Accounting Guidance Note No. 2007/1

Accounting Guidance Note No. 2007/1 Accounting guidance notes are intended for use by Australian Government reporting entities covered by: S49 of the Financial Management and Accountability Act 1997; or Clause 2 of Schedule 1, of the Commonwealth Authorities and Companies Act 1997. The aim of the accounting guidance notes is to provide non-mandatory explanation and examples relating to the interpretation and application of Australian Accounting Standards and the Finance Minister s Orders to the above entities. Accounting for Internally Developed Software Purpose To provide guidance on what costs can be capitalised for internally developed software intended for internal use. Target audience This guidance note applies to Australian Government entities who internally develop software for internal use. Applicable accounting pronouncements AASB 138 Intangible Assets. AASB 116 Property, Plant and Equipment. AASB 136 Impairment of Assets. Interpretation 132 Intangible Assets Web Site Costs. Definitions used Internally developed software is software developed by the entity, or that is purchased by the entity but is significantly modified, for internal use. Intangible assets are identifiable non-monetary assets without physical substance. Page 1 of 6 Accounting Guidance Note 2007/1

Internal use is where there is no substantive plan is in existence, or being developed, to market the software externally during the software s development. Key points Is internally developed software accounted for under AASB 116 or AASB 138? 1. Internally developed software is an intangible asset and would be accounted for under AASB 138 unless it is a component of an asset that has a significant physical component, such that the asset could not operate without the software. For example, computer software for a computer-controlled machine tool is an integral part of the related hardware and is treated as property, plant and equipment. The same applies to the operating system of a computer which should be accounted for under AASB 116. What costs can be capitalised? 2. AASB 138 divides the development of internally developed software into two stages, a research stage and a development stage. All costs incurred during the research stage are expensed when they are incurred. Costs incurred during the development stage are capitalised if they meet the requirements set out in AASB 138, otherwise the costs are expensed. 3. The research stage includes activities aimed at obtaining knowledge, evaluating alternatives and making selection decisions. 4. The development stage includes activities that relate to design, construction and testing prior to the asset being available for use. 5. There are specific additional requirements to be met for internally generated assets before development costs can be capitalised, these include: it is technically feasible that the intangible asset will be completed so that it will be available for use; it is the intention to complete the intangible asset and use it; the entity has the ability to use the intangible asset; it can be demonstrated that the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset; there is adequate technical, financial and other resources to complete the development and to use the intangible asset; and the expenditure attributed to the intangible asset during its development can be measured reliably. Page 2 of 6 Accounting Guidance Note 2007/1

6. The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management during the development phase. 7. The following are examples of development costs that can be capitalised: staff time (including project managers) directly related to developing or testing the asset in the development phase; contractor and supplier expenses involved in the development and/or testing the asset; depreciation of software licences and computers specifically required to develop or test the asset; the costs of data migration but only for test data used for system testing; and initial pilot system to test feasibility prior to developing the final system to be capable of being used by the entity. 8. Entities are required to have sufficiently robust costing systems to ensure these costs are reliably measured. 9. The following are examples of costs that are considered to be operating expenses and should not be capitalised: staff time not directly related to the project for example attending training; stakeholder meetings; training and developing user manuals; post implementation reviews; data migration outside of system testing; project governance committees; and administration costs not directly related to development. 10. See Attachment A for a table providing examples of project cost allocation. 11. AASB 138 disallows costs that have previously been expensed to be capitalised at a later date. 12. Another example of a cost that cannot be capitalised is the inefficiencies in development (e.g. if an agency developed a system to provide functionality of xyz, however a later decision decided to abandon the work on z, the costs related to z could not be capitalised). Page 3 of 6 Accounting Guidance Note 2007/1

Depreciation and impairment 13. Internally developed software is carried by the entity at cost and amortised generally on a straight line basis over its useful life in accordance with AASB 138. 14. The internally developed software is also subject to impairment (write-down) if the economic benefits of the system are unlikely to be realised in accordance with AASB 136 Impairment of Assets. 15. The internally developed software is impaired when the recoverable amount of the asset is less than the carrying amount. The difference is then recognised as an impairment loss. 16. AASB 136 considers the present value of estimated future cash flows from continuing use of the software, which is the recoverable amount. Future economic benefits flowing from an intangible asset may include revenue from the sale of products or services, cost savings, or other benefits resulting from the use of the asset by the entity. Disclosure requirements 17. Disclosure requirements are detailed in AASB 138 paragraphs 118 to 128. Budget implications 18. The following table illustrates the impact on budget aggregates at the research, and development stage and for impairment: Research stage - expensing Development stage capitalising (Work in Progress / Asset under Construction) Capitalised as an operational / depreciable asset Impairment write down of the asset FISCAL BALANCE Nil impact UNDERLYING CASH BALANCE Nil impact Page 4 of 6 Accounting Guidance Note 2007/1

Illustrative example Illustrative example - Expense or capitalise? Information: An entity develops a new IT software programme to record customer details. The entity incurred the following costs to develop the new software: (a) (b) (c) (d) (e) (f) (g) $5,000 consultant fees to search and evaluate off the shelf systems; $2,000 in employee expenses to select the final off the shelf system; $3,000 in employee expenses to design the changes required to the off the shelf system; $10,000 in employee expenses to construct and test the new software; $5,000 for new terminals to replace old terminals that did not have the capacity to handle the new software; $500 to promote the new software to staff; and $2,000 in training staff to operate the new asset. Answer: Assuming that the requirements to capitalise have been met. These costs would be treated as outlined below: (a) (b) (c) (d) (e) (f) (g) expense $5,000 consultant fee as it was incurred in the research stage; expense $2,000 employee expenses to select the final off the shelf system; capitalise $3,000 employee expenses to design changes required to the off the shelf system; capitalise $10,000 employee expenses to construct and test the new system; recognise as property, plant and equipment $5,000 new terminals; expense $500 to promote new software to staff; and expense $2,000 training of staff to operate the new asset. Contacts Questions or comments about this Guidance Note should be addressed to Accounting Policy Branch at accountingpolicy@finance.gov.au Page 5 of 6 Accounting Guidance Note 2007/1

ATTACHMENT A Examples of Project Costs Allocations EPENSE SOFTWARE CAPITAL (AASB 138) PLANT & EQUIPMENT CAPITAL (AASB 116) RESEARCH STAGE Consultants Fees Staff Costs DEVELOPMENT STAGE Off the shelf System Consultants Fees Design & Construction Equipment Other (printers, PC s, etc) Data Migration (outside of system testing) Staff Costs - Development Staff Costs - Testing IMPLEMENATION STAGE Training - Staff Costs Promotional Costs Manuals Page 6 of 6 Accounting Guidance Note 2007/1