Under current U.S. Generally Accepted Accounting Principles (GAAP), the treatment of internal-use software development costs is determined based on the specific stages of the development process. In the preliminary project stage, activities such as planning, evaluating alternatives, and determining feasibility are considered, and all costs incurred during this stage are expensed. During the application development stage, activities include designing the software, coding, installation, and testing. Costs directly related to development, such as fees paid to third parties, payroll for employees working on the project, and interest costs, are capitalized, while training and data conversion costs are expensed. Finally, in the post-implementation or operation stage, which focuses on training and maintenance, all costs are expensed. This stage-based approach is detailed in ASC 350-40, "Intangibles—Goodwill and Other—Internal-Use Software."

In October 2024, the Financial Accounting Standards Board (FASB) proposed updates to this guidance to better align with modern, non-linear software development practices, such as agile and iterative methods. Proposed ASU Targeted Improvements to the Accounting for Internal-Use Software.pdf The proposed changes include eliminating references to sequential development stages and introducing revised criteria for capitalization. Under the proposal, costs would be capitalized once management authorizes and commits to funding the project, and it is probable that the software will be completed and perform its intended function. If significant development uncertainties exist, such as novel or unproven functionalities, the guidance suggests these costs should be expensed until the uncertainties are resolved. Additionally, the proposal requires presenting cash outflows for capitalized internal-use software costs as investing activities in the statement of cash flows to enhance transparency.

The proposed changes offer several advantages. They align better with contemporary software development practices, making the guidance more relevant and easier to apply. Enhanced transparency through improved financial statement disclosure provides stakeholders with clearer insights into software development costs. Simplifying the capitalization process by focusing on management's commitment and project completion likelihood reduces complexity.

However, the proposal also has potential drawbacks. It requires increased judgment to determine the probability of project completion and assess development uncertainties, which could introduce subjectivity and inconsistencies. Organizations may face implementation challenges as they transition to the new criteria, potentially requiring changes to internal processes and controls. The emphasis on resolving significant uncertainties before capitalization could also result in more costs being expensed, affecting financial metrics.

The proposed Accounting Standards Update is expected to be finalized in February 2025.