Capitalization of Software Development Costs: A Survey of Accounting Practices in the Software Industry

Software companies are required by SFAS No. 86 to capitalize certain development costs of software to be sold, leased or otherwise marketed. Capitalization occurs once technological feasibility has been reached and costs are determined to be recoverable. Capitalization ends and amortization begins when the product is available for general release to customers. These guidelines provide a great deal of flexibility to management in determining " technological feasibility " and amortization parameters. Differences in management philosophy and judgment in dealing with the requirements of SFAS No. 86 can have a significant impact on both earnings and operating cash flow. In this report we examine how these differences impact reported financial performance and hurt comparability across companies in the software industry. The Georgia Tech Financial Analysis Lab conducts unbiased stock market research. Unbiased information is vital to effective investment decision-making. Accordingly, we think that independent research organizations, such as our own, have an important role to play in providing information to market participants. Because our Lab is housed within a university, all of our research reports have an educational quality, as they are designed to impart knowledge and understanding to those who read them. Our focus is on issues that we believe will be of interest to a large segment of stock market participants. Depending on the issue, we may focus our attention on individual companies, groups of companies, or on large segments of the market at large. A recurring theme in our work is the identification of reporting practices that give investors a misleading signal, whether positive or negative, of corporate earning power. We define earning power as the ability to generate a sustainable stream of earnings that is backed by cash flow. Accordingly, our research may look into reporting practices that affect either earnings or cash flow, or both. At times, our research may look at stock prices generally, though from a fundamental and not technical point of view. RESERVED. The information contained in this research report is solely the opinion of the authors and is based on sources believed to be reliable and accurate, consisting principally of required filings submitted by the companies represented to the Securities and Exchange Commission. HOWEVER, ALL CONTENT HEREIN IS PRESENTED "AS IS," WITHOUT WARRANTIES OF ANY KIND, EXPRESS OR IMPLIED. No data or statement is or should be construed to be a recommendation for the purchase, retention, sale or short-sale of the securities …