What are the pros and cons of capitalising software development costs?
What are the pros and cons of capitalizing software development costs and amortizing vs expensing and carrying forward losses? Is it just to make to make the balance sheet look nicer or are there more (tax) advantages?
Does the strategy change for companies depending on profit/loss situation?
I note that R&D must be expensed and the norm for product development companies is to expense IT (see the survey in the 2006 report, Capitalization of Software Development Costs: A Survey of Accounting Practices in the Software Industry, in which 146 out of 207 software companies did not capitalize their software development).
Phil Joel ,
Director at SavvySME
I can't comment on the Tax benefits but this is a strategy that some companies used to boost their reported P/L. For instance, if a company was making $100K in Revenue and had $50K in software development cost and assuming there's no other cost, then in theory the company would have $50K of profit. But if the company decides to capitalise the software development say over 5 years and take the depreciation then the expense line for the software development becomes something like $10k (I'm over simplifying to illustrate the point). So the company's profit is now $90K. If that same company was publicly listed then all the sudden, the earnings look a lot better and therefore can potentially get the P/E re-rated and hence a higher share price.