Navigating the Minefield of Accounting for Software

March, 2018

For IT managers, understanding the rules around accounting for software costs can be difficult. As a result, IT leaders often simply defer to their accounting departments to decide how software costs should be treated but never fully understand the rationale behind the decisions.

As shown in Figure 1 of the full report, Accounting for Software: Understanding CAPEX and OPEX, author Glen Alleman provides a primer on these key concepts. He explains the difference between capital expenditures (CAPEX) and operational expenditures (OPEX) and how they relate to accounting for software costs. He also outlines how these principles vary according to the application development method, whether a traditional waterfall approach or a newer iterative process, such as agile development. Finally, he highlights the factors that drive business leaders to favor CAPEX or OPEX in accounting for software.  

CAPEX fig 1 WEBv2 - Navigating the Minefield of Accounting for Software

To get an idea of how complex accounting for software costs can be, consider a few points:

  • Enterprise software licenses are CAPEX, but the annual maintenance costs are OPEX.
  • Functional design is OPEX, and technical design is CAPEX. The connections between functional design and technical design is blurred when done by collaborative teams.
  • Project travel and expense are operating expenses—except when they are part of a capitalizable activity.
  • Software as a service (SaaS) is pure OPEX. Even if you end up customizing a SaaS application, the development costs will still be OPEX because you are renting the software. You don’t own the asset; that is, it doesn’t sit on the company’s balance sheet. This is one reason that financial executives often find SaaS an attractive option.

The full report is part of our IT Manager Toolbox series.

This Research Byte is a brief overview of our report on this subject, Accounting for Software: Understanding CAPEX and OPEX. The full report is available at no charge for Computer Economics clients, or it may be purchased by non-clients directly from our website (click for pricing). The full report is authored by Glen B. Alleman, a principal member of Niwot Ridge, LLC, a professional services firm delivering program performance improvement to government agencies and their contractors and enterprise commercial firms.