Research Update: Software Capitalization and Amortization.
Software Capitalization and Amortization is complicated and frequently handled incorrectly.
First, a little background. The Financial Accounting Standards Board (FASB) has a rule, FAS 86: "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". The rule pertains primarily to high tech companies that develop software. According to the rule, all development costs are expensed (i.e. taken in the quarter that they occur) until the product is technologically feasible. But what does technologically feasible mean? Many companies (and most prominent companies) argue that the software is tehnologically feasible when it is ready to ship. So they expense all
of their development costs and they do NOT capitalize software development.
Other companies argue that after a prototype or beta product is complete, technological feasibility has been established. Then all further development is capitalized. For these companies, the development costs are amortized over the life of the product (usually a very short period for software products). TAVA has chosen to capitalize much of their software development costs.
Recently, FASB received a request from the Software Publishers Association (SPA) to reconsider FAS 86. Quoting: "The SPA wants to have these costs expensed as research and development because the application of the existing standard is inconsistent, and the financial reporting arising from the capitalization of such costs is
unreliable." nysoft.com
(Note: The SPA includes Microsoft, Netscape, Borland, and many other software companies: spa.org
Because of this inconsistent use and "unreliable financial reporting", investors usually prefer companies that do NOT capitalize software. Since there is a choice, heavy capitalization of software development is commonly referred to as "aggressive accounting". The accountants hate this term, but investors are concerned about the future impact to earnings. For TAVA, the Company currently has $3,673,000 in software development costs to write off. This amortization should occur over the next seven quarters!
But another aspect of the rule is relevant to TAVA. If the "useful life" of the product is less than 2 years, all development costs should be expensed. NOTE: "useful life" in this sense is an accounting concept. Any technical / market argument about whether or not Y2K work extends beyond Jan 1, 2000 is moot. For PlantY2KOne, the useful life is now less than 2 years, therefore all development costs should be expensed. However, TAVA capitalized $306,000 in development costs last quarter and this appears incorrect.
Both ACLY and DDIM correctly modified their software capitalization and amortization this year with significant impact to their bottom line. TAVA should be next. |
