A software company is developing a new application it plans to sell to external customers. It incurs coding and testing costs before completing a detailed program design and a working model confirmed to meet the product's design specifications, and it incurs further coding and testing costs after that point, up until the product is made available for general release. Under ASC 985-20, how should each set of costs be treated?
- Both sets of costs are capitalized, because all software development costs are capitalizable once a company has committed to building a product it intends to sell
- Both sets of costs are expensed as incurred and treated as research and development, because software marketed to external customers is never eligible for cost capitalization
- Costs incurred before technological feasibility is established are capitalized as an intangible asset, while costs incurred after technological feasibility is established are expensed as cost of goods sold
- Costs incurred before technological feasibility is established are expensed as research and development; costs incurred after technological feasibility is established, up to general release, are capitalized
Why D? And why not the others?
Correct answer: D. Costs incurred before technological feasibility is established are expensed as research and development; costs incurred after technological feasibility is established, up to general release, are capitalized
ASC 985-20-25 requires that all costs incurred before a software product intended to be sold, leased, or otherwise marketed reaches technological feasibility be expensed as incurred as research and development. Technological feasibility is established once the entity has completed all the planning, designing, coding, and testing necessary to confirm the product can be produced to meet its design specifications, including functions, features, and technical performance. Costs incurred after that point, through the point the product is available for general release to customers, are capitalized as an intangible asset. Here the costs before the design and working model were confirmed are R&D expense, and the costs afterward, up to general release, are capitalized. The option capitalizing both sets of costs ignores the technological-feasibility trigger entirely. The option expensing both sets ignores that ASC 985-20 explicitly permits capitalization after feasibility is reached. The option reversing the treatment — capitalizing pre-feasibility costs and expensing post-feasibility costs as cost of goods sold — inverts the standard's trigger point and mischaracterizes ongoing capitalized development costs as a cost-of-sales item, which they are not until the software is actually sold.
Source: FASB ASC 985-20-25-1 and 25-2 (research and development costs for computer software to be sold, leased, or otherwise marketed — technological feasibility)