Capitalising Software Costs: Are You Getting It Right?
As more public sector bodies invest in new software systems, we are increasingly being asked whether these costs should be capitalised or expensed. The OCAG Technical Bulletin on Intangible Assets and CGAS 31 provide useful guidance in this area. The OCAG bulletin focuses on the accounting treatment of software hosted on the cloud, while CGAS 31 highlights the distinction between research and development costs. Together, they point to two key questions finance teams should consider:
- Does the arrangement create an intangible asset or is it a SaaS contract?
- Is the expenditure research or development in nature?
1. Does the arrangement create an intangible asset or is it a SaaS contract?
When advising clients, we first consider whether the organisation owns or controls the software asset. A growing number of public sector bodies are adopting Software as a Service (SaaS) arrangements, whereby the body pays a fee in exchange for access to software hosted and controlled by the supplier. In a SaaS arrangement, costs generally cannot be capitalised as the organisation is paying for access to software owned by the supplier rather than owning the software outright.
However, where a SaaS arrangement does not exist and the organisation controls the software, only costs directly attributable to preparing the software for use can be recognised as an asset. Determining which costs qualify requires consideration of the expenditure incurred. In our experience, the distinction between SaaS arrangements and software that creates an intangible asset is one of the most common areas of confusion.
2. Is the expenditure research or development in nature?
CGAS 31 requires organisations to distinguish between research and development activities when assessing software project costs. Costs incurred during the research phase, such as assessing needs, evaluating alternatives and determining feasibility, are treated as an expense. Development costs, such as software configuration, customisation, integration and testing, may qualify for capitalisation where they are directly attributable to preparing the software for use. Training, promotional activities and general administration costs are generally charged as an expense when incurred.
A Practical Example
A public sector body is implementing a new grants management system to help collect applications, notify applicants and manage payments. During the project, it incurs the following costs:
- €400,000 on software configuration and customisation
- €150,000 on system integration and testing
- €50,000 on staff training
In this case, the configuration, customisation, integration and testing costs would generally qualify for capitalisation as they are directly related to preparing the system for use. The training costs, however, would be expensed. As a result, €550,000 may be recognised as an intangible asset, while €50,000 would be charged to expenditure.
Key Considerations
In summary, before deciding whether software costs should be capitalised, public sector bodies should assess:
- Whether the arrangement creates an intangible asset or is simply a SaaS contract; and
- Whether the expenditure relates to research activities or the development of the software.
It’s important to get these assessments right, as they can have a significant impact on both reported results and the value of assets shown in the financial statements.
If you would like advice on the treatment of software project costs, contact David Coombes, Partner in our our Public Sector & Government Services team.
