We support young talents in the arts Deloitte - major partner of the Jindřich Chalupecký Award Accounting news Czech Accounting, IFRS and US GAAP August 2011, Deloitte Czech Republic 02 Czech Accounting Accounting for Annual Bonuses 03 IFRS New IFRSs on consolidation, joint ventures and disclosures New Amendments to IAS 1 Presentation of Financial Statements New Amendments to IAS 19 Employee Benefits Invitation to the Autumn IFRS Seminars 05 US GAAP Software under US GAAP capitalization rules
Czech Accounting Accounting for Annual Bonuses This issue of Accounting News looks at how annual bonuses (or payroll bonuses) should be accounted for and the related impact on corporate income tax calculation. Annual bonuses may be structured and calculated in various manners. Sometimes the calculation is clear and simple, eg as an employee, you are entitled to a bonus equal to your average monthly salary and the amount is easily identifiable. In other cases, bonuses are calculated according to a set complicated algorithm, eg when certain performance is achieved, in combination with an employee s success in sales or the sick leave rate. Bonuses are also provided as a share in the company s profit. Recognition of Annual Bonuses To recapitulate, we can use the Other Reserves, Accrued Expenses, or Estimated Payables accounts to recognise annual bonuses. In accordance with Section 57 of Regulation 500/2002 Coll., reserves are intended to cover future liabilities or expenditure, the nature of which is clearly defined and which are likely to be incurred, but which are uncertain as to the amount or the date on which they will arise. If you know the amount of the bonus, you can use Account 383 Accrued expenses. According to Czech Accounting Standard No. 17, accrued expenses include expenses that relate to the reporting period but that have not yet materialised. It is possible to recognise only the amounts known to be incurred to a relevant account and in a certain amount. If the amount is unknown, Account 389 Estimated payables can be used. As compared to Account 383, the exact amount is not known, and thus it is only an estimate of bonuses. What is the difference between these treatments? The principal difference among recognising bonuses on Account 389 Estimated payables, Account 383 Accrued expenses or Account 459 Other reserves is the assessment of whether the undisputable claim for payment arose before the end of the reporting period or whether it is only likely that such claim will arise. When an undisputable claim arises before the end of a reporting period, we can use the accrued expenses account if we know the exact amount (383 Accrued expenses). If we do not know the exact amount, we use Account 389. If, however, it is only likely that the claim will arise in the future, we recommend using Account 459 Other reserves. Let us briefly summarise the accounting treatment: Do we know the purpose? Do we know the amount? Did the claim arise before the end of the reporting period? Yes Yes Yes 383 Accrued expenses Yes No Yes 389 Estimated payables Yes Yes /No No 459 Other reserves The limit as to when estimated payables accounts and other reserves accounts should be used is very unclear and the interpretation is not necessarily unambiguous. Tax Deductibility And what about the tax deductibility of these bonuses? In spring 2011, the Supreme Administrative Court issued a ruling on the tax deductibility of bonuses that are provided in connection with a company s profit. Pursuant to this ruling, it can be concluded that only those bonuses whose claim is undisputable as of the balance sheet date can be treated as tax deductible. An annual bonus is usually a non-claimable component of the salary where the legal claim for payment does not depend on the performance of work in the specific taxation period but arises after other conditions are met (eg approval by a responsible person). In the case of annual bonuses where the employee will not be entitled to receive the bonus as of the balance sheet date (it will be approved by a responsible person in the following year), the bonus cannot be treated as a tax-deductible expense. In addition to the condition whereby approval must be granted by a responsible person, the claim may relate to other conditions as well (eg the ruling of the Supreme Administrative Court above states as a condition a resolution by the General Meeting on the profit from which the bonus is calculated). In conclusion, we can state that if the claim for a bonus is undisputable as of the balance sheet date (ie as of the date on which the financial statements are prepared), the entity can recognise either accrued expenses (the purpose and amount of the bonus is known) or an estimated payable (the purpose is known, but the amount is not). In both cases, it will be a tax-deductible expense. In other cases, it will be a tax non-deductible expense when the condition for recognising a reserve is met. 02
New IFRSs on consolidation, joint ventures and disclosures In the May edition of our Accounting News we informed you that on 12 May 2011 the IASB had published its package of five new and revised standards addressing the accounting for consolidation, involvements in joint arrangements and disclosure of involvements with other entities (IFRS 10, IFRS 11, IFRS 12, IAS 27 (2011), IAS 28 (2011). We are providing more information about these new issued standards in this edition of our Accounting News. Effective date Each of the five standards have an effective date for annual periods beginning on or after 1 January 2013, with earlier application permitted so long as each of the other standards in the package of five' are also early applied. However, entities will be permitted to incorporate any of the disclosure requirements in IFRS 12 Disclosures of Involvement with Other Entities into their financial statements without technically early applying the provisions of IFRS 12 (and thereby each of the other four standards). The Package of five new and revised standards has not yet been endorsed by the European Commission for use in the EU. IFRS 10 Consolidated Financial Statements IFRS 10 replaces those parts of IAS 27 Consolidated and Separate Financial Statements that address when and how an investor should prepare consolidated financial statements and replaces SIC-12 Consolidation Special Purpose Entities in its entirety. Overview of significant changes IFRS10 uses control as the single basis for consolidation, irrespective of the nature of the investee. IFRS 10 identifies the following three elements of control: power over the investee; exposure, or rights, to variable returns from involvement with the investee; and the ability to use power over the investee to affect the amount of the investor's returns. An investor must possess all three elements to conclude it controls an investee. The assessment of control is based on all facts and circumstances and the conclusion is reassessed if there is an indication that there are changes to at least one of the three elements of control. Elements of control: Power Power exists when the investor has existing rights that give it the current ability to direct the activities that significantly affect the investee s returns ( the relevant activities ). Power most commonly arises through voting rights granted by equity instruments, but can also arise through other contractual arrangements. Rights to direct the relevant activities do not need to be exercised for them to provide an investor power. If two or more investors have rights to direct different relevant activities, the investors must decide which of the relevant activities most significantly affects the returns of the investee. The following factors should be considered in determining whether an investor has power over an investee: the purpose and design of the investee; the relevant activities of the investee and how decisions are made about those activities; whether the investor's rights give it the current ability to direct the relevant activities; whether the investor is exposed, or has rights, to variable returns from its involvement with the investee; whether the investor has the ability to use its power over the investee to affect the amount of the investor's returns; and relationships with other parties. The relevant activities for entities whose operations are directed through voting rights will generally be its operating and financing activities. Examples of activities that may be relevant activities include product development, purchases and sales of goods or services, managing financial assets, acquiring and disposing of assets or obtaining financing. Examples of decisions about relevant activities include establishing operating and capital decisions of the investee and appointing and remunerating an investee s key management personnel and terminating their employment. There may be situations where voting rights are less relevant because the rights relate to administrative tasks only. In these cases, a careful analysis of the investor s contractual and non-contractual rights as well as its related party relationships is necessary. IFRS 10 provides the following examples of special relationships between an investor and investee that may indicate power: the investee s key management personnel are current or previous employees of the investor; the investee's operations are dependent on the investor; a significant portion of the investee s activities either involves or is conducted on behalf of the investor; and the investor s exposure, or rights, to investee returns is disproportionately greater than its voting or similar rights. 03 continues on next page
IFRS 10 specifies that only substantive rights and rights that are not protective are considered in assessing power. For a right to be substantive, it must give its holder the practical ability to exercise the right when the decisions about the relevant activities of the investee need to be made. Rights do not need to be currently exercisable to be substantive. Also, substantive rights held by other parties may prevent the investor from controlling the investee. Protective rights IFRS 10 distinguishes between substantive rights and protective rights. An investor who holds only protective rights would not have power over an investee and could not prevent another party from having power over an investee. Protective rights relate to fundamental changes to the activities of an investee or apply in exceptional circumstances". Examples of protective rights may include the right to approve new debt financing, the right of a party holding a non-controlling interest in an investee to approve the investee's issuance of additional equity instruments or the right of a lender to seize assets in the event of default. Control with less than a majority of voting rights IFRS 10 clarifies that an investor can have power over an investee even though it does not hold a majority of the voting rights. For example, an investor may have power through a contractual arrangement, holding voting rights, holding potential voting rights or a combination thereof. A contractual arrangement between an investor and other investors can give the investor the right to exercise voting rights sufficient to give the investor power, even if the investor itself does not have sufficient voting rights to give it power. For example, a contractual arrangement may provide the investor the ability to direct enough other vote holders on how to vote to enable the investor to make decisions about the relevant activities or provide the investor with the current ability to direct the operating and financial activities of an investee. An investor that holds less than a majority of the voting rights should also consider the size of their holding of voting rights relative to the size and dispersion of holdings of the other vote holders and any additional facts and circumstances that may be relevant (such as voting patterns at previous shareholders meetings). Principal vs. agent relationship IFRS 10 introduces guidance on assessing whether an entity with decision making rights is a principal or agent. The standard describes an agent as a party who has been engaged to act on behalf, and for the benefit, of another party (the principal ). However, the Standard clarifies that an investor is not an agent simply because other parties benefit from their decision making. Relationships with other parties IFRS 10 also provides guidance on when an investor may have a relationship with another party such that the investor may direct the other party in acting on the investor s behalf (referred to as a 'de facto agent'). The guidance on considering the investor s relationship with other parties is necessary to reflect properly the relationship that a group may have with an investee. An investor and its de facto agents may each have power and economic involvements that when considered in isolation may not result in either party being identified as having control, but which together result in the group having control. Elements of control: Exposure, or rights, to variable returns The second criterion in the consolidation assessment is that the investor has exposure, or rights, to variable returns of the investee, IFRS 10 uses the term returns rather than 'benefits' to clarify that the economic exposure to an investee may be either positive, negative or both. Examples of returns from involvement with an investee could include changes in the value of the investment in the entity, residual interests in cash flows of structured entities, dividends, interest, management or service fee arrangements, guarantees, tax benefits, or any other returns that may not be available to other interest holders. While only one investor will control an entity, multiple investors may share in the returns of the investee. IFRS 10 clarifies that although certain economic interests may be fixed (e.g. a fixed coupon debt instrument or a fixed asset management fee based on assets under management) they might still result in variable returns as they expose the investor to variability such as credit risk from the debt instrument and performance risk from the asset management arrangement. Elements of control: Ability to use power to affect returns The third pillar in the assessment of control considers the interaction between the first two control components. To have control over an investee, an investor must not only have power over an investee and exposure or rights to variable returns from its involvement with the investee, but also have the ability to use its power over the investee to affect its returns from its involvement with the investee. Other considerations Continuous assessment IFRS 10 requires a continuous assessment of control of an investee. This continuous reassessment would consider both changes in an investor's power over the investee and changes in the investor s exposure or rights to variable returns. This assessment will be made based on changes in facts and circumstances but would be visited at least at each reporting period. Transitional provisions IFRS 10 requires retrospective application in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, subject to certain transitional provisions. When the initial application of IFRS 10 results in consolidation of an investee that was not previously consolidated, an investor should measure the assets, liabilities and non/controlling interests in that previously unconsolidated investee on the date of initial 04 continues on next page
application as if that investee had been consolidated from the date when the investor obtained control of that investee on the basis of the requirements of IFRS 10 (if the investee is a business, this would mean applying IFRS 3 Business combinations as of that date). However, if this is impracticable, the investor should apply the requirements of IFRS 3, with the deemed acquisition date being the beginning of the earliest period for which application is practicable (which may be the current period). When the initial application of IFRS 10 results in no longer consolidating an investee that was previously consolidated, an investor should measure its interest in the investee at the amount in which it would have been measured if the requirements of IFRS 10 had always been effective. If measurement of the interest is impracticable, the investor should apply the requirements of IFRS 10 for accounting for a loss of control at the start of the reporting period in which IFRS is adopted. Expected impact of adopting IFRS 10 in practice Compared to IAS 27, IFRS 10 anticipates using judgement to a greater extent and includes multiple indicators and factors to be considered. The adoption of IFRS 10 will not affect most of the traditional and standard investor investment relationships, ie the investor holds more than a majority of voting rights and this proportion is in line with the extent to which the investor is able to influence the operations of the investee and participate in returns arising from the investment. Differences as compared to IAS 27 and SIC 12 may occur if: The voting rights have no major influence on the entity s relevant activities; Potential voting rights exist; There are mutual funds; Special purpose entities exist; Different parties have rights over different activities; The principal agent relationship exists; and There are related parties holding an investment in the entity. In addition, we recommend reviewing all investments which are complex, non-transparent, or include non-standard or supplementary provisions. It is always useful to consider what the entity s objective with respect to the investment is and what goal it wishes to attain through the investment. With the adoption of IFRS 10 it is more likely that the reassessment of investments will lead to change the accounting treatment (consolidation versus significant influence) even though there is no change in voting rights held. IFRS 11 Joint arrangements IFRS 11 supersedes IAS 31 Interests in Joint Ventures and SIC 13 Jointly Controlled Entities Non-Monetary Contributions by Venturers. Joint control IFRS 11 defines a joint arrangement as an arrangement of which two or more parties have joint control and makes clear that joint control exists only when decisions about the relevant activities require the unanimous consent of the parties that control the arrangement collectively. Joint operations and joint ventures The new standard establishes two types of joint arrangements: joint operations and joint ventures. The two types of joint arrangements are distinguished by the rights and obligations of those parties to the joint arrangement. In a joint operation, the parties to the joint arrangement (referred to as joint operators ) have rights to the assets and obligations for the liabilities of the arrangement. By contrast, in a joint venture, the parties to the arrangement (referred to as joint venturers ) have rights to the net assets of the arrangement. IFRS 11 requires that a joint operator recognise its share of the assets, liabilities, revenues and expenses in accordance with applicable IFRSs while a joint venturer would account for its interest using the equity method of accounting under IAS 28 (revised 2011) Investments in Associates and Joint Ventures. The option of proportional consolidation included in IAS 31 has not been retained. IFRS 11 applies to all parties that have an interest in a joint arrangement, not just to those that have joint control. Therefore, all parties that have an interest in a joint operation should recognise their share of assets, liabilities, revenues and expenses arising from that interest. However, the accounting for an interest in a joint venture will depend on whether the party has joint control. A party that has joint control or significant influence over a joint venture will account for its interest using the equity method of accounting, a party that does not will apply IFRS 9 Financial Instruments (or IAS 39 Financial Instruments: Recognition and Measurement, as applicable). Hence, adoption of IFRS 11 requires that all parties to joint arrangements evaluate whether the arrangement meets the definition of a joint operation or a joint venture. The standard provides guidance on factors to consider in the identification of a joint venture. Separate financial statements Joint operations are accounted for in the same manner in the separate financial statements as in the consolidated financial statements (i.e., the investor recognises directly its shares of assets, liabilities, revenues and expenses related to the joint operations). Joint ventures, like investments in associates and in subsidiaries, are accounted for in the separate financial statements of the venturer either at cost or under IFRS 9 (or IAS 39, as applicable) as permitted by IAS 27. 05 continues on next page
Disclosures The disclosure requirements for entities involved with joint arrangements are established in IFRS 12. Transitional provisions When adoption of IFRS 11 requires a change in accounting, the impact of the change is calculated as at the beginning of the earliest period presented and the comparative periods are restated. Transitional provisions vary depending on how an interest is classified under IAS 31 Interests in Joint Ventures. Adoption of IFRS 11 will require adjustments to the financial statements in two circumstances: Before IAS 31 Jointly controlled entity accounted for using the equity method After IFRS 11 Joint operation Accounting as at beginning of the earliest period presented derecognise the equity method investment; recognise assets (goodwill if any) and liabilities arising from the joint operation; if the amount of net assets recognised exceeds the carrying amount of the equity method investment derecognised, the excess reduces goodwill to the extent it exists, with any remaining excess recognised against retained earnings; and if the amount of net assets recognised is less than the carrying amount of the equity method investment derecognised, the difference is recognised against retained earnings. Before IAS 31 Jointly controlled entity accounted for using proportionate consolidation After IFRS 11 Joint venture Accounting as at beginning of the earliest period presented derecognise assets (including goodwill if any) and liabilities; recognise the equity method investment at the carrying amount of the net assets derecognised; and perform an impairment test and recognise the impairment loss, if any, as an adjustment of retained earnings. The expected impact of adopting IFRS 11 in practice All investors in a joint arrangement (including those that do not have joint control) may be impacted. The mechanics of equity accounting, as detailed in IAS 28, have not changed and the accounting for joint operations according to IFRS 11 is consistent with the current treatment of jointly controlled operations and jointly controlled assets under IAS 31. Under IFRS 11, the existence of a separate vehicle is a necessary, but not sufficient, condition for a joint arrangement to be considered a joint venture. In the absence of a separate vehicle, IFRS 11 makes it clear that the parties to the joint arrangement have direct rights and obligations to the assets and liabilities of the arrangement and hence the arrangement will be classified as a joint operation. This is a significant change from the requirements of IAS 31, which treats the establishment of a separate legal vehicle as the key factor in determining the existence of a jointly controlled entity. It is possible that an investment that previously met the definition of a jointly controlled entity under IAS 31 will be a joint operation under IFRS 11. Additionally, an investor that previously accounted for an interest in a joint operation under IFRS 9 (or IAS 39 as applicable) because it did not have joint control would be affected upon the adoption of IFRS 11 since the investor would have to recognise directly its share of assets, liabilities, revenues and expenses relating to the joint operation. The elimination of the proportionate consolidation can have significant impact on the consolidated financial statements of the investor which will use the equity method instead. In many cases this change will cause the reduction in the recognised revenues, production costs and therefore also in the gross margin, liabilities and current assets. The entities can maintain the use of the proportionate consolidation method for internal reporting purpose and also for IFRS 8 segment information (with appropriate reconciliation). IFRS 12 Disclosures of Involvement with Other Entities IFRS 12 applies to entities that have an interest in subsidiaries, joint arrangements, associates or unconsolidated structured entities. The entity is required to disclose information that helps users of financial statements understand the nature of and risks associated with its interests in other entities and the effects of those interests on its financial statements. IFRS 12 is intended to integrate the disclosure requirements on interests in other entities, currently included in several standards, and also adds additional requirements in a number of areas. 06 continues on next page
Significant judgements and assumptions An entity should disclose information about significant judgements and assumptions it has made in determining whether it has control, joint control or significant influence over another entity and the type of joint arrangement. An entity should also provide these disclosures when changes in facts and circumstances affect the entity s conclusion during the reporting period. The Standard provides examples of the judgements and assumptions requiring disclosure. Interests in subsidiaries An entity that is a parent should disclose information regarding: the composition of the group; non-controlling interests (including summarised financial information about each subsidiary with material NCI); significant restrictions on the parent s ability to access or use the assets and settle the liabilities of its subsidiaries; the nature of, and changes in, the risks associated with interests in consolidated structured entities; and the effects of changes in its ownership interest that did or did not result in a loss of control during the reporting period. Disclosure is also required when the financial statements of a subsidiary are as of a date or for a period that is different from that of the consolidated financial statements. Interests in joint arrangements and associates An entity should disclose information about the nature, extent and financial effects of its interests in joint arrangements and associates, including information about contractual relationships with the other parties to the joint arrangements or other investors that have interests in associates. An entity should also disclose the nature of, and changes in, the risks associated with its interests in joint ventures and associates. Interests in unconsolidated structured entities IFRS 12 defines a structured entity as an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity. Examples of structured entities include securitisation vehicles, asset-backed financings and certain investment funds. The Standard requires extensive disclosures to help users understand the nature and extent of an entity's interests in unconsolidated structured entities and the risks associated with those interests. Aggregation of information IFRS 12 requires granular information in a number of areas (for example, in respect of each material joint arrangement and each subsidiary with NCI material to the group) and specifies that information relating to interests in subsidiaries, joint ventures, joint operations, associates and unconsolidated structured entitles be presented separately, but does permit some aggregation of information within these classes of entities. The Standard requires that the level of detail provided through disclosures should satisfy the needs of users of financial statements but should not result in excessive detail that may not be helpful to those users. An entity may aggregate information but only if that does not obscure the information provided. The expected impact of adopting IFRS 12 in practice The Standard requires more extensive disclosures in a number of areas. IAS 27 (2011) Separate Financial Statements The requirements relating to separate financial statements are unchanged and are included in the amended IAS 27. The other portions of IAS 27 are replaced by IFRS 10. IAS 28 (2011) Investments in Associates and Joint Ventures IAS 28 is amended for conforming changes based on the issuance of IFRS 10, IFRS 11 and IFRS 12. New Amendments to IAS 1 Presentation of Financial Statements On 16 June 2011, the International Accounting Standards Board (IASB) issued Presentation of Items of Other Comprehensive income (amendments to IAS 1). The amendments: Introduce new terminology referring to a statement of profit or loss and other comprehensive income and statement of profit or loss, but the use of these terms is not mandatory. Retain the option to present profit or loss and other comprehensive income together, i.e. either as a single statement of profit or loss and comprehensive income, or a separate statement of profit or loss and a statement of comprehensive income. Require the grouping of items of other comprehensive income based on whether they are potentially reclassifiable to profit or loss subsequently, i.e. those that might be reclassified and those that will not be reclassified. Require tax associated with items presented before tax to be shown separately for each of the two groups of other comprehensive income items (without changing the option to present items of other comprehensive income either before tax or net of tax). Do not affect the measurement and recognition of items of profit or loss and other comprehensive income. Contain illustrative examples of presentation of profit or loss and other comprehensive income. Are applicable to annual periods beginning on or after 1 July 2012, with early adoption permitted. 07
New Amendments to IAS 19 Employee Benefits Invitation to the Autumn IFRS Seminars On 16 June 2011, the IASB issued amendments to IAS 19 Employee Benefits (2011) that change the accounting for defined benefit plans and termination benefits. The amendments: Require recognition of changes in the defined benefit obligation and in plan assets when those changes occur, thus eliminating the corridor approach permitted under the previous version of IAS 19 and accelerating the recognition of past service costs. Introduce enhanced disclosures about defined benefit plans. Modify accounting for termination benefits. Clarify a number of practical issues, including the classification of employee benefits. Are applicable to annual periods beginning on or after 1 January 2013, with early adoption permitted. Retrospective application is required with certain exceptions. Updated seminar: IFRS News in 2011 The aim of the seminar is to provide the participants with information on changes in IFRS. Dates: Prague, 19 October 2011 and 14 December 2011 Ostrava, 1 November 2011 Brno, 24 November 2011 More information on: www.deloitte.com/cz/akce/ifrs Seminars are predominantly intended for accountants, economists and financial managers of projects related to IFRS and to all who would like to know more about IFRS. Seminars will be held in the Czech language. Seminars are not intended for firms engaged in providing accounting advisory services. 08
US GAAP Software under US GAAP capitalization rules Nowadays we would hardly find a company in business which does not use any software tools. When reporting under US GAAP, Czech companies may sometimes struggle when considering what can be capitalized to the value of software or how to comply with all documentation requirements to meet the US GAAP pronouncements. This may be sometimes quite tricky especially for software developers and sellers. US GAAP provide detailed guidance on software and deal with numerous accounting issues. In fact it is a very vast and complex area. This article focuses especially on costs of computer software (SW) and basic principles regarding expenses that can be capitalized as intangible assets. Key elements to consider In general, we have to distinguish between internal-use SW (not marketed), purchased software that has an alternative future use (to be further marketed) and product masters (a completed version of internally developed SW product to be sold, leased, or otherwise marketed). Internal-use software Internal used SW is governed and defined by Accounting Standard Codification (ASC) 350-40. Obviously the main criteria for software to be classified as internal-use are acquisition or internal development solely to meet the entity's internal needs and no substantive plan to market the software externally. It seems that the definition of Internal SW is clear and straightforward, but there are many cases when the assessment whether internal or not is not that easy. For example, for a communications entity selling telephone services, software included in a telephone switch is part of the internal equipment used to deliver a service but is not part of the product or service actually being acquired or received by the customer, therefore should be classified as Internal-use. For particular examples what can or cannot be classified as Internal-use software, see ASC 350-40-55-1 through 55-2. Capitalizable costs internal-use software The company can capitalize internal and external costs incurred during the application development stage. It is important to distinguish between costs incurred in the preliminary project stage and the application development project stage. The preliminary stage is during the period before the management or relevant authority commits to funding a computer software project, eg. signs a contract with a third party. The preliminary stage includes activities such as design, analysis of technology availability, etc. All costs incurred in the preliminary project stage have to be expensed. The basic overview of capitalizable costs is provided in ASC 350-40- 30-1. The main capitalizable costs of computer software developed for internal use are as follows: a. External direct costs of materials and services consumed (eg. third-party fees for software development, costs incurred to obtain computer software or travel expenses incurred by employees directly associated with developing software), b. Payroll and payroll-related costs (for example, costs of employee benefits) for employees who are directly associated with and who devote time to the internal-use computer software project, to the extent of the time spent directly on the project, c. Interest costs incurred while developing internal-use computer software (there is detailed guidance on the interest capitalization rules, governed by ASC 835-20). Capitalization shall cease no later than the point at which a computer software project is substantially complete and ready for its intended use, that is, after all substantial testing is completed. Selected practical examples Can the company capitalize costs to develop or obtain software that allows for access to or conversion of old data by new systems? Yes. Conversion costs associated with developing or obtaining software that allows for access or conversion of old data by new systems should be capitalized. Can the company capitalize training costs? No. Training costs are not internal-use software development costs and, if incurred during the application stage, shall be expensed as incurred. The exception may be the case if the company designs or purchases software for a computer-based training program. Can the company capitalize costs of specific upgrades and enhancements? Yes. It must be probable that those expenditures will result in additional functionality. Can the company capitalize maintenance costs? No. If maintenance is combined with specified upgrades and enhancements in a single contract, the cost shall be allocated between the elements of a contract and maintenance costs shall be expensed over the contract period. 09 continues on next page
US GAAP Can the company capitalize costs associated with leasing the third party computer equipment and related supplies? Yes, the costs incurred to lease computers and related equipment for a specific software development project qualify as external direct costs that should be capitalized. Basic presumptions are that these costs are incurred during the application development stage, lease is classified as operating and the company cannot retain the leased equipment for other purposes when the project is completed. May the company capitalize payroll and payroll-related costs of employees who do not devote 100 percent of their time to the project? Yes. Employees are not required to devote 100 percent of their time to the internal-use computer software project in order for their applicable payroll and related costs to be capitalizable. Many entities do not have a job-costing or other system that can accumulate an employee's time and cost for specific projects. In these instances, reasonable allocations of the employees' payroll and payroll-related costs to the project would be acceptable. If the company developing software for internal use provides stockbased compensation to its employees, can the company capitalize stock compensation costs associated with employees that work directly on its software development projects? Yes. Stock-based compensation plans are part of an employee's total compensation and payroll-related fringe benefits. Accordingly, costs associated with participants in the company s stock-based compensation plan who work directly on internal-use software development projects should be capitalized. Is it appropriate for the company to capitalize the facility usage charges and other related charges (overheads)? No. If the facility is used for another purpose after the completion of the project, the company should not capitalize costs associated with the facility usage charges, computer time, and other facility related charges because these are deemed to be overhead costs. These charges can be capitalized only in case they are used solely for the project. 10 Product Masters software developed to be marketed Production costs of software are described in ASC 985-20-25-3. It is important to note that production costs can be capitalized after the technological feasibility of software has been established. The technological feasibility is a milestone and US GAAP guidance sets detailed criteria to be met, governed by ASC 985-20-25-2. US GAAP guidance related to production costs does not clearly define cost categories which can or cannot be capitalized. In general, we can assume that the same principles that are used to determine the cost of other inventory or property items also should be used to measure the cost of software products. Therefore, production costs should include direct and indirect costs, such as programmers' salaries, outside contractor costs, computer time, and allocated facility costs (to the extent that such costs clearly relate to production), among others. Capitalization of computer software costs shall cease when the product is available for general release to customers. Selected practical examples related to capitalization Can the company capitalize general and administrative costs? No. An allocation of general and administrative expenses is not appropriate because those costs relate to the period in which they are incurred. Can the company capitalize research and development costs? No. The company can capitalize only costs subsequent to technical feasibility establishment. Can the company capitalize interest costs? Yes. Software production costs to produce product masters would be covered by ASC 835-20-15-5(b). Accordingly, provided all other ASC 835-20 criteria are met, interest capitalization would be appropriate. If the company incurs a significant amount of time performing "bug fixes" and related testing after the establishment of technological feasibility, can the costs related to those activities be expensed? Yes. ASC 985-20-25-3 through 25-11 requires the capitalization of all production costs, including "bug fixes," subsequent to establishing technological feasibility until the product is available for general release to customers. However, costs incurred related to "bug fixes" after a product is ready for general release to customers should be considered maintenance and be charged to expense. Can the company capitalize maintenance and customer support costs? No. Costs of maintenance and customer support shall be charged to expenses when the related revenue is recognized or when those costs are incurred, whichever occurs first. Purchased software with alternative future use Companies may prefer the possibility of purchasing software from third parties instead of internal development. Purchased computer software may be modified or integrated with another product or process. If the purchased software is intended to be sold, leased or otherwise marketed and there is no alternative future use of such software, the capitalization principles are the same as for the product masters described above. If purchased software has an alternative future use, the cost shall be capitalized when the software is acquired and accounted for in accordance with its use. Therefore this SW will be treated as a single separate intangible asset and should be amortized over its estimated useful life.
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