Aimee

Hi everyone and welcome to our latest episode of RSM Audit Unlocked. We're really excited to have you here today. We're at Felons in Brisbane in a very sunny location. I'm Aimee, I'm a partner at the Melbourne office. 

Jess

And I'm Jess, a director in the Brisbane office. 

Aimee

Today we're diving into one of those questions, where it depends. So those typical accounting questions, that aren’t black and white.

This is around, should you expense or capitalise your software development costs? This decision can have a major impact on your financial statements, have an impact on investor perception, and even your tax bill. 

Aimee

So let's get started with the essentials. So software development costs, these can either be expensed immediately in your P&L or capitalised as an asset in your financial statements on your statement of financial position. This can make your financials look very different and it all depends on where the project sits. Is it in the early-stage research phase or is it in the development phase later down in the project? The rules are grounded by SSB 138 intangible assets and it's no joke. It can be quite complex and there's a lot of criteria that you have to meet. And before we go any further, don't forget R&D tax incentives. we're not going to cover those today. That's a whole new separate session, but these can actually save companies thousands on the tax bill and provide really good cash incentives for early-stage companies.

Jess

You'll find a link into some more detail on that in the article that we have written accompanying this episode. 

Aimee

Jess, let's break this down. What are the differences between research and development costs? 

Jess

I'm glad you asked me, Aimee. Research costs should always be expensed. This includes things such as feasibility studies, brainstorming sessions, exploring tech options. Basically, if there's no clear benefit yet, straight to the P&L.

Development costs on the other hand, well here's where it gets really interesting. If your project ticks all the right boxes, then you might want to consider capitalising. 

Aimee

Interesting. So we talk about ticking those boxes in line with the accounting standards. What is the criteria that companies need to meet before they are capitalising those costs as development costs? 

Jess

Great question. There's five key points that need to be considered. So one being has a technical feasibility study being performed? Two, is there an intent to complete or use the asset at the end of the day? Three, will the asset actually be able to generate future economic benefit to the client? Four, is there adequate resources to develop it in its first part? And five, is there a way of reliably measuring the costs? And that's the one we find a lot of companies get caught up on a little bit.

But basically, if you hit all five boxes, you can capitalise. If you're not hitting one, you're expensing.

Aimee

We're going to go into some quickfire questions, so get ready. What is the impact on the financial statements of this topic? 

Jess

So expenses lowers your profit today, but it keeps the balance sheet clean. It also means you're not looking at impairment considerations, et cetera. Whereas capitalisation boosts your assets and smooths out your expenses as you advertise it over a period of time. 

Aimee

So how does this affect your taxes? Always a very important question for companies. 

Jess

It's one of my favourite sections of a file tax. So expensing gives you an immediate tax deduction, whereas capitalising defers them. Timing can be especially important if you're managing cash flows from this perspective.

Aimee

Brilliant. So I see a lot of companies capitalising internal development costs. Can this be done? 

Jess

Yes, it can. As long as it meets the five criteria we spoke about before. And you're thinking about custom internal tools that can be used and long-term value to the business. And that's really that point around technical feasibility and ability to generate future economic benefit that you're trying to prove up with that.

Aimee

Do companies need to keep detailed records? 

Jess

You know they do. So really important to make sure there's an auditable paper trail. We're talking contracts, time sheets, project milestones. Make sure it's there. 

Aimee

So as you will notice from all the other episodes we've done, we really love a good checklist. So what is the audit ready checklist for this specific area? 

Jess

The audit survival checklist, Aimee.

One, have you got a written capitalisation policy? Two, have you got detailed costs documented? So you're making sure, like we just said, you've got supporting information behind the costs. Three, is there an amortisation schedule? And as we noted in session two, does that actually tie back to the financial statement support, trial balances, et cetera?

Aimee

Register, we will love a good register which ties back and details all of the projects. 

Jess

That's it and I think the other point is and this is one that you need to work with your project managers on is making sure you've got a clean project timetable with milestones set out. So we're wanting to keep it clear, keep it clean and avoid audit pain. 
 

Aimee

Great. So lastly we always love a good hot tip as well in addition to these checklists so give us some of your hot tips of what companies can do when they're capitalising software development costs. 

Jess

So number one, make sure you're not waiting until the end of the year. Capitalisation consideration should be a live decision so that at year end, there's no surprises. If you're not tracking from the start, you could be setting yourself up for a mess. The second point I'd like to raise is around, you know, ensuring you're tracking your time. So a lot of these capitalised costs actually relate to capitalised time from your staff. So ensuring that you've got the right systems in place and controls around tracking the time and allocating against project milestones is really key. 

Aimee

Have they got clear time sheets in place? 

Jess

Yes, with approvals. 

Aimee

Yeah, approvals and do the rules actually meet what they you would expense as being capitalised as well? 

Jess

Correct, yeah.

Number three would be considering the continuous development blur. So if you don't have those really clear milestones, it can be really difficult to keep track of what's the research phase, what's the development phase. It might mean you end up under capitalising or over expensing. And I think that's a really key point for people to consider. 

The fourth one is your favourite, registers. We need a live capex register. That's our best friend at all times. And it just helps prove that you've applied your judgment and you've not just made up post-30

June what should be capitalised versus what should be expensed. 

Aimee

That's definitely one of my favourite recommendations I provide to clients at the end of an audit. 

Jess

But yeah, making sure I suppose that register is keeping track of the date you've capitalised something, the project description that the cost relates to. What phase of the project you're up to. And then, making sure the amortisation schedule sort of works through as well from there. 

The next point I've sort of thought about would be around separating enhancements from maintenance. So, you might hear your technical or your development team call it “sprint work.” Making sure the finance team needs to know sort of what is maintenance and what is value add time. Enhancements can often be capitalised, but if you're fixing bugs and doing minor upgrades, it's not going to be a capitalised item. 

Aimee

Well, I feel like that covers all of the main topics around this area today. So understanding whether to expense or capitalise software development costs is definitely more than a tick the box exercise. It's a strategic decision that affects everything, including from investor perception and even your tax return.

If you've got any questions on the back of this episode, please feel free to reach out to myself or Jess. We would really love some more questions. This is actually our last episode in the series, but we will be back for some more exciting topics, getting into some more juicy technical topics. So please let us know what you would like to hear more about. 

If you found this episode helpful, please do share. We'd really appreciate that. So thank you for tuning in. See you next time.