benefits) for employees who are directly associated with and who devote time to the internal-use computer software project, to the extent of the time spent directly on the project. Examples of employee activities include but are not limited to coding and testing during the application development stage.
c. Interest costs incurred while developing internal-use computer software. Interest shall be capitalized in accordance with the provisions of Subtopic 835-20.

Stock-based compensation costs should be included in the same line or lines as the cash compensation (e.g., payroll costs) paid to the employees receiving the stock-based awards. Therefore, payroll-related costs described in ASC 350-40-30-1(b) above include stock-based compensation for employees who are directly associated with and who devote time to the software project.
The following types of costs are expensed as incurred, even during the application development stage:
  • Training costs
  • Data conversion costs (such as employee time spent physically converting data), except for costs to develop or obtain software that allows for access or conversion of old data by new systems. The process of data conversion from an old system to a new one may include purging or cleansing existing data, reconciling the data in the old and new systems, creating new or additional data, and converting old data to the new system.
  • General and administrative costs and overhead costs
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