Companies can capitalize software development costs when the product is \"techno

Question

Companies can capitalize software development costs when the product is "technologically feasible". Some companies never capitalize their software costs - for example, Microsoft.

Reliance Inc., a software development company capitalizes those software costs allowed under GAAP. The following information is taken from its financial statements.

  

a. If Reliance Inc. had not capitalized its software costs but expensed them instead what would they have reported as software expense each year, assuming unamortized balance of software costs was $35 in year X0?
b. What is the likely effect upon net income variability of expensing rather than capitalizing software development costs?
c. How might income be manipulated under either of these two methods (expensing and capitalizing)?

Explanation / Answer

a. The uncapitalization costsof $ 35 in year ) would be shown as expenses in the next year. (Can cannot make futher analaysis as full financial data is not available)

b.Net income will normally have greater variability under the expensing method. Capitalizing and amortizing has a smoothing effect on net income (net income will only have the same variability under the two methods if the costs incurred are the same each period or they are increasing/decreasing at a constant rate)

c.When costs are expensed, net income is immediately affected by changes in softwaredevelopment expenditures. Hence if a company is desperate to increase net income it can cutsoftware development costs (this of course will probably come back to haunt them in futuresperiods).

When costs are capitalized and subsequently amortized, a decrease in this year's expenditures will have a much smaller effect than if these costs were expensed immediately. However, management has plenty of latitude in determining when and which costs get capitalized andover how long they are amortized. Therefore, if a company wanted to increase its net income this period it could 1) increase amortization period, 2) capitalize more costs and/or 3) capitalize costs sooner

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.