Should we be capitalising staff costs relating to software development?

In the start-up or growth phase of a technology company, staff costs are generally expensed through the statement of profit or loss. Over time, as a company matures and headcount grows, the company may hire dedicated software developers who can become a significant cost centre. The question of whether these staff costs should be capitalised as an intangible asset often arises, and some uncertainty can exist as to the point in time in which capitalisation of these costs should commence.

This article covers the three key questions that should be asked prior to capitalising staff costs relating to software development. These questions are based on the requirements of AASB 138 Intangible Assets.

Is the staff cost incurred as part of research or is it a development cost?

An intangible asset cannot be recognised in relation to costs incurred during the research phase of an asset. These costs must be expensed as they are incurred. Research activities focus on obtaining knowledge, assessing options and feasibility studies.

Conversely, costs incurred in the asset's development phase can be capitalised. Development costs are generally related to the software asset's actual coding in a sandbox environment and the testing performed to ensure it is performing as designed.

It is important to make this distinction to ensure research costs are not being inappropriately capitalised.

What is the asset being developed, and will it generate future economic benefits?

While software developers will likely spend their time developing multiple assets without recording how they are spending their time, it is essential to define the asset or assets being developed. An entity may have many different assets that are in different stages of production. Clearly defining what these assets are and what phase they are up to (e.g. research, development, asset in use) will be a key driver for decisions made on which assets can be capitalised.

Once these assets have been defined, there is then a requirement to demonstrate that they will generate future economic benefits. While this may not be clear in the early phases, as development continues, the ongoing feasibility of the software asset would be considered to ensure that future benefits will be generated from the asset.

Can the cost of the developed asset be reliably measured?

It may seem simple to calculate the specific cost of deploying software developers. While staff members’ salaries are readily available, the key challenge is assessing the proportion of time spent developing specific assets outside of time spent undertaking research, maintenance, and day-to-day operational work.

This challenge is often overcome by obtaining timesheet or ‘ticket’ data from developers, which can provide insight into how their time is being spent. Before capitalising staff costs, a solution to determine the specific time spent on each asset (and what tasks are being performed) should be implemented to ensure that time spent can be reliably measured.

While the above considerations are crucial in assessing whether an intangible project cost can be recognised, they don’t exist in isolation, and it is important to consider the requirements of AASB 138 Intangible Assets in full when assessing this for your own business.

If the criteria are met to capitalise certain development costs, it is also important to consider the asset’s appropriate useful life, which will impact the annual amortisation expense and also whether any impairment indicators are present based on the requirements of AASB 136 Impairment of Assets (which require certain intangible assets to be assessed for impairment on an annual basis).

How BDO can help

Our Technology, Media & Telecommunications experts can help you to assess whether the requirements of AASB 138 Intangible Assets apply to your staff costs. Contact us today.