Fasb Codification

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1. The inventory at your company consists of computer software that the company has developed and is selling. You capitalized (rather than expensed) the cost of duplicating the software, the instruction manuals, and training material that are sold with the software.

985 Software: 330 Inventory: 25 Recognition

25-1 The costs incurred for duplicating the computer software, documentation, and training materials from the product masters and for physically packaging the product for distribution shall be capitalized as inventory on a unit-specific basis.

The cost of duplicating the software, instruction manuals, and training materials that are sold with the software is capitalized and amortized to current and future periods. Any costs incurred beyond the Research and Development stage can be capitalized when it is pertaining to the development of software that is to be sold, leased, or otherwise marketed to third parties. Standard 985-330-25-1 applies to these costs as the FASB ASC defines the Product Masters as "a completed version, ready for copying, of the computer software product, the documentation, and the training materials that are to be sold, leased, or otherwise marketed".

The company has established technological feasibility for the software product and no longer has to charge to the R&D expense the costs incurred in creating the product. Technical feasibility is established when the company has the capability, in terms of software, hardware, personnel and expertise, for the completion of the project. The materials have obviously surpassed the Research and Development stage if they have been prepared for the duplication stage. All R&D costs are expensed until technological feasibility; and it not until this point that some future development costs can be capitalized.

There are no clear guidelines on this matter, but the Financial Accounting Standards Board did issue Interpretation No. 6, Applicability of Statement No. 2 to Computer Software (an interpretation of FASB Statement No. 2 February 1975). The bottom-line is up to the accountant and the company and how they would prefer to approach the capitalization of software costs which is not always black and white. From an aggressive approach, the company is permitted to capitalize some future development costs to raise their current period income and assets and to lower their future period incomes. The conservative approach, on the other hand, would be to expense these costs which would consequently reduce the current operating cash flows. Whereas, the aggressive approach permits companies to record these capitalizations in the investing section of the statement of cash flows rather than the operating section which results in a comparatively higher operating cash flow.

If companies choose the aggressive approach, the capitalized software costs be establish a proper amortization pattern for such costs - either the Percent-of-revenue approach or the Straight-line approach. The company must use the approach with the greatest amortization charge. If the Straight-line approach fits the situation, the reported cost of the capitalization must be spread over the assumed economic life of the item - typically 3 to 5 years for Information Technology. Otherwise, the amount of amortization charged will be the ratio of current revenues to current and anticipated revenues.

The company has chosen the aggressive approach in capitalizing the costs (treating them as an asset) to benefit the company in the present and to reduce the income in the future periods through amortization. They adhered to GAAP principles and chose the path that would be most beneficial to them in the income statement. They established technical feasibility and proceeded to capitalize the costs incurred for the software and its related documentation.

Intermediate Accounting 14 Edition, Kieso, Weyandt and Warfield. Shaw, H. Software Capitalization Clouds Comparisons....
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