Accounting to the Rescue
- By Larry Goldstein
An oft-overlooked accounting standard could
be your key to better project cost management.
You may not know it, but there is an accounting standard that should be of
interest to you and your CFO; it presents a valuable resource for both technologists
and accountants. Unfortunately, in my experience, relatively few CFOs and even
fewer CIOs are aware of the standard’s existence and, more importantly,
they are blissfully unaware of how it can help an institution spread the cost
of major technology projects over multiple budget periods.
The standard is the American Institute of Certified Public Accountants’
Statement of Position 98-1, Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use (SOP 98-1). Though issued in 1998, the provisions
of SOP 98-1 were not effective until the fiscal year ended in 2000. And although
technically applicable only to independent colleges and universities, the National
Association of College and University Business Officers (NACUBO) issued an advisory
report encouraging all higher education institutions to follow the standard.
Still, despite the fact that that standard was issued so long ago, I frequently
encounter campus executives who are not familiar with its provisions.
What is SOP 98-1?
As suggested by its title, SOP 98-1 addresses accounting for software developed
or otherwise acquired for internal use. The standard isn’t concerned with
desktop application software such as Microsoft Office or Crystal Reports. Instead,
think ERP—whether purchased as a package or homegrown. Everyone recognizes
that massive sums are invested in these applications; the issue is whether to
treat the investment as a capital asset (e.g., a building) or as an expense
of the current period (e.g., travel to a conference). For years, there was no
guidance in this area. What SOP 98-1 d'es is standardize how organizations measure
and report their investment in large-scale computer software.
In fact, SOP 98-1 addresses various categories of investment related to internal-use
computer software, and establishes guidelines for determining which costs should
be treated as a current period expense, and which costs should be capitalized
and charged to future periods through amortization. This is analogous to how
investments in other major assets are handled. For instance, assume a truck
costs $50,000 and is expected to provide service for 10 years. Rather than treat
the initial purchase price as an expense in the year it’s acquired, the
$50,000 is recorded as an asset and $5,000 is recognized as depreciation expense
each of the next 10 years. From a budgeting standpoint, isn’t $5,000 much
easier to cover than $50,000?
How It Works
Costs related to software projects are classified by SOP 98-1 based on the
phase in which they’re incurred. The three phases include: 1) preliminary
project stage, 2) application development stage, and 3) post-implementation/operation
stage. During the preliminary project phase, costs are incurred as various alternatives
are identified, evaluated, and a final selection is made. The development stage
includes acquisition and customization (or coding, if homegrown), installation,
and testing. The post-implementation operation phase includes training and application
Stage One: Preliminary. Under the accounting standards established
in SOP 98-1, all costs sustained during the preliminary project stage are to
be expensed during the period in which they occur. The preliminary project stage
is a time for researching alternatives and considering various options. Costs
incurred at this stage do not increase the cost of the application (which, if
they did, might then be amortized. In fact, this prevents that kind of cost/amortization.)
This treatment is consistent with the general principal that research and development
costs must be expensed immediately. Costs incurred in this phase include a wide
range of items, such as travel to visit peers currently using alternatives under
consideration, consulting fees paid to outsiders engaged to help with the selection
process, and costs related to the RFP process.
“"Technologists are blissfully unaware that an accounting standard can
help an institution spread the cost of major technology projects over multiple
Stage Two: Application Acquisition. Once the decision is
made to acquire a specific application, the costs involved are isolated and
accumulated so they can be capitalized. This is true for amounts paid to a vendor,
as well as to salaries and benefits paid to staff working directly on the project.
However, as in the planning phase above, some costs incurred in this phase must
be expensed and cannot be counted as part of the application’s capitalized
cost. For instance, any training costs that might crop up during this phase
must be expensed. On the other hand, the purchase of software needed in order
to convert existing data, represents a capitalizable cost. Other data conversion
costs also should be capitalized as part of the project. Similarly, consulting
fees for assistance during implementation—either for customization or
project management—are appropriately capitalizable. Campuses also should
capitalize the payroll and payroll-related costs for staff assigned to the project,
as well as the expenses incurred for project-team travel to conferences related
to the project. (The exception to this general rule is for effort related to
training which, as explained above, should be expensed.)
Stage Three: Post-Implementation. Costs occurring in the
post-implementation/operation stage, typically training and maintenance costs,
should be treated as an expense during the period in which they’re incurred.
There is one exception to the general rule that post-implementation/operation
stage costs should be expensed: If upgrade and/or enhancement costs are acquired
following implementation—and they add new functionality—the costs
should be added to the application cost already capitalized. This will increase
the annual amortization for the remaining life of the application.
More Help from SOP 98-1
SOP 98-1 also establishes standards for determining when the application development
stage actually begins and ends. Two events must occur for the development stage
to commence: 1) The preliminary project stage must end (i.
e., a decision must
be made), and 2) management must commit funding to the project. Once both have
occurred, the costs become subject to capitalization. Costs will continue to
be capitalized until the post-implementation/operation phase is reached, unless
it becomes apparent that the project will not be completed and placed in service.
If that should happen, amounts previously capitalized are recognized as a loss.
Under normal circumstances, however, the application development stage ends
when the software project is substantially complete and ready for its intended
use. The trigger identified in the standard is the completion of testing. At
this point, any additional costs that are incurred should be expensed.
Adherence to the standard can provide significant benefits. First, by following
the provisions of the standard, institutions can make meaningful comparisons
with others following the standard. Second, and possibly of greater importance,
the fact that many significant costs can be capitalized rather than charged
against the current budget means that investment in expensive projects can be
spread out over the anticipated useful life of the project. For instance, ERPs
frequently take several years to implement and are expected to provide service
for many years. Rather than charge all of the up-front costs to the current
year budgets, it’s much more reasonable and manageable to accumulate the
costs, capitalize then, and amortize them over the entire useful life of the
ERP. Bottom line? It pays to get to know SOP 98-1.