For years, accounting for internal-use software under Accounting Standards Codification (ASC) 350-40, Internal-Use Software, has lagged behind the way companies actually build technology. While software teams embraced agile development, accounting guidance continued to rely on waterfall-style project stages that rarely exist in practice. ASU 2025-06, Intangibles – Goodwill and Other – Internal-Use Software, Targeting Improvements to the Accounting for Internal-Use Software, represents the Financial Accounting Standards Board’s (FASB’s) attempt to close that gap, fundamentally changing when software costs are capitalized and introducing a framework that aligns more closely with modern development practices.
This is a significant change to the software capitalization guidance and directly impacts companies that invest in building enterprise systems, cloud applications, mobile platforms, websites or internally developed technology. The amendment does not impact software development costs to be sold, leased or marketed under ASC 985-20, External Use Software.
The amendment’s most significant change is the removal of the software development stages, or project stages, for software capitalization threshold purposes. The ASU no longer references preliminary project, application development and post-implementation stages. These phases previously determined which software development costs meet the criteria for commencing capitalization, with preliminary project costs expensed, and capitalization commencing at the application development stage.
Under new guidance, there is a new capitalization threshold, which begins when:
The Probable-To-Complete Recognition Threshold should be evaluated for significant development uncertainty associated with the software’s development activities. The amendment states two factors to consider in determining whether significant development uncertainty exists:
In relation to factor #1, if the technology's functions are so novel the company is unsure of their technical feasibility, then significant development uncertainty exists.
Regarding factor #2, minor features are not considered significant. The FASB intends this to refer to the core functionality necessary for the software to achieve its intended purpose. Below are several examples of software projects and related items considered significant performance requirements:
| Software Project | Significant Performance Requirements |
|---|---|
| ERP implementation | General ledger, AP, AR, payroll integration |
| Mobile banking app | Deposit capture, bill pay, account transfers |
| eCommerce platform | Shopping cart, payment processing, inventory integration |
| Artificial intelligence application | Model functionality, outputs, training capabilities, user interactions |
If significant performance requirements are still being designed or are continuously revised, capitalization is delayed.
The table below summarizes general activities to capitalize or expense:
| Capitalize | Expense |
|---|---|
| Designing chosen path, including software configuration and interfaces | Internal and external costs incurred before the capitalization requirements are met |
| Coding | Internal and external training costs |
| Installing hardware | Maintaining software, including bug fixes |
| Testing, including parallel processing | Application maintenance |
| Modifying existing software, resulting in additional functionality |
The table below summarizes the types of costs able to be capitalized:
| Capitalize |
|---|
External direct costs of materials and services:
|
Payroll and related expenses:
|
| Interest incurred in accordance with ASC 835-20 – Capitalization of Interest |
General and administrative costs, including overhead costs, are not capitalized.
The guidance around website development costs has not significantly changed; however, such costs have been consolidated into ASC 350-40, where legacy guidance discussed website development in ASC 350-50. Essentially, website hosting fees, website content costs and search engine registration costs are expensed. Costs related to overall design of the web page and costs to obtain internet domains may qualify for capitalization, but they may require evaluation under the new guidance under ASC 350-40.
The other notable change is the disclosure requirements for internal-use software costs. Before this update, intangible asset disclosure requirements applied. Now, the disclosure guidance for property, plant, and equipment applies to internal-use software costs and amortization, regardless of classification on the balance sheet. No additional software capitalization disclosures or separate cash flow statement presentation is required.
| Under Prior Guidance | Under ASU 2025-06 |
|---|---|
| Focus on identifying project stages | Focus on probability of completion |
| Capitalization begins during application development phase | Capitalization begins after funding commitment and uncertainty resolutions |
| Documentation centered on phase transitions | Documentation centers on management judgement and project readiness |
| Disclosures follow finite-lived intangible asset guidance | Disclosures follow property, plant and equipment guidance |
ASU 2025-06 is effective for annual reporting periods beginning after December 15, 2027, including interim periods within those years. Early adoption is permitted.
The ASU permits three transition approaches.
The audit focus will shift from identifying project stages to assessing the reasonableness of management’s judgments. In many cases, the underlying evidence may come from project management tools, development backlogs, sprint documentation, testing results and governance approvals rather than traditional accounting records. Companies that proactively establish documentation frameworks before adoption may experience a smoother audit process. Below are examples of evidence to support management assertions auditors may request:
| Assertion | Potential Evidence |
|---|---|
| Project authorized | Board approval, steering committee approval, signed contract |
| Funding committed | Approved budget, purchase orders, vendor contracts |
| Requirements identified | Design documents, functional specifications, user stories |
| Requirements stabilized | Change logs showing revisions are no longer substantial |
| Novel functionality resolved | Testing results, successful proof-of-concept, user acceptance testing |
ASU 2025-06 is more than a technical accounting update. It represents a shift toward recognizing how software is developed in today’s environment. While the new model may simplify certain aspects of capitalization, it places increased emphasis on management judgment, governance and documentation. Organizations that begin evaluating their software development processes now will be better positioned to navigate adoption and support their accounting conclusions when the standard becomes effective.
Contact Logan Rose or a member of your service team to discuss this topic further.
In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.