As discussed in SW 1.4, a reporting entity accounts for software costs in accordance with the guidance on internal-use software in ASC 350-40 when no substantive plan exists or is being developed to market the software externally. In some circumstances, a reporting entity that previously had no plan to market software to other parties—and therefore, capitalized costs under ASC 350-40—will subsequently decide to license or sell the software. In this situation, ASC 350-40-35-7 requires the proceeds received from the license or sale of the software, net of direct incremental costs of marketing (e.g., commissions, software reproduction costs, warranty and service obligations, installation costs), to be applied first against the carrying value of any capitalized internal-use software costs. No profit should be recognized until aggregate proceeds from the licenses and amortization have reduced the carrying amount of the software to zero. Once the carrying amount has been reduced to zero, any additional proceeds should be recognized in accordance with ASC 606—if licensing or selling software is part of the reporting entity’s ongoing major or central operations—or ASC 610-20, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets.

If during the development of internal-use software, a reporting entity decides to market the software to others, the guidance in ASC 985-20 for externally marketed software should be followed on a prospective basis. As discussed in SW 1.4, if a reporting entity has a pattern of selling software to third parties 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.

See SW 1.5.2 for discussion of arrangements when a reporting entity provides access to software through a cloud computing arrangement.

Example SW 3-3 illustrates the accounting for the subsequent license of internal-use software to other parties.

EXAMPLE SW 3-3
Accounting for the license of internal-use software to other parties

Retail Co is a national retail enterprise that has agreed to sell its stores located in the northeast region to a third-party purchaser. As part of this sale, the purchaser will license a software package that Retail Co had previously developed for its internal use. Retail Co had never intended to market or license the software externally; therefore, the software development costs were capitalized based on the guidance for internal-use software. To facilitate the transfer of the purchased operations, Retail Co has agreed to license the software to the purchaser for one year at a market rate of $100,000. The carrying value of the internally developed software is $5,000.

How should Retail Co account for the license of its software to the purchaser?