An update from the Financial Accounting Standards Board concerning capitalizing software is on the way. The new pronouncement, ASU 2025-06, was announced over the summer and goes into effect for annual reporting periods beginning after Dec. 15, 2027, but early adoption is permitted. Entities can choose from three transition approaches: prospective, retrospective or modified, which is based on the status of the project and whether software costs were capitalized before the date of adoption.
With the new pronouncement targeted at improving accounting for internal-use software, a more flexible and intuitive framework that aligns with modern development practices is achieved. Benefits include clearer guidance, reduced compliance costs and improved financial reporting accuracy.
Stifled by stages
By the old standards, projects handled by tech startups were broken down into four prescriptive and sequential software development stages from the conception of an idea through completion. In the preliminary project stage, companies would expense anything during planning of the project as incurred to the P&L. The second stage was the application development stage where costs incurred via payroll for employees or consultant expenses to write code could be capitalized. However, any training or data conversion costs had to be expensed.
In the post implementation-operation stage, which is primarily training and maintenance, costs could once again only be expensed. For some companies there would be a fourth stage concentrated on upgrades and enhancements that would serve to increase the functionality of the software. Those costs could be capitalized, but any maintenance costs still had to be expensed.
As you may have picked up on, these categorizations are not always the easiest to keep track of, especially with a larger team. If you don’t have a system that directly tracks the time people are spending on each task, then you’re left with high-level estimations and judgements that are difficult.
Startups don’t often have the luxury of possessing a sophisticated system or time tracker to collect data that could be used for accurate analysis, for example, in case of an audit. This new pronouncement could help alleviate those headaches.
Modernizing accounting
By definition of the new standards, internal-use software must be acquired, internally developed or modified solely to meet the company’s internal needs, with no substantive plan to market the software externally. This pronouncement modernizes accounting for this software, particularly when developed using incremental and iterative methods like agile. The new guidance is neutral to different software development methods, including methods that entities may use to develop software in the future.
It removes the prescriptive project stages and capitalization now begins when management has committed funding and it’s probable the project will be completed and used as intended. The use of the word “probable” further colors some gray areas that could make it easier to capitalize software, an additional departure from the old standards.
Also, the guidance for website development costs has been superseded and incorporated into the internal-use software standard, and will no longer be in its own separate guidance.
All capitalized internal-use software costs must now be disclosed under ASC 360-10, the disclosure guidance outlining the accounting treatment for property, plant and equipment, not the general intangible asset disclosure rules.
This topic is an area that is very often misunderstood when startups are trying to present U.S. GAAP-based financial statements. Startup management and investors should start conversations early with their accounting advisors to ensure this accounting standard update is understood so they can incorporate the concepts into their financial reporting practices.
Mary Wisenski is a partner in the assurance and advisory practices at the Connecticut accounting firm Fiondella, Milone & LaSaracina LLP (FML CPAs).
