What is internally developed software?
Internally developed software (IDS) is software that is either:
- developed internally by a Commonwealth entity (entity), or
- purchased and then significantly modified by an entity for internal use.
Internal use is where there is no substantive plan in existence, or being developed, to market the software externally during the software’s development. Software held for sale should be accounted for under AASB 102 Inventories or AASB 5 Non-current Assets Held for Sale and Discontinued Operations (see paragraph 3 of AASB 138 Intangible assets (AASB 138)).
Example:
Systems Application and Product (SAP) financial management information systems are designed and modified by SAP and, therefore, are unlikely to meet the IDS definition.
Recognition of internally developed software assets
Intangible assets are identifiable non-monetary assets without physical substance. An intangible asset must only be recognised if it meets the definition and recognition criteria in AASB 138 (paragraphs 11-17 and 21-23 respectively).
The definition criteria for intangible assets require that the ‘asset’ is:
- identifiable, that is, it can either be separately sold, rented or exchanged, either individually or together with related assets or liabilities, or arises from contractual or other legal rights, and
- provides future economic benefits controlled by the entity.
Generally, IDS are intangible assets accounted for under AASB 138. In limited circumstances, if the IDS is part of a larger asset that has a significant physical component, and the larger asset could not operate without the software, then AASB 116 Property, Plant and Equipment applies and the IDS must be treated as property, plant and equipment (see paragraph 4 of AASB 138).
Example:
Computer software for a computer-controlled machine that cannot operate without that specific software, is an integral part of the machine and is treated as property, plant and equipment.
Capitalisation of IDS costs
Under AASB 138, the generation of IDS is separated into 2 phases (see paragraphs 8 and 52 of AASB 138):
- research phase - includes activities aimed at obtaining knowledge, evaluating alternatives and making selection decisions. In the research phase, all costs are expensed when they are incurred and cannot be capitalised (see paragraph 54 of AASB 138).
- development phase - includes activities that relate to design, construction, build and testing prior to the software asset being available for use.
- Costs incurred during the development phase are only capitalised if they meet the requirements set out in paragraphs 21 and 57 of AASB 138. Paragraph 57 of AASB 138 requires entities to demonstrate that they will be able to complete development of the IDS and then sell or use the asset.
- Under paragraph 66 of AASB 138, IDS costs in the development phase that may be capitalised comprise all directly attributable costs necessary to create, produce and prepare the asset to be capable of operating as intended.
If an entity cannot distinguish the phase in which a project-related cost was incurred, then the expenditure is treated as if it were incurred in the research phase and must be expensed (see paragraph 53 of AASB 138).
Practical guidance:
Paragraph 57(c) of AASB 138 advises that an intangible asset arising from IDS development is to be recognised if, and only if, an entity can demonstrate the ability to use or sell it. It is recommended that entities focus on the ability to use the software asset rather than sell it because paragraph 57(d) of AASB 138 advises that entities are not required to demonstrate the existence of a market but must demonstrate the usefulness of the intangible asset.
As assets are initially measured at cost, entities require sufficiently robust costing systems to ensure costs can be reliably measured.
Example:
Entity costing systems need to be able to measure the employee benefit costs attributable to the cost of IDS development. Items such as employee ‘on costs’ should be reasonable and there should be no profit margin. If employees are working on multiple projects, costs must be able to be evidenced as being directly attributable to the specific IDS.
Practical guidance:
A level of professional judgment is required in the determination of costs as ‘capital’ or ‘expense’. It is advisable that entities consult the relevant finance/accounting team and their auditors (where appropriate) for guidance.
Paragraph 71 of AASB 138 disallows costs that have previously been expensed from being capitalised at a later date.
Practical guidance:
If an item has been classified as an expense in error, it can be subsequently capitalised during the same financial year, provided the recognition criteria in AASB 138 were met when the error occurred.
Accounting for IDS after initial recognition
AASB 138 and section 17 of the Public Governance, Performance and Accountability (Financial Reporting) Rule 2015 outline requirements for ongoing measurement of IDS after initial recognition.
Practical guidance:
AASB 138 refers to the term ‘amortisation’ which, in effect, has the same meaning as ‘depreciation’.
AASB 138 requires reference to an ‘active market’ for fair value measurement to apply. Under most circumstances, it would be highly unusual for there to be an ‘active market’ for IDS. Therefore, it is unlikely that IDS will be measured at fair value.
Following completion and implementation of IDS, subsequent expenditure that only maintains the benefits expected from the asset should be expensed. Additions to intangible assets should only be recognised when both the definition and recognition criteria of AASB 138 are met (paragraphs 8-17 and 21-23 respectively).
IDS is 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 (AASB 136). Entities are required to perform an annual assessment of impairment indicators for IDS held at cost in accordance with paragraph 9 of AASB 136.
Entities must:
- test for impairment annually intangible assets not yet available for use
- test initially recognised intangible assets for impairment before the end of the current annual period.
Disclosure requirements
Paragraphs 118-128 of AASB 138 set out disclosure requirements for intangible assets.
Budget implications
The following table illustrates the impact on budget aggregates at the research and development phases of IDS and for subsequent impairment.
| Transaction | Fiscal Balance | Underlying Cash Balance |
|---|---|---|
| Worsen (operating expenses reduce net operating balance) | Worsen (payments for employees and services are treated as an operating cash outflow) |
| Worsen (due to movement in non-financial assets (NFAs)) | Worsen (investments in NFAs are treated as a cash outflow) |
| Worsen/Nil impact (nil impact if no additional expenditure at this stage, otherwise same as above) | Worsen/Nil impact (nil impact if no additional cash outflow at this stage, otherwise same as above) |
| Nil impact (no impact on net operating balance from operations or NFAs) | Nil impact (no cash inflow/outflow) |
