Generally Accepted Accounting Principles (GAAP) provide specific guidance on whether the cost of acquired computer programs should be recorded as an asset (capitalized) or as an expense in the period incurred. If the software is purchased for internal use and meets certain criteria, its costs are capitalized. This means the expenditure is initially recorded as an asset on the balance sheet, rather than an immediate expense on the income statement. An example includes a company acquiring a customer relationship management (CRM) system intended for long-term use within the organization.
Properly determining if the cost of acquired programs should be capitalized has a significant impact on an entity’s financial statements. Capitalization spreads the cost over the software’s useful life through depreciation or amortization, leading to a smoother expense recognition and potentially a more accurate representation of the entity’s financial performance. Historically, inconsistent treatment of such costs led to variations in reported earnings, prompting the development of clear standards to enhance comparability and reliability across different companies.
