Capitalizing vs Expensing Assets

There are 3 answers; What does the IRS say?; What does your Auditor say: and what is the value of the single line-item purchases?

What is the estimated life of the products, what does the IRS regs say? Are the items "installed" like cabling or a switch/router or are they iPad tablets....

Based on the given background you will definitely need to capitalized servers and office furniture (most are high dollar items). Computers/equipment may or may not fall into the grey area.

Caveat, if you are leasing they need to be capitalized.

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Going along with what Wayne said, keep in mind the IRS is changing the rules for de minimus deductions. Is your company audited, reviewed, or has some type of applicable financial statement? I attended a webinar on it recently, but I do not have my notes on me right now to go too in depth. Here is a link if you are interested: http://www.bkd.com/webinars/2012/what-contractors-need-to-know-regarding-tangible-property-regulations.htm

One thing I learned from the webinar is that if you have 10 computers that individually are below your threshold, but in aggregate does not fit the tax year's less than or equal to the greater of 0.1% of the taxpayer's gross receipts for the taxable year as determined for Federal income tax purposes; or 2% of the taxpayer's total depreciation and amortization expense for the taxable year as determined in its AFS, then you may still have to capitalize a portion of the computers for tax purposes.

As part of full disclosure: I am not an expert in this area, what I stated immediately above is my interpretation of a webinar I attended. I am not a CPA, I do not work in public accounting. I have always worked in corporate accounting. I may be correct, but I would advise watching the webinar and discussing what you learned with your tax CPA.

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Thanks for your answers, Wayne and Chris. We're not audited by an accounting firm or the IRS, but I want to keep our books as clean as we can in case we will be soon.

Yes, reading more on this it does appear the rules are about to change, so will keep my eye on that.

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We were doing the same thing you're doing now - book the same as tax. But after a while our asset listings got out of control and I had to rely on an accounting firm to track that for us and tell me our depreciation expense.

Our policy now is that everything under $500 gets expensed right away. Items over $500 get capitalized and depreciated on straight line for book, and MACRS for tax. Because we're private, we just made the change prospectively.

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In a related matter need some help and possiblly an auditor for my enterprise integrated smart process application platform co. As I understand currently, software co’s are required by SFAS 86 to capitalize certain development costs of software to be sold, rented/leased or otherwise marketed. And that capitalization occurs once technological feasibility has been reached and costs are determined to be recoverable.Capitalization ends and amortization begins when the product is available for general release or ship date to customers.

However, since above is a guideline only, determining “technological feasibility” and amortization parameters is a puzzle. The “flexibility” leads to all sorts of questions; when can you tell when you cross over from “R” to “D”? And that is trickier distinction with iterative or agile development vs traditional software waterfall design approaches.

My interpretation is that “D” costs can be capitalized in agile since most of your D is done DURING iterations PRIOR to reaching technological feasibility whereas in waterfall approaches, all the D is done AFTER technological feasibility is reached.

Our platform evolution is now up to v 5.0 and thus we're pretty far down the road in terms of technological feasibility; and we’re still iterating quarterly or every six months for our clients and therefore thought we could capitalize all this iterative “D”. In our agile environment, assume that most of the “R” was completed pre 2008….” We reinvested $2.1 million in our software from our energy services revenue. The software has seen two major evolutionary releases since 2008”.

And I am assuming that we are “creating new assets” e.g. v.5.0,5.1, 6.0, 7.0 etc to depreciate alongside the original assets v 3.5, 4.0 etc i.e. when new asset is placed in service, where its useful life will be equal to the remaining useful life of the original asset)..or are we stuck calling these costs to “rebuild” –i.e. evolutionary releases or is it to repair a design flaw? If the latter, then it hits the P&L cash flow not balance sheet.

So does v 5.0 qualify as enhancements not resulting in significant additional capability beyond that for which the software was “originally intended”….as it was supposed to work right the first time? My thinking was that we built out the software , then customers realized it wasn’t “complete” and we spent more money from energy services to iterate and make complete….therefore it should be capitalized.

Thus if you replace the prior builds with a new build at higher cost, the old “wasted money” should be written off. One can probably argue the point with auditors if the old platform versions are still being used, and the new work is a new module in which case one can argue that you have developed a new asset that is separate from the old one.

The two functions of the quoted rule (ASC 350-35-1) are to force the write-off of something that doesn’t exist or is not functional, or; to prevent gaming of the accounting rules. Since we are building software that is incremental to what we had, and what we had still has value, I believe we’re not violating the spirit of these rules if we account for it as new separate asset. But need to confirm this with an auditor.

A big part of reason for trying to capitalize our software investment is 1) try and keep IT COGS expenses low and stretched out over a period of years by deferring the handling of those expenses to the out years through depreciation which reduces current year IT budget and 2) it enhances the intangible asset base on our balance sheet, so to investors –even though operational impact is more or less same either way- “optically” it looks like they are investing in a company that has software assets. It’s probably too much of a stretch.

Lastly, the norm is for most software development or products co’s to expense development anyway as evidenced by Salesforce and the 146 out of 207 software co’s surveyed that expense. Notwithstanding, Salesforce still allocates 15% IT COGS as R&D expense collection on balance sheet. And in most industries there are available tax credits for R&D expenses. And I think the R&D tax credit rules are changing for 2014 under some new federal legislation this where it may benefit us to expense vs depreciate. Again, a lot of this accounting stuff not in my wheelhouse.

Sorry alot of preamble here but wanted to give some background and hope someone can help. Looking to hire an auditor who can help us with these matters.

Thanks for your patience, new to group.

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