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Capitalization of Software Product Development Costs

Chintan (Partner) (35 Points)

31 August 2009

I wanted to know about the accounting practices around software product development.

I am planning a new venture which will provide software on the web (as a service). There is significant upfront and continuous investment in product development. Suppose I invest Rs 20 lakhs upfront and then around Rs 3 lakhs per month on product development and upgradation what is the policy around capitalization.

What is the amount I can capitalize?

What would be the depreciation?

Regards

Chintan

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4 Replies

RITESH KOTHARI (B.COM, FCA, DISA(ICAI)) (778 Points)
Replied 31 August 2009

IT MEANS YOU WOULD BE MANUFACTURING SOFTWARES FOR OTHERS.

AM I RIGHT OR NOT?

AFTER THAT I COULD GUIDE YOU .

REGARDS,

CA RITESH KOTHARI

Aditya Maheshwari (CA in Practice) (35867 Points)
Replied 31 August 2009

Yes as mentioned above further clarification is required to answer ur query.

If u are going to purchase a software and then develop it before selling it then it will be treated as ur business and it will be like purchase and sale or just providing it for use on the web then the entire upfront payment and development expenses will be capitlised upto the time the software is put to use as per my understanding of ur query

Chintan (Partner) (35 Points)
Replied 31 August 2009

Thanks for your replies. The software applications are being developed inhouse and there are going to be multiple applications which will be developed over the next 2 years. As and when each application is ready we will start selling it to customers on a subscripttion (monthly fee) based model.

Hope this clarifies. If I am allowed to capitalise then what is the depreciation method and rate.

Regards

Kaustuv (Practicing CA) (1773 Points)
Replied 31 August 2009

AS-26 on intangible asset provides us that:-

An intangible asset arising from development (or from the development phase of an internal project) should be recognised if, and only if, an enterprise can demonstrate all of the following:

the technical feasibility of completing the intangible asset so that it will be available for use or sale;
its intention to complete the intangible asset and use or sell it;
its ability to use or sell the intangible asset;
how the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and
its ability to measure the expenditure attributable to the intangible asset during its development reliably.

The cost should be expensed off unless it meets the recognition criterias mentioned.

Regarding amortisation, the following guidance is available:-

The amortisation method used should reflect the pattern in which the asset's economic benefits are consumed by the enterprise. If that pattern cannot be determined reliably, the straight-line method should be used. The amortisation charge for each period should be recognised as an expense unless another Accounting Standard permits or requires it to be included in the carrying amount of another asset.

and,

The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. Amortisation should commence when the asset is available for use.

I hope the above would clear your doubts. If you are unclear about something, please feel free to contact me.

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