With the increased speed that CIOs and CTOs are moving their teams into agile environments, their financial brethren are running to catch up. Having been grounded in the days of waterfall methodologies, the financial side of the house is dealing with great uncertainty on how to account for software development costs. Questions include: Are all development costs now expensed because of the continual planning, developing and pivoting of software projects that occurs within agile? If development costs can be capitalized, what is the appropriate way to track these costs – through hours or something new altogether like story points? We will explore how the historic accounting guidance that was developed specifically through the lens of waterfall methodologies remains applicable within agile methodologies. We will look at the alternative ways to amortize these capitalized development costs and evaluate the pros and cons of doing so. In addition to the financial reporting aspects of this presentation, we will also explore the benefits gained by moving from project-based funding to overall product–based funding and what key requirements must be in place to have that successful. The goal of this presentation is to increase awareness among the audience that while making the decision to become agile is a business decision, this decision cannot be done in isolation. The business will eventually need the approval by their finance colleagues and if these financially grounded colleagues are not educated on the financial and accounting implications of moving to agile methodologies they may block such a move based on their misunderstandings alone. Getting everyone on the same page is a key success factor when moving to agile.

1. AVOIDING THE PITFALLS OF
CAPITALIZING SOFTWARE
IN AN AGILE WORLD

2. 22
68%
Improved Business Agility
68%
Lower Overall Cost
67%
Speed of Implementation
66%
Easier Information Sharing
63%
Allows us to Focus Resources
Elsewhere
59%
Delivers Unique Functionality
Source: Forrester’s Global Business
Technographics Software Survey, 2016
WHY THE
CLOUD?
Benefits of cloud apps that firms
most often rate very important or
important

3. 33
53%
47%
IT Non-IT Business
Source: IDC’s Worldwide Semiannual IT Spending
Guide: Line of Business, 2016
BY 2019 ALMOST HALF OF
GLOBAL TECHNOLOGY PURCHASES VIA
NON-IT BUYERS

4. 44
When the business is
ready to move forward...

5. 55
When the business is
ready to move forward...
…Don’t forget to include
Finance & Accounting…

6. 66
…Or they could block you

7. 7
PAUL ARGIRY, CPA
1987 1992 2000 2007 2016

8. 88
• Accounting for Software Development Costs
• Methods to Track Costs
• Table Exercise – Time vs. Story Points
• Amortization
• Impact of the Cloud
• “20% Limit”
• Capitalization Opportunity
WHAT WE’LL COVER TODAY

9. S O F T W A R E
D E V E L O P M E N T

10. 1010
1. We’ve done capitalization under waterfall for decades – what
happens under agile?
2. With the constant deployment of software and continual changes
everything is expensed, right?
3. How would we track these costs within an agile environment -
must be different?
COMMON QUESTIONS

11. C A P I T A L I Z A T I O N

12. 1212
TYPES OF CAPITALIZATION
ASC 350-40
SOP 98-1
ASC 985-20
FASB 86
SOFTWARE TO BE SOLD,
LEASED OR MARKETED
INTERNAL-USE
SOFTWARE

13. 13
PRELIMINARY
PROJECT STAGE
APPLICATION
DEVELOPMENT STAGE
POST-IMPLEMENTATION
OPERATION STAGE
Costs expensed as incurred
Most costs capitalized as
incurred
Costs expensed as incurred
Conceptual formulation of
alternatives & requirements
Design of chosen path,
including software
configuration and interfaces
Deployment
Evaluation of alternatives Coding Training
Determination of existence of
needed technology
Installation of hardware Application maintenance
Final selection of alternatives
Testing - including parallel
processing phase
Support
DEVELOPMENT STAGES

14. 14
• Preliminary Stage completed
• Management authorizes &
commits to funding
• Probable project will be completed
& software used as intended
CAPITALIZATION PERIOD
BEGIN END
• Computer software substantially
complete
• Ready for intended use
• After all substantial testing
completed

15. 15
• Preliminary Stage completed
• Management authorizes &
commits to funding
• Probable project will be completed
& software used as intended
CAPITALIZATION PERIOD
BEGIN END
• Computer software substantially
complete
• Ready for intended use
• After all substantial testing
completed

16. 16
WATERFALL ALIGNS NICELY WITH
ACCOUNTING GUIDANCE
PRELIMINARY
PROJECT
APPLICATION
DEVELOPMENT
POST-IMPLEMENTATION
OPERATION
REQUIREMENTS
ANALYSIS
CODING
VERIFICATION
DEPLOYMENT
MAINTENANCE

17. 17
Transitioning to agile is not problematic because:
• It is the nature of the cost, not entirely timing of their
occurrence, that matters
• These do not change under either software development model
– waterfall or agile
• Tracking of activities is key for capitalization
• Preliminary Project Stage must be completed
NATURE OF COST IS KEY

18. 18
NATURE OF COSTS, NOT TIMING,
IS MOST IMPORTANT WITHIN AGILE
PRELIMINARY
PROJECT
APPLICATION
DEVELOPMENT
POST-
IMPLEMENTATION
OPERATION
CONCEPTUAL FORMATION
& EVALUATION
DEPLOYMENT & MAINTENANCE
2-week
sprint
2-week
sprint
2-week
sprint
DESIGN AND CODING
Expense as incurred Expense as incurredMost costs capitalized as incurred

19. 1919
EXPENSE STAGE
Overhead & administrative support All Stages
Determine business, performance & system
requirements
Preliminary
Create business process & IT solution proposal Preliminary
Business process re-engineering Preliminary
Create project proposal Preliminary
Complete business case Preliminary
Establish project team & management Preliminary
Strategic decisions allocating resources Preliminary
Develop project schedule Preliminary
Host project kick off meeting Preliminary
Create & deliver user training Dev & Post-Implement
Perform data conversion Development
Deploy solution Post-Implementation
Activate & transition Go-Live support team Post-Implementation
Monitor solution performance & metrics Post-Implementation
Maintenance Post-Implementation
Bug fixes Post-Implementation
Determine final project costs Post-Implementation
EXPENSED
ITEMS
Internal-Use Software

20. 2020
CAPITALIZE STAGE
Software licenses including conversion software Any stage
Design requirements and document processes Development
Define interfaces, conversions & enhancements Development
Install technical development environment Development
Test performance Development
Conduct readiness review Development
Finalize end-to-end test plan Development
Coding & Development Development
Install hardware Development
Sprint Planning Development
Retrospectives Development
Complete user-acceptance testing Development
Perform stress testing Development
Complete final deployment plan Development
Travel for consultants & internal employees Development
CAPITALIZED
ITEMS
Internal-Use Software

21. 21
Expense as R&D
• Planning
• Designing
• Coding
• Testing
CAPITALIZATION PERIOD
BEGIN
DEVELOPMENT
TECHNOLOGICAL
FEASIBILITY
GENERAL
RELEASE
Capitalize: Costs must
be recoverable
• Overhead is
Capitalizable
• G&A still expensed
Expense all subsequent
costs
• Maintenance
• Customer Support

22. 2222
Ensure High-Risk development issues:
- Novel
- Unique
- Unproven functions/features
Have been resolved via coding and testing before capitalizing costs
AVOID THIS PITFALL WITHIN
TECHNOLOGICAL FEASIBILITY

23. M E T H O D S T O
T R A C K C O S T S

24. 2424
METHODS TO TRACK COSTS FOR
CAPITALIZATION
Each team member submits
time into a time tracking
system
TIME
Scrum story points are used to
capitalize costs incurred by
the entire team
STORY POINTS

25. T A B L E G R O U P
E X E R C I S E

26. 2626
TRACKING COSTS PROS & CONS
TIME STORY POINTS
PROSCONS
Align with current practices
Should be intuitive for
employees to understand
Potentially higher correlation
with team’s effort à so more
stories/features completed =
higher capitalization
Data naturally captured
within scrum
Impacts productivity if done
accurately à counter to agile &
scrum
Inaccurate if done fast to avoid
impacting productivity
Story points are subjective for
each team so aligning
consistency may prove
challenging
Overall use of story points
based on estimation which
auditors may frown upon

27. 2727
39%
Source: 2013 Electric Cloud Survey
of 1,146 respondents
Idle & Admin time

28. A M O R T I Z A T I O N

29. 29
AMORTIZATION
Preliminary Stage completed
Management authorizes &
commits to funding
Probable project will be
completed & software used as
intended
CAPITALIZATION
BEGINS
CAPITALIZATION
ENDS
• Computer software
substantially complete
• Ready for intended use
• After all substantial testing
completed
Amortization begins when:
• Software is ready for intended use
• All substantial testing completed
• Amortization begins regardless software
placed in service in planned stages
• For dependent modules needed to
function, amortization begins when both
that module and dependent modules are
ready for their intended use
• Amortized over estimated useful life (e.g.
4 years)
AMORTIZATION PERIOD

30. 30
AMORTIZATION PERIOD OPTIONS
• Capitalize software at each specific
sprint and amortize immediately
• Given overall project has one defined
useful life, subsequent capitalization
and amortization over remaining
useful life
• Assume 4-year useful life:
• 1st sprint amortized over 48
months
• 2nd release over 47 months
• 3rd release over 46 months, etc.
EACH SPRINT
• Software deployed in larger Epics (i.e.
every 4-6 months)
• Capitalized and amortized based on
that specific Epic and its related
useful life of 4 years
• Subsequent Epic would start anew
with its own useful life - could be 3,
4 or 5 years
EACH EPIC

31. 3131
AMORTIZATION
PRELIMINARY
PROJECT
APPLICATION
DEVELOPMENT
POST-
IMPLEMENTATION
OPERATION
CONCEPTUAL FORMATION
& EVALUATION
DEPLOYMENT & MAINTENANCE
2-week
sprint
2-week
sprint
2-week
sprint
DESIGN AND CODING
Amortization Period
Capitalization

32. 32
• Amortized on a product by product basis
• Starts when product available for General Release
• Based on ratio of current software revenue compared to total
expected revenue over software life
• Regular impairment tests à Write down to Net Realizable Value
AMORTIZATION

33. 3333
SOFTWARE DEVELOPMENT COSTS
INTERNAL USE
(ASC 350-40)
TO BE SOLD
(ASC 985-20)
Begin Capitalization
• Preliminary project stage
complete
• Management authorizes and
commits funding; and
• Probable project will be
complete
• Technological feasibility
reached; and
• Costs are recoverable
End Capitalization
• Testing substantially completed
and software ready for intended
use; or
• Unlikely project will be
completed
• Available for General
Release
Amortization • Systematic over useful life
• Proportion of software
generated revenue
compared to total
revenue expected over
software life

34. 3434
EXPANDING CLOUD WORKLOADS

35. 3535
DIGITAL TRANSFORMATION
Source: MIT Center for Digital Business
HIGHER MARKET
VALUATIONMORE PROFITABLE
26% 12%

36. 3636
One
Third
“TRANSFORM OR PERISH”
Source: IDC’s “FutureScape: Worldwide
CIO Agenda 2016 Predictions”
Top 20 Companies in Industry Segments

37. 3737
Within the Cloud - Software Capitalization:
• “Software To Be Sold” accounting if:
1. Take possession of software, and
2. Run in another hosted environment - without incurring a
significant penalty
• If not both = “Internal-Use Software”
Plan Ahead - “Trial & Error” of developing solution expensed if both
conditions met under “Software To Be Sold” à otherwise capitalize costs
under “Internal-Use”
THINK BEFORE YOU LEAP…

38. 3838
Source: Gartner’s “Opex vs. Capex: CIOs Should
Partner with CFOs” May 21, 2015
IT Budgets should limit
depreciation and
amortization to 20% of
total IT spend

39. C A P I T A L I Z A T I O N
O P P O R T U N I T Y

40. 4040
• Business Transformation
• Balance Mode 1 and Mode 2
• Change From Project Based to Product Based
• Reduce / Remove Impediments & Admin Burden
Desired Result =
Increased Cap Rate & Lower Overall Dev Costs
KEY CONSIDERATIONS

41. Q U E S T I O N S ?