In order to gain a better understanding of both the software industry and the applicable guidelines for capitalizing software, some outside research into the industry and FASB standards was completed. This research was complied as a part of the risk assessment portion of the audit process (Whittington & Pany, 2012). The issue of capitalizing the costs of developing a software program for sale is a complicated issue. This is due in part to the fact that the nature of technology is constantly changing so clear procedures regulating when to write off a software system vary according to the pace of technological changes within the industry.
Therefore, while a company is developing software, they should report the incurred creative costs to a research and development account (Warfield, Weygandt, & Kieso, 2007). Once the software product has reached a point where it is feasibly considered a technological product the costing can be adjusted to begin capitalizing the costs (Warfield, Weygandt, & Kieso). As established in FASB Statement No. 2, any costs incurred in the developing, creating, testing, and so forth of software products will be charged to the research and development expense account; however any adjustments to the software for upgrades and any costs to market the product would not be included in the research and development expense account (Accounting-Financial-Tax.com, 2012). This is because by the point the product is ready to be marketed or needs to be upgraded to meet new technological standards, the feasibility of the product has been established and therefore the product should be capitalized (Accounting-Financial-Tax.com). If however, after meeting the feasibility requirements, there is substantial risk associated with the product development, the costs assigned to the product should continue to be charged to the research and development expense account until the product is more stable and ready to market (Accounting-Financial-Tax.com).
Amortizing costs and reporting costs further complicate this issue. Amortization must be recorded at the higher of one of two approaches. Companies can utilize the straight-line approach which spreads costs over the life of the asset or the percent of revenue approach which amortizes costs based on the ratio of current revenues versus the anticipated future revenues for the product (Warfield, Weygandt, & Kieso, 2007). Because the software industry is volatile and FASB standards are conservative in nature, capitalized costs should be reported at the lower of book value or net realizable value (Warfield, Weygandt, & Kieso). Obviously, with the complexities and intricacies of this industry audit issues are certain to arise.
Major Audit Issues
Evidently, due to the difficulty of documenting exactly when a product passes from an unfeasible to feasible status, potential issues develop in the auditing process. For instance, the feasibility can vary depending on the existence of a...