October 18, 2025
Technology, and especially software, continues to evolve rapidly. Based on stakeholder feedback, the current software accounting guidance is outdated and lacks relevance with current software development methods, which involve more of an agile, incremental, and iterative method. As a result, the FASB issued ASU 2025-06, which makes targeted improvements to ASC 350-40 to increase the operability of the recognition guidance, considering different methods of software development. The new guidance is more principles-based, which will enhance comparability in financial reporting.
ASU 2025-06 does not change: (1) the existing accounting requirements for external-use software development costs under ASC 985-20, (2) what internal-use software costs can be capitalized, or (3) when internal-use software cost capitalization ceases.
Background
ASC 350-40 provides the guidance for the costs to develop or obtain software for internal use. Under ASC 350-40, entities capitalize development costs incurred for internal-use software based on the nature of the costs and the project stage during which they occur.
The current guidance defines three stages in the development of internal-use software:
- Preliminary project stage
- Application development stage
- Postimplementation-operation stage
Typically, only costs incurred during the application development stage are eligible to be capitalized.
Changes to recognition
ASU 2025-06 eliminates all references to the predefined software development stages above.
Now, entities are required to capitalize internal-use software costs only when both of the following conditions are met:
- Management has authorized and committed to funding the software project.
- It is probable that the project will be completed, and the software will be used to perform its intended function.
Probable-to-complete threshold
The FASB added guidance around the probable-to-complete threshold. Specifically, the probable-to-complete recognition threshold is not met until significant uncertainty associated with the development activities of the software has been resolved.
Significant development uncertainty exists if either of the following factors is present:
- The software has novel, unique, unproven functions or features, or technological innovations that have not been resolved through coding and testing.
- The significant performance requirements of the software have not been identified, or the identified significant performance requirements continue to be significantly revised.
Once the significant development uncertainty has been resolved, an entity would begin capitalizing software costs.
The FASB indicated that it expects that more costs will be expensed for the development of software sold as part of a cloud computing arrangement. This is because the additional considerations around the probable-to-complete threshold could cause the significant development uncertainty not to be resolved until relatively late in the development process.
Website Development Costs
ASU 2025-06 supersedes ASC 350-50, which provided guidance around the accounting treatment for website development costs. Website development costs are now integrated into the broader framework for internal-use software under ASC 350-40.
Changes to Disclosures
ASU 2025-06 specifies that all entities must apply the property, plant, and equipment disclosure requirements under ASC 360-10 to all capitalized software costs accounted for under ASC 350-40, regardless of how the costs are presented in the financial statements. These disclosures include the capitalized internal-use software balance and accumulated amortization at the balance sheet date, the amortization for the period, and a general description of the method used in computing amortization.
Effective Date and Transition
ASU 2025-06 is effective for fiscal years beginning after December 15, 2027, and interim periods within those years. Early adoption is permitted.
Entities may apply the guidance using a prospective, retrospective, or modified transition approach.
Retrospective approach – Record a cumulative effect adjustment through retained earnings as of the beginning of the first year after adoption.
Modified prospective approach – (1) prospective application to software costs incurred on new projects and software projects in-process as of the adoption date; and (2) a cumulative effect adjustment through retained earnings for any in-process project capitalized costs that do not qualify for capitalization under the amended guidance as of the adoption date.
