A:

Computer software can be considered a long-term asset that falls under fixed assets like buildings and land. However, there are times when software should not be considered a long-term asset. In this article, we'll review the accounting standards that are in place to classify computer software.

Intangible assets are typically nonphysical assets used over the long-term. Intangible assets are often intellectual assets, and as a result, it's difficult to assign a value to them because of the uncertainty of the future benefits.

On the other hand, tangible assets are physical and measurable assets that are used in a company's operations. Assets like property, plant, and equipment (PP&E) are tangible assets.

PP&E refers to long-term assets, such as equipment that is vital to a company's operations and has a definite physical component. Under most circumstances, computer software is classified as an intangible asset because of its nonphysical nature. However, accounting rules state that there are certain exceptions that permit the classification of computer software, such as PP&E (property, plant and equipment).

    Below are the accounting standards that describe how and when computer software should be classified as PP&E:

    • Financial Accounting Standards Advisory Board (FASAB) Statement of Federal Financial Accounting Standards (SFFAS) No. 10, Accounting for Internal Use Software.
    • Governmental Accounting Standards Board (GASB) Statement No. 51, Accounting and Financial Reporting For Intangible Assets.

    What Is PP&E

    It's important that we first define the accounting standard for PP&E. According to SFFAS No. 6, tangible assets are classified as PP&E if:

    • They (assets) have estimated useful lives of 2 years or more.
    • They are not intended for sale in the ordinary course of operations.
    • They have been acquired or constructed with the intention of being used or being available for use by the entity.

    Criteria for Capitalization As PP&E

    There are rules that are applied to determine whether or not software must be capitalized as PP&E or expensed. If software meets the criteria of property, plant, and equipment as stated above, it can be classified as PP&E. According to SFFAS No. 10:

    "Entities should capitalize the cost of software when such software meets the criteria for general property, plant, and equipment (PP&E). General PP&E is any property, plant, and equipment used in providing goods and services." 

    • Management has some discretion since there are no dollar amount thresholds for the cost of computer software whether it's internal or new software.
    • Capitalization thresholds should be established by management in accordance with PP&E guidelines. For example, for a bulk software purchase, both the bulk cost and the useful life of the software should be included in the calculation. If it is contractor-developed software, the amount paid to the vendor for development and implementation should be classified.
    • Capitalization of software doesn't include software that is an integral part of property, plant, and equipment. According to SFFAS No. 10 section 38 & 39; it states:

    "For example, if the software is a part of a weapons systems, it would not be capitalized but included in the cost of investing in that weapons system. On the other hand, software used to accumulate the cost of acquiring that weapons system or to manage and account for that item would meet the criteria for general PP&E and should be capitalized."

    • The capitalization cutoff is not determined by an amount but rather when the testing stage of the software has been completed. According to SFFAS 10, paragraph 20:

    “Costs incurred after final acceptance testing has been successfully completed should be expensed. Where the software is to be installed at multiple sites, capitalization should cease at each site after testing is complete at that site.”

    It's important to review the financial accounting standards before making any decisions on whether to expense or capitalize computer software as PP&E. This article only touches on a few of the key topics. Many other instances may have different accounting standards that might need to be applied such as cloud computing, multi-use software, developmental software, and shared software between divisions.

    For more on the differences between tangible and intangible assets, please read "How Do Tangible and Intangible Assets Differ?

    RELATED FAQS
    1. What is property, plant, and equipment?

      Property, plant, and equipment are physical or tangible assets that are long-term assets that typically have a life of more ... Read Answer >>
    2. How do tangible and intangible assets differ?

      Tangible assets are physical assets that are used in a company's operations. Intangible assets are nonphysical, long-term ... Read Answer >>
    3. How do intangible assets show on a balance sheet?

      Intangible assets are often intellectual assets, but their valuation and accounting can vary, depending on whether they're ... Read Answer >>
    4. How do fixed assets and current assets differ?

      Current assets can be converted into cash in less than one year, while fixed assets are long-term physical assets. Read Answer >>
    5. What kinds of events or circumstances will increase or decrease the proportion of ...

      Learn the variety of events and circumstances which can significantly increase or decrease the proportion of intangible assets ... Read Answer >>
    6. What are some of the better types of financial analysis software?

      Discover what features make for good financial analysis software, some popular options and why analysts need to pick the ... Read Answer >>
    Related Articles
    1. Investing

      How to Evaluate a Company's Balance Sheet

      Asset performance shows how what a company owes and owns affects its investment quality.
    2. Managing Wealth

      Comparing Tangible and Intangible Assets

      Tangible assets are physical assets such as land, vehicles or equipment.
    3. Investing

      The 5 Biggest Chinese Software Companies (CHL, TCEHY)

      Read about the five largest and most influential software companies in China, including a new startup considered to be an upcoming superstar.
    4. Managing Wealth

      How to Calculate Your Tangible Net Worth

      You can calculate your tangible net worth with a simple equation.
    5. Investing

      How Intuit's Transition to the Cloud Has Driven Revenue Growth (INTU)

      Learn how Intuit is transitioning its users to the cloud, and how the company's revenue growth is being affected in the short and long terms.
    6. Investing

      Fidelity: Software Stocks to Benefit From Tax Cuts

      Software stocks tend to perform well at the late stage of the economic cycle says a Fidelity Investments fund manager.
    7. Investing

      Explaining amortization in the balance sheet

      Read to find out more about amortization, an important way to account for the value of intangible assets.
    8. Tech

      The Top 5 Large-Cap Software Stocks for 2016

      Discover the top five large-cap software stocks for 2016, with a summary of each company and what will make the stock appreciate in the upcoming year.
    9. Investing

      Must-Have Software For The Home Office

      If you have a home business, these pieces of software can be extremely helpful to you.
    RELATED TERMS
    1. Property, Plant, and Equipment (PP&E)

      Property, plan, and equipment (PP&E) are long-term assets vital ...
    2. Tangible Asset

      A tangible asset is an asset that has a physical form, and includes ...
    3. Capital Asset

      A capital asset is a type of asset with a useful life longer ...
    4. Intangible Asset

      An intangible asset is an asset that is not physical in nature ...
    5. Business Asset

      A business asset is a piece of property or equipment purchased ...
    6. Software As A Service - SaaS

      A cloud-computing approach to providing users with access to ...
    Trading Center