Financial Accounting: In an Economic Context

THE COSTS OF DEVELOPING COMPUTER SOFTWARE

Statement of Financial Accounting Standards No. 86 specifies that the costs of developing and producing computer software products that will be available for sale or lease should be capitalized and amortized over their economic lives. Prior to this standard, all such costs incurred prior to the development of a prototype were expensed, and many small software development companies claimed that this practice understated net income, making it very difficult to attract outside capital. This standard had a significant impact on the financial statements of many companies involved in the development of computer software. For example, consider the excerpt below from a financial report of Wang Laboratories, Inc. Note that the net effect of the change increased net income by $19.3 million.

The Company adopted a change of accounting for costs of computer software. The change was made in accordance with provisions of Statement of Financial Accounting Standards No. 86, which specifies that certain costs incurred in the development of computer software to be sold or leased to customers are to be capitalized and amortized over the economic life of the software product. Total costs capitalized during the year approximated $21.1 million, of which $1.8 million has been amortized and charged to expense.