Should software development costs be capitalized?

As app developers, we understand that every project is unique and comes with its own set of costs. One common question that arises during the budgeting process is whether software development costs should be capitalized or not. In this article, we will explore both sides of this argument and help you make an informed decision about your next project.

Capitalization vs Expensing

: A Brief Overview

Before diving into the pros and cons of capitalizing software development costs, it’s important to understand what these terms mean.

* Capitalization refers to the process of adding a cost to the asset’s basis, which increases its carrying value on the balance sheet. This is commonly used for long-term assets that have a useful life beyond one accounting period.

* Expensing, on the other hand, refers to the process of deducting a cost from a company’s taxable income in the year it was paid. This is commonly used for short-term assets that have a limited useful life or are expected to be fully depreciated within one accounting period.

Should Software Development Costs Be Capitalized?

Yes, Capitalization Can Be Beneficial

  1. Longer useful life: Software development projects often take longer than one accounting period to complete, which means they have a longer useful life beyond one accounting period. By capitalizing these costs, you can spread them out over the project’s useful life and reduce the impact on your income statement in the short term.
  2. Should Software Development Costs Be Capitalized?

  3. Improved asset value: Capitalizing software development costs increases the asset’s carrying value on the balance sheet, which can improve its overall value. This can be particularly beneficial for companies that are looking to raise capital or sell their assets in the future.
  4. Tax benefits: By capitalizing software development costs, you may be able to claim tax deductions over time as the asset depreciates. This can help offset some of the initial expense and provide a longer-term tax benefit.

No, Expensing Can Be More Efficient

  1. Lower upfront costs: Expensing software development costs means that you can write off the full amount in the year it was paid, which can reduce the upfront cost of your project. This can be particularly beneficial for small businesses or startups that may not have the financial resources to invest in a project upfront.
  2. Simplified accounting: Expensing software development costs means that you don’t need to track and account for the cost over time, which can simplify your accounting process.
  3. Flexibility: By expensing software development costs, you have more flexibility in how you allocate resources to different projects. This can be particularly beneficial for companies that are working on multiple projects at once or have changing priorities.

Case Studies and Personal Experiences

To better understand the pros and cons of capitalizing software development costs, let’s look at some real-life examples:

Capitalization

  • Company A is a software development firm that works on large-scale projects that take several years to complete. They decide to capitalize their software development costs, which allows them to spread out the expenses over time and reduce the impact on their income statement in the short term. This helps them secure financing for future projects and maintain a strong balance sheet.
  • Company B is a startup that is developing a new mobile app. They decide to expense their software development costs, which allows them to write off the full amount in the year it was paid and reduce their upfront costs. This helps them conserve cash and focus on building a successful product without being constrained by financial limitations.

Expensing

  • Company C is a software development firm that works on small-scale projects that are completed within one accounting period. They decide to expense their software development costs, which allows them to deduct the full amount in the year it was paid and reduce their taxable income. This helps them maintain a lean balance sheet and focus on maximizing profits.
  • Company D is a large corporation that is developing a complex enterprise software solution.