Uniqus Point of View

Accounting Considerations related to platform development and technology costs

28, July 2023

Background

For Brick – and – Mortar Companies, which require significant investments as set up costs, there exist clarity in terms of evaluating the expenditure to be capitalized as Property, Plant and Equipment (PPE), if it is probable that future economic benefits associated with the incurred costs will flow to the entity and its cost can be measured reliably, irrespective of the fact that the cost is incurred during the asset development phase. This is very common for items of PPE resulting from In- house development.
In recent times, along with capital investments in tangible assets, there has also been a significant increase in the number of companies making material investments in platform development and technology costs. With increasing spends related to platform development and technology costs, there is always a question whether such costs which are being incurred can be capitalized as Intangibles, rather than being expensed in the income statement.
This publication provides insights from an accounting and reporting perspective on this matter.

Platform Development and Technology Costs

Technology spends by companies can be broken down into three major categories:
1. Internally developed – Technology is developed internally by the entity, operating in its own environment.
2. Acquired from third party – License is obtained from a third party. This includes software functioning in a company’s or a third party’s environment.
3. SaaS – An entity is granted a right to access software hosted on a cloud environment (Software as a service – SaaS).
It is important to carefully consider whether development and technology costs incurred in any of the above categories should be capitalized or expensed.

Internally Developed Assets – Existing Accounting Requirements

A brief narrative on accounting under the Ind AS, IFRS and US GAAP is outlined below:

A. Ind AS 38 / IAS 38

When undertaking an assessment of whether platform development and technology costs should be capitalized or expensed, the starting point is to assess whether the costs can be capitalized as intangible asset. Ind AS and IFRS standards on intangible assets spell out similar requirements while accounting for such assets.

B. ASC Subtopic 350-40

There is an explicit guidance on costs incurred for computer software developed or obtained for internal use. FASB’s ASC Subtopic 350-40 on Internal-Use Software, the PDF illustrates the various stages of development.

ASC 350-40 further states that upgrades and enhancements are modifications to existing asset which result in additional functionality. For costs related to specified upgrades and enhancements to internal use software to be capitalized, it must be probable that those expenditures will result in additional functionality.

Considering there is no such explicit guidance for costs on development of internal-use software under Ind AS and IFRS, the costs of such software are accounted for under the general principles for internally generated intangible assets as stated in Ind AS 38 / IAS 38.

Asset Acquired from Third Party – Existing Accounting Requirements

The cost of an intangible asset acquired from third party, is the cash paid or fair value of any other consideration given, plus transaction costs. Ind AS, IFRS and US GAAP support this accounting principle as long as the definition of Intangible asset as explained earlier is met.
Under Ind AS and IFRS, the cost further includes any directly attributable expenditure incurred in preparing an asset for its intended use such as employee costs, professional fees, testing costs etc. However, under US GAAP, there is no such principle and an assessment for capitalization need to be undertaken based on the nature of the costs incurred.

SaaS Arrangements – Existing Accounting Requirements

Ind AS / IFRS Standards contain very limited guidance about a customer’s accounting for SaaS arrangements or implementation costs for those arrangements. The SaaS arrangements may either be within the scope of Ind AS 116 / IFRS 16 or Ind AS 38 / IAS 38 or may be in the nature of service contract.
A detailed discussion of accounting for such SaaS arrangements is included in IFRIC agenda decisions dated March 2019 and March 2021.
SaaS arrangement as a Lease

Intangible asset (software license):
In respect of a software license cost under SaaS arrangement which is not excluded from scope of leases, the entity may, but is not required to apply Ind AS 116 / IFRS 16 as lease of intangible asset.
Tangible assets:
SaaS arrangement includes the right to use an asset (e.g., underlying servers or other tangible assets) for which the customer has the right to obtain substantially all the economic benefits from use of the asset and the right to direct the use of that asset.

Accounting Challenges

The general recognition and measurement guidelines for intangible assets are as provided above. When implementing the accounting frameworks, this raises the following challenges:

Distinguishing development activities from research activities.
Assessing whether and when the conditions for capitalizing development costs are met; Evaluating whether the rights granted in the SaaS Arrangement are within the scope of IAS 38 as an intangible asset or IFRS 16 as lease arrangement. Otherwise, the arrangement is generally a service contract.

Diversity in Practice

The general recognition and measurement guidelines for intangible assets are as provided above. When implementing the accounting frameworks, this raises the following challenges:

Various judgmental aspects associated with research and development costs.
The processes and systems in companies not being geared to capture the data points to support the decision to capitalize.
Absence of formal controls from an Internal Financial Controls (IFC) or a SOX 404 perspective.

There is diversity in practice in accounting for platform development and technology costs. Major Indian and global corporates have different approaches and policies to assess and account for such spends, which are a function of their existing processes and systems in relation to this topic.

Questions for Finance Teams to Address

In absence of clearly defined guidelines and varied practices adopted by entities in accounting and reporting for platform development and technology costs, the question arises that what is the right approach when it comes to accounting for platform development and technology costs.
Some of the questions which are relevant for the finance teams under Ind AS, IFRS or US GAAP are:

Q1: Have we correctly identified all directly attributable costs such as material costs, employee costs, service costs and borrowings costs etc. necessary to create, produce, and prepare the asset eligible for capitalization.

Q2: Have we correctly estimated the useful life of capitalized asset ranging from 3 to 10 years over which it should be amortized.

Q3: Are we correctly monitoring and tracking the manpower costs incurred as a part of software development, which needs to be capitalized or we need to adopt new processes and systems.

Q4: What practice other companies are following to account for similar arrangements.

Q5: For agile development models have we correctly identified the software coding or revision in coding and other similar costs which can be capitalized.

Q6: For SaaS arrangements, have we correctly identified and capitalized the customization costs such as costs incurred to modify the software code in the application or writing additional code in SaaS arrangement.

Q7: Have we ensured that implementation costs of a hosting arrangement in the nature of Service Contract are not capitalized.

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