Key Takeaways:

  • Perpetual software licenses are classified as long-term assets but require careful evaluation for proper accounting treatment.
  • Perpetual licenses involve a one-time purchase and confer indefinite usage, while subscription models offer more flexibility with periodic payments.
  • Software licenses may qualify as PP&E under certain conditions, but typically, they are classified as intangible assets.
  • Criteria for capitalizing versus expensing software costs involve assessing the software's purpose and its role within organizational assets.
  • Specialized accounting standards guide classification decisions, affecting financial statements and tax implications.
  • Organizations must consider the software lifecycle, potential obsolescence, and regular updates to maintain functionality and security.

A perpetual software licenses accounting treatment can be viewed as computer software considered to be a long-term asset. The software would be classified as an asset, exactly like land or buildings. There are some situations, however, when the software is not classified as a long-term asset.

Perpetual Software Licenses

Perpetual licenses are considered the traditional model when purchasing software for a business. The software license is paid for up-front and can be used indefinitely.

When purchasing the license, there is an option to pay for one-off implementation services along with a support contract that renews annually.

If you choose a subscription licensing model, you pay a per-user fee monthly or annually. This fee allows the use of software throughout the duration of the subscription. With a subscription, you lease the software and don't own it.

The change from traditional perpetual license model software to Software as a Service has increased due to cloud computing.

An advantage of subscription software is that it replaces the capital outlay of buying software licenses with the option to make subscription payments. This makes the software more affordable.

Revenue Recognition for Perpetual Software Licenses

Revenue from perpetual software licenses is recognized differently than for subscription models. Since a perpetual license entails a one-time fee for indefinite use, revenue is generally recognized upon delivery of the software and transfer of usage rights. This treatment aligns with the guidance in ASC 606, which mandates that revenue should be recorded when control is transferred to the customer. However, companies offering ongoing maintenance or support services must recognize revenue for these services over the term of the contract. This separation of revenue streams ensures that financial reporting accurately reflects earned revenue and remaining obligations.

Perpetual Versus Subscription Software

Perpetual

If you want to own the software license and have access to the newest releases, you want perpetual software. Buying software can be expensive, though.

While a perpetual license may be used indefinitely, it has a short lifecycle. It will become obsolete at some point in the future. This may be due to the hardware it is run on and/or because of its companion software.

To keep up with the latest software, you will need to upgrade your software periodically to ensure compatibility.

Using a product that has reached the end of its update options, fixes, and patches will expose your system to risks such as spyware, viruses, and malicious software.

If you hire new employees, you will need to buy additional licenses. If they leave, you will be stuck with useless licenses.

Subscription

With a subscription license, there is more flexibility since you only pay for what you use. This means you can add licenses and remove them as needed.

When upgrades and new features are released, subscription holders receive updates in real time. These are included in the subscription price. There is never an issue with having outdated software that causes compatibility problems.

Considerations for Transitioning to Subscription Software Models

The shift from perpetual to subscription software models impacts both financial and operational aspects. A subscription model can lower initial costs, improve cash flow predictability, and reduce maintenance burdens, as updates are handled by the provider. However, transitioning can increase total software costs over time due to ongoing subscription fees. Accounting for subscriptions also shifts from a capital expenditure to an operating expense model, impacting the financial statements differently. Organizations considering this shift should assess the impact on their cost structure, cash flow, and asset management strategies​.

Software Licenses and Accounting

Property, plant, and equipment (PP&E) are considered tangible assets. They are physical and measurable and used to manage a company's operations. They are referred to as long-term assets vital to operations and have a physical component.

Intangible assets are also used over a long-term period, but they are generally considered nonphysical assets.

Computer software is typically classified as an intangible asset because it is nonphysical in nature. There are accounting rules that have exceptions permitting computer software to be classified as PP&E.

Criteria for Capitalizing Software Costs

Capitalization of software costs requires assessing the purpose and scope of the software within the organization. According to accounting standards, software can be capitalized if it is an integral part of production or serves as a significant asset to operations. Costs related to software acquisition, development, and enhancement qualify for capitalization if they meet certain criteria, such as direct relationship to production or operational functionality. Capitalized costs include purchase, implementation, and customization fees. However, costs for routine maintenance and minor upgrades are typically expensed. This classification directly affects the asset’s amortization, where capitalized costs are depreciated over the software's useful life, impacting balance sheets and tax reporting​.

Accounting Standards & PP&E

There are accounting standards describing when and how computer software should have a PP&E classification.

The following resources provide information for accounting standards.

  • Accounting for Internal Software.
  • Statement No. 10 - Statement of Federal Financial Accounting Standards (SFFAS) from the Financial Accounting Standards Advisory Board.
  • Statement No. 51 - Governmental Accounting Standards Board (GASB).
  • Accounting and Financial Reporting for Intangible Assets.

According to statement No. 6 from SFFAS, a tangible asset is classified as PP&E if it has a useful lifespan of two or more years; is not intended for sale in ordinary business operations, and was constructed or acquired for use or is available for use.

There are also rules determining if the software is capitalized as PP&E or expensed. If the software meets the criteria for PP&E, then it can be classified as such.

Because no dollar amount limits are in place for computer software cost, whether new or internal, management has some discretion if the software meets the criteria.

An example would be the purchase of a bulk software package. In this case, the bulk cost and the useful life of the software would be calculated. If a contractor develops the software, the amount paid to the vendor that was paid to develop and implement the software would be classified.

Software considered an integral part of PP&E is not capitalized.

Accounting Implications for Software Development Costs

Software developed in-house is accounted for under specific stages of development. According to FASB and IFRS standards, the preliminary project stage, which involves planning and feasibility assessments, incurs costs that should be expensed. However, costs in the application development stage, such as coding and testing, are capitalized. After implementation, any costs associated with maintenance or minor updates are expensed. This phased approach in accounting for development costs ensures that only those expenses that contribute directly to asset creation are capitalized, resulting in a more accurate reflection of the company’s asset base and financial position​.

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